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Total System Services, Inc. (NYSE:TSS)

Q2 2014 Earnings Conference Call

July 22, 2014 5:00 PM ET

Executives

Shawn Roberts – Senior Director-Investor Relations

Philip W. Tomlinson – Chairman and Chief Executive Officer

M. Troy Woods – President and Chief Operating Officer

Paul M. Todd – Senior Executive Vice President and Chief Financial Officer

Analysts

David Togut – Evercore Partners Inc.

Glenn T. Fodor – Autonomous Research US LP

Georgios Mihalos – Credit Suisse

Ashish Sabadra – Deutsche Bank AG

Darrin D. Peller – Barclays Capital

Brett Huff – Stephens Inc.

Jim Schneider – Goldman Sachs

James Friedman – Susquehanna Financial Group

Tulu Yunus – Nomura Securities International, Inc.

Operator

Good afternoon. At this time, I would like to welcome everyone to the TSYS 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 your host, Mr. Shawn Roberts, Senior Director of Investor Relations. Mr. Roberts, you may begin.

Shawn Roberts

Thank you, Shinelle and welcome, everyone. On the call today, our Chairman and CEO, Phil Tomlinson will begin with his opening remarks. Our COO, Troy Woods, who will provide business highlights on our four segments. And then, turn it over to our CFO, Paul Todd, who is going to review our consolidated financials. And as usual after that we will open it up for Q&A.

I would 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 would like to introduce TSYS' CEO, Phil Tomlinson.

Philip W. Tomlinson

Thank you, Shawn and good evening everybody. We have been on our best behavior tonight because one our directors is here, Bill Isaac, who I’m sure a lot of you know. We’re thrilled that Bill was here with us and Bill we’re going to try and make us proud so, bear with us.

I just want to take a few moments and make a comment or two regarding the June 23 press release announcing my outcome and retirement here at the end of the month. At this transition, really as a result of a carefully developed long-term succession planning process and we believe the passing of the torch has been and will be seamless the fact that you all know we’re uncomfortable with Troy makes that even easier for us.

I’ve been talking to friends and families since the announcement, realized several things first over my tenure as CEO of – lot of very bright sale and buy-side analyst and investors. They have been very, very instrumental to our long-term market success. And I appreciate that very much, fortunately you have had the opportunity to Internet, with most all of you in many different venues and I have to say, I’ve enjoyed every minute of it. I’ll cherish the relationships that you have with our company and trust all of you will continue to see TSS as a good company that you want to own. Second, as I start thinking about my potential retirement a couple of years ago, you always find out that there is always is a few things that you want to do or that you have a bucket list of a few issues. And the first thing was I want to try to get TSS back to a growth story through new client wins and total revenue growth, developing and bringing new products to market faster and better and building a stronger and more skilled acquisition capability and I think we’ve done all of those things.

Also as I have talked to many of you, you know it was important to me personally to do everything possible to get the BoA business back, the Bank of America business back to TSS, it was a heartbreaker in 2005 when they left and that’s a relationship that we are incredibly proud of, so I’m very happy about that. And certainly maybe and no doubt about it, maybe the most important is to increase shareholder return in a meaningful way.

I’m thrilled that we have a very skilled management team and a passionate smart TSS team and they have made all of this possible and I think as you go see a lot more of it you have not dreamed of. Thank you all of you for your support. I would like to again thank the entire TSS team for theirs. I’m confident in Troy’s ability to lead TSS as our new CEO and also I’m thrilled that Paul Todd is our new CFO and trust that you support them and listen to them as you have me over the years.

I told you several years ago that the story of Sunday afternoon, dinner when my mother would come around to me and my three brothers and tell us the hold on to your fork and when she said that we knew that we had some good dessert coming, some pie or cake or something and so we always knew there is something big and better was coming along. And so I’m telling you today again to hold on to your fork, because I truly believe that best of TSS is yet to come. So with that thank you and now I would like to turn the call over to Troy Woods for more color about our second quarter.

M. Troy Woods

Thank you, Phil. I appreciate very much for your very kind and thoughtful comments about me and the team and I would be absolutely total remised if I did not take this opportunity to thank Phil for his extraordinary leadership as well as his vision and passion for TSS. As Phil indicated he officially retires July 31 as CEO and what many of you may not realize is July 31 will also be his 40th anniversary with this company. And it would truly be impossible to calculate or quantify the positive impact Phil has had during his career on TSS, our team members and clients around the world. We are truly blessed to have had his leadership during some of our most challenging and exciting growth periods and I know we will benefit from his contribution far into the future.

So Phil all the best to you and your family and may the win continue to be at your back. We will miss you.

Philip W. Tomlinson

Thank you.

M. Troy Woods

We will miss you. Just as we have seen with the transition of our CFO responsibilities from Jim Lipham to Paul Todd I predict the transition of midst and executive responsibilities from Dan Henry to care us and CEO responsibilities from Phil to me will also be seamless. And this all made possible because of 10,000 plus team members with a passion for our customers, the business, and a drive to win which differentiate us in the marketplace. These team members truly do make it all happen.

Now let me quickly review some of the highlights for the second quarter as it was an incredibly busy and productive one. Consolidated total revenues were up 30.4% to $602 million. Our first time ever over $600 million on a quarter, adjusted EPS was up 19.8% to $0.45 per share. Adjusted operating margin for the quarter was 24.94% an increase of 357 basis points, over last quarter.

During the quarter we repurchased 3.7 million shares of our stock for a total spend of $115.7 billion. We completed the exit of our Japanese businesses which included the divestitures of our issuer processing business and our 54% stake in GP net. We achieved the highest number of accounts on file on our history, for the North America and International segments. We also say transaction volume records in the North America and International segments as well as our SCS business and our merchant segment.

As always nice to be recognized for your hard work and dedicated service, and we were fortunate we recognized in the second quarter for several awards and recognitions. Earlier this quarter, we were honored by Visa for Superior Service Quality in the area of issuer processor our authorizations, receiving two quality performance awards. Tonight in Washington D.C., we are receiving the Financial Services Roundtable 2013, corporate social responsibility leadership award.

I might add the TSYS is the only payments company being recognized by the financial services roundtable. Both are great recognitions and we are proud and honored to have been recognized. And finally, and probably most importantly all four segments expanded their adjusted operating margin sequentially from the first quarter as well as TSYS on a consolidated basis.

Now I’d like to turn your attention to each of our four reporting segments for additional color on their respective performance for the second quarter. I’ll begin these reviews with the North America segment which begins on Slide 6. The North America segment produced year-over-year quarter revenue growth of 8.7% for a total of $233.2 million, this is the second largest year-over-year quarter increase in five years only surpassed our last quarters 9.1% increase.

The 8.7% revenue growth for the quarter was primarily result of higher transaction and account file volumes. But we also experienced increases in revenue from fees and services associated with data retention, messaging, loyalty processing redemption and rebates, managed services and fraud related services. This quarterly growth rate also includes the grow-over of the Chase licensed revenue which anniversaried the beginning of this quarter. The North America adjusted operating margin was 36.3% a 310 basis points sequential improvement over the first quarter.

On the business development front, we signed new agreements in the community and regional bank space with Nicole bank and People’s Bank of Alabama. As well as extended contracts with Barclays Bank and First-Citizens Bank & Trust.

On the conversion front during the quarter, we converted approximately 5 million accounts made up of existing client portfolio acquisitions and that brings our last 12 months converted accounts to approximately 17 million.

As we stated last quarter, we have 91 million accounts scheduled for conversion in the third quarter. A tremendous amount of thesis and client work is underway as we diligently move toward these conversions. We do expect decisions around final conversion dates to be completed soon and these decisions could affect the current conversion schedules. Leave our client sensitivity around providing specific conversion dates we will no longer provide specific conversion dates for any of our converting customers.

So based on where we are in these processes and what we know at this time our corporate guidance remains unchanged. We are also guiding our revenue growth for the North America segment to be in the 8% to 10% range for the year and adjusted operating margin for the year to be in the 34% to 36% range. We are continually encouraged with the robust account and volume growth of the North America segment.

The phase of credit card direct mail offers in the United States was up 7% last quarter to $992 million and the recent JP Morgan Chase and Cap One card growth announcements were also encouraging data points for the sector. All in all, it was another very good quarter for the North America segment.

I would now like to review the international segment on slides 8 and 9. Last quarter I mentioned that the first quarter was a very difficult comparison quarter with the number of moving parts. I am pleased to report that the second quarter results are much better and reflect the continued focus on positioning the segment for sustainable revenue and profit growth.

Revenues for the quarter were $84.7 million, about 10.6% over the second quarter of 2013. Again, just as in the first quarter revenues were positively affected by movements and the exchange rate. For the second quarter this amounted to $6.7 million. On a constant currency basis overall revenues for the quarter were up 1.8%.

Our top line growth profile continues to be adversely affected as we close lower margin businesses. Also during the quarter we experienced lower client project revenue as our customers have delayed some projects to later in the year. However, we did note an uptick in new project revenue in June and we believe this trend will continue for the remainder of the year.

Adjusted operating income for the quarter was $11.7 million, resulting in a 13.9% adjusted operating margin compared to 10% for the same quarter last year. We anticipate the margin will continue to expand through the remainder of the year as we drive additional efficiencies across the segment and we also remain confident in reaching our margin improvement build for 2015.

Our account growth for the quarter was primarily driven by our commercial, single use commercial and debit accounts as we continue to board new customers on to the TSS platform. Our business development activities are continuing to gain momentum as well. This quarter we supported an international launch for a major commercial product issuer for single use accounts for the travel sector.

We are currently working on three conversions and three program launches that will deliver approximately 3 million new consumer and commercial accounts over the next 24-months. We continued to win in the marketplace and retain clients against tough competition as evidenced by a newly signed managed services agreement to support a new client in the UK.

And finally, a new letter of intent was received this quarter to process for a major new high street retail bank brand, that includes credit and debit card processing as well as back office managed services.

Our review of the merchant segment begins on slide 10, the merchant segment revenues were $108.3 million, down 4.1% for the quarter compared to the second quarter of 2013. Well, we are very pleased with the growth performance from our direct CPay joint venture and ProPay businesses, our growth from our legacy TSYS Merchant Solutions Group was less than expected for the quarter.

In spite of setting a record this quarter for SBS sales volume, we were not able to translate this volume growth into comparable revenue growth. Several factors contributed to the sluggish direct TMS revenue growth. One, the projected organic growth rate for our national managed account portfolio is running below expectations. Two, the number of net merchant locations added are also running below expectations. And three, there were a few one time challenges on the months subsequent to our back end conversion, which has negatively impacted revenue. These areas have clearly presented some headwinds for our direct business and we are aggressively addressing each one of them.

And the area of new business development for our direct business, during the quarter we signed three new large national accounts and two large notable healthcare system providers, which will further expand our reach into the healthcare sector.

We also signed over 30 new value added resellers, financial institutions and referral partners, which will act as a feeder source for new merchant leads down the road. Now, some commentary on our indirect business, even though our indirect business has exceeded plan for the two straight quarters, it will continue to be a full on the segments overall revenue growth profile, the reasons we have addressed in previous quarters.

For example, last quarter I indicated that clients would probably pay us approximately 35% less in 2014 than they paid us in 2013. However, we now believe that number will be closer to 50% less. As we have stated previously, the indirect business remains critical to the long-term success of the merchant segment and to TSYS due to the economies of scale the strong cash flow and the expanded capability set offered to both our indirect and direct lines of businesses.

During the quarter, we were able to expand our merchant segments operating margins to 30.4% versus 28.8% in the first quarter the 160 basis points improvement. Past January we guided at the merchant segment revenue would be down 1%, 2% for the full-year.

For the first half of 2014 the direct and indirect businesses have performed in opposite directions from our initial expectation, due to these movements, a mix of our business and for reasons I addressed earlier and as we shared with you at our Analyst Day meeting in May. We still expect the segments overall revenue will be down and for single-digits for the full-year over 2013. We still expect to meet our guidance range for operating margin of 31% to 33%. We will continue to aggressively address our TMS Direct business, as we remain keenly focused on organic growth, selective M&A opportunities prudent expense control.

And finally, our NetSpend segment review begins on Slide 12. NetSpend revenue for the quarter was $116.8 million up 11.4% over the second quarter of last year. The decrease in revenue from the first quarter to the second quarter is typical coming out of our tax season and you can see the same type drop off from the first quarter of 2013 to the second quarter of 2013. And even though revenue declines in the second quarter versus the first quarter we were able to increase our margin quarter-over-quarter.

Last quarter I mentioned that we were working on two very important initiatives that could have significant meaningful impact on our customer satisfaction and should also resulted in increasing the lifetime of our accounts and ultimately drive higher lifetime value. As a reminder these two initiatives are the overdraft platform migration and the shift from pay-as-you-go plans to the monthly fee plan.

We are beginning to see a leveling off and the shift from pay-as-you-go customers to our monthly fee plan to a more normal rate versus the accelerated rate we saw in late 2013 and earlier this year. For example the negative revenue impact associated with the shift declined more than 50% from the first quarter to the second quarter. This leveling of coupled with the implementation of new business previously announced, we’ll result an improved revenue growth metrics in the third and fourth quarters.

During the second quarter we added 2000 retail locations and over 80 PayCard clients bringing us to a total of 1980 trusted companies who distribute our PayCard’s to their employees. We are currently operationally focused on the launch of Western Union which is scheduled for later this quarter. And we also launched the Paychex PayCard program approximately three weeks ago and its clients are already paying their employees on our cards.

I think it is also important to note that we have already received well over 600 leads through the PayChex channel and we believe this will be a great source of new PayCard accounts in the future. We are also pleased to announce that the Brink's Company a global leader and secure logistics and respected brand to mitigate to all as partnered with NetSpend on a general purpose reloadable card it will began offering under the Brink's brand.

This endorsement is a big win for consumer payments and in particular prepaid for brand like Brink's that is enormous with trust and security. This Brink's brand and GPR card is an addition to the Brink's money payroll card that we launched last year. While the ramp-up of all of these new initiatives does require some additional upfront investments, we are still expecting our adjusted operating margin to be in the high-20s to low-30s for the year.

Prepaid customers continue to be very sawy consumers and they look for established trusted brands that they know would deliver the futures, experience and value they are looking for. And no one in the business can match our breadth and depth of trusted brands.

Trusted brands, a wealth of innovative features, preplan options, convenient places to buy and reload. It all adds up to making ours the card of choice for millions and counting, giving our cardholders the freedom to choose how, when and where they buy.

Now I’d like to turn it over to our CFO, Paul Todd for more in-depth financial review of the second quarter financials. Paul.

Paul M. Todd

Thank you, Troy. Before I dig into the consolidated operating results for the quarter, I want to highlight several things as it relates to our performance and achieving our strategic goals. First as Troy has reviewed with the segmented results for the quarter, I want to again reiterate that we have been on a transformational journey that TSS over the last several years to being a diversified payments company.

And as part of this journey, our four segments operate strategically in different markets with different growth profiles, margins, opportunities and challenges and produce different, but complimentary strategic and economic benefits to us on a consolidated basis. This quarter and the remainder of this year highlight this fact as 2014 has a lot of moving parts on a segment basis that’s somewhat balanced out on a consolidated basis.

Also its important to point out that each of our segments results for the quarter delivered against their own key segment strategic goals, first on the North America side the $18.7 million in quarterly revenue growth from last years second quarter was good progress toward our strategic goal of being the number one global provider of credit card issuer processing solutions. The work done during the quarter on the conversion pipeline also continues to deliver against that strategic goal.

Second, on the international side. During the second quarter we made considerable progress against our strategic goal of increasing international segment margins to the mid-teen. Third on the merchant segment, while we were not as successful as we would have liked in making significant progress in becoming a top ten global acquirer, we did continue work on strengthening our organic growth plans and we believe that strategic benefits of completing the back end conversion, while impacting our short term results will pay longer-term future benefits as we move toward achieving our strategic goal in the future, we will continue to refine our organic plans and look to make complimentary acquisitions in our merchant segment on a go forward basis to achieve our strategic goal in this segment.

And finally in our NetSpend segment are a 11.4% quarterly revenue growth and the recently announced new business signings of PayChex, Western Union and Brink’s made significant progress in delivering against our strategic goal of becoming the number one U.S. provider of branded prepaid solutions. While our strategic goals are important on a segment basis, they are equally as important on a collective basis as they fuel our consolidated growth and create a unique people centered payments platform and company that is unlike any other in the industry.

Now let me dive into the numbers starting on Slide 15. As we stated in our release, we are pleased with our results for the quarter with revenues before reimbursable up 34.2% or a $137.1 million for the quarter versus the second quarter of 2013. NetSpend contributed most of that with a $116.8 million in revenue for the quarter while North America had another outstanding quarter of 8.7% and our international segment was also up over the second quarter of last year coming in at 10.6% reported growth or 1.8% on a constant currency basis.

Total revenues were up a $140.2 million or 30.4% to $602 million and as Troy stated earlier, it’s the highest quarter of revenue in the company’s history. Adjusted EBITDA was a $170.9 million up 22% over last year for the quarter, bringing the year-to-date growth and adjusted EBITDA to 21.6% over last year. This year-to-date adjusted EBITDA excludes $17.6 million of stock-based comp and $2.4 million of M&A expenses related to NetSpend.

Finally, adjusted EPS from continuing operations was up 19.8% for the quarter to $0.45 compared with $0.37 for the same quarter last year. In order to avoid any confusion between liquidity and profitability measures we will use the term adjusted EPS as a profitability measure going forward instead of the adjusted cash EPS that we either use previously.

Turning to page 16, our adjusted operating margin for the quarter was 24.9%, up 357 basis points on a sequential quarter basis and driving us to a 23.2% adjusted operating margin year-to-date as shown on slide 17. We have seen some margin pressures in some of our businesses in the first half of the year, we believe the margins in the second half will improve on a consolidated level. And as we said on our last call, we still expect the adjusted operating margin on a consolidated basis to be in the range of 25% to 27% on a full year basis.

Also recall that our segments report their results on an adjusted segment operating income basis, which excludes amortization of acquisition intangibles, NetSpend M&A expenses, and corporate admin which includes stock-based compensation.

And slide 16 and 17 provide a bridge between the adjusted segment operating income for each of our segments and our consolidated adjusted operating income.

On slide 18, we provided a roll forward of our cash balance beginning with the $307 million from last quarter and ending with $251 million for this quarter with our two largest outflows being our share repurchases of $115.7 million and our CapEx of $59 million up which about 40% as related to property and equipment, 37% related to conversion activity and the remaining 23% being related to both internally developed and license software and we ended the quarter with a strong cash position up $251 million.

On cash flow year-to-date, our free cash flow was $133.7 million, up $54.9 million or 69.6%. Free cash flow was negatively impacted by $42 million resulting from our Japan exit. And as we stated in our last call, we continue to expect ongoing free cash flow to be in the range of $35 million to $37 million a month, and excluding the one time $42 million negative Japan exit impact on an annual basis, free cash flow is expected to be in the range up $420 million to $444 million a year. We also do not expect any change to our previously stated CapEx estimate up $200 million to $210 million for the full year.

Speaking of cash, while we remain optimistic about the growth opportunities of our businesses, we are also fully committed to returning excess cash to our shareholders and as we mentioned at our Analyst Day in May, and as Troy mentioned earlier, we purchased 3.7 million shares of our stock in the quarter at an average price of $31.26 for total cost of $115.7 million leaving 8.3 million shares remaining under our current plan.

We will evaluate opportunities in the second half of 2014, and could resume buyback activity in an opportunistic way at anytime. As it relates to shares at the end of June we had $185.6 million of common shares outstanding and the average basic weighted shares outstanding with a $186.4 million on a quarter to-date basis or a $187.1 million on a year to-date basis. As it relates to leverage we are comfortable with our overall current debt level and our strategy to use our capital remains the same.

We scheduled debt reduction, dividends and a balanced approach to acquisition and buybacks as use of our capital going forward. On taxes we maintain our estimated 2014 tax rate to be in the 34% to 35% range and finally as Troy mentioned earlier our full year consolidated guidance remains unchanged.

And with that we will open it for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is from David Togut with Evercore. Please go ahead with your question.

David Togut – Evercore Partners Inc.

Thank you congratulations Phil on your retirement and great success that TSS had on to your watch.

Phil W. Tomlinson

Thank you, David.

David Togut – Evercore Partners Inc.

If I could just dig in a little bit to the NetSpend results. Troy you highlighted some of the business model changes that has contributed to the slowdown in revenue growth just perhaps flush out a comment you made in the call can you address whether the revenue that NetSpend has now bottomed out at 11% and in connection with that what do you think is a sustainable growth rate for the business, with the new business model that you are pursuing?

M. Troy Woods

Thank you David. Yes couple of comments to that as it relates to the rest of this year, yes it has bottomed out and you can expect to see is that I think I mentioned in my prepared remarks at the third quarter and the fourth quarter you will see elevated growth metrics for NetSpend. And also mentioned with respect to the shift and play as you go to monthly plan we saw a significant improvement from the first quarter to the second quarter with that shift being 50% less. So, really beyond 2014 David obviously we are not going to get into the growth profile beyond that of what we have said in the past and we certainly still stand behind it that NetSpend is absolutely a double digit top line growth company for the foreseeable future.

David Togut – Evercore Partners Inc.

Got it. And just shifting over the merchant business you update us on unit pricing trends that you are seeing both in the direct and the indirect business on a year-over-year basis?

M. Troy Woods

Yes, David a couple of points there we’ve talked about that some in the past as well as the shift in going from bundle to unbundle on the couple really good point to talk about really one as it has been the case for the past several quarter the actual per unit pricing if you will for the direct business is basically unchanged there is really not a penny difference per trend between this time last year and this year. Now the mix is changed as we’ve talked about before with more unbundle business versus bundle business. But the good news is we talked coming out of the fourth quarter about some projects and initiatives that we’re initiating to try to get our arms around slowing that shift and we have seen a significant change in new business that we are signing up, we’ve seen about 12 basis points shift in new business that we’re signing up that are now bundled versus where it was towards the end of 2013. And as it relates to our plan if you will, or our expectations, we are not seeing any degradation beyond what we planned for 2014 at this moment for the bundled to unbundled shift.

David Togut – Evercore Partners Inc.

Quick final question from me, could you discuss any changes you intend to make as you become CEO of TSS?

M. Troy Woods

Well, I’m still President and COO and there will certainly be plenty of time to address that David and I appreciate that. I will share this with you at 25,000 feet, David, and I told this to our executive leadership and I told this to the board that if the board was looking for someone to turn this company upside down to change all of a strategic direction of this company and to change the culture of this company that may get the wrong guy. So we’ll make tweaks and changes, there will certainly be some changes along the way. But overall, that’s probably the best way to sum it up today.

David Togut – Evercore Partners Inc.

Congratulations on your promotion, Troy.

M. Troy Woods

Thank you, David.

Operator

Your next question is from Glenn Fodor with Autonomous Research. Please go ahead with your question.

Glenn T. Fodor – Autonomous Research US LP

Thanks for taking my question, and Phil, definitely, congratulations. I’ve pilot you guys for a long time, so good to see you are finally taking a much deserved break, and Troy congratulations to you. Paul, just on share buybacks, I mean you bought $3.7 million as of the Investor Day I believe that was account, none after that, much of the resources, because of blackout restrictions, but it doesn’t sound like you did anymore after June 30. Sorry, if I missed the texture, but could you just explain a little more on the pattern that we’re seeing on – why you’re active to a certain point and held off after that?

Paul M. Todd

Yes, Glenn, thanks for the question. I think there is no way to categorize any kind of a pattern as we’ve approached stock buybacks in the past, we look at this as it relates to acquisition opportunities and kind of balancing the opportunities set from an acquisition standpoint, and also balancing that against the buyback scenarios. And so we make decisions on those kind of opportunistic situations, and so there is no way to kind of have a linear description of exactly, why one period we did one thing, and why one period we did another thing and we’re going – as I said, we’re going to constantly evaluate the buyback opportunities in the second half of the year, but those are constantly being kind of balances, we’re looking at acquisitions. So a lot of times what we’ll do is not evident to the public, because we’re not seeing what we’re doing from an acquisition evaluation standpoint. So I think that would be kind of the commentary around that one.

Glenn T. Fodor – Autonomous Research US LP

Okay, thank you. And then Troy, on prepaid, last quarter, you guys made some comments that you are expecting some type of regulatory changes at some point and then we’re all waiting for something that handed down. But it sounds like it’s going to surround disclosures and fine print and nothing too egregious on the industry. But number one, would you concur with that assessment? And number two, if that is the case, is there – if you had to make any sort of adjustments to the model or any of your packaging on such, any material investment costs that we should be thinking about? Again, within reason of the possible scenarios? Thanks.

M. Troy Woods

Sure, Glenn. I think what I have said in the past it’s not so much that we’re expecting regulatory changes, what we’re expecting is that the CFPB and now they have come out and proactively said that they’re going to address, overdrafts and prepaid. Really to go beyond that, Glenn it would be difficult when you talk about what kind of investment we might need to take to change systems we don’t know what it is. Obviously, we have an overdraft program at that prepaid if you will know, we had it for years both from the PayCard and the GPR side. We do all things that are required of us to do and then some. And so I think we’ll just have to see what comes out of the CFPB later this year and as I understand it will have some relatively reasonable period of time to comment on that as well everybody else and probably only get that time where we get some sense of whatever they say and if it sticks what would be required at TSS, NetSpend to go make those proposed changes.

Glenn T. Fodor – Autonomous Research US LP

Thanks, Troy. Appreciate it.

Operator

Your next question is from George Mihalos with Credit Suisse. Please go ahead with your question.

Georgios Mihalos – Credit Suisse

Great, thanks for taking my question and let me add my congratulations to you both Phil and Troy. Wanted to start off on the merchant side just as it relates to the direct revenue growth. Should we be thinking of a return in direct revenues to sort of the mid-single digit range? Something more like a 4% you posted in the first quarter over the back half of the year, or will take longer?

Philip W. Tomlinson

George, the short answer is going to take longer. It will be higher than the second quarter and it will be better in the third quarter. But, it's not going to get back to that number at least for the next two quarters.

Georgios Mihalos – Credit Suisse

Okay. And then maybe just shifting gears to be the North American operation which continues to outperform. Looking at the margin profile the outlook for 34% to 36% for the full year I think you are all ready at about 35% over the first half of the year if I’m not mistaken your margin should go up over the back half of the year is there your reason why you won’t do better than the 36% or you just sort of being conservative there.

Philip W. Tomlinson

Well, you are right. You make a good observation. Obviously, you know where we’re here today as I indicated in some of my opening comments George we’re expecting some decision soon around so many of these conversions we have stacked up for the third quarter and I think just knowing where we’re today and knowing where those conversions stand, we certainly stand behind the 34% to 36% and what we’ve said and in the past that you can expect for the most part that the third and fourth quarter will be a little bit higher probably than that range.

George Mihalos – Credit Suisse

Okay. That's helpful. Just ask question from me. I know in the past, you guys had a slot in your presentations of sort of a broke out for us what the impact on the business has been from pricing and from lost business. I was wondering if you guys could update that at all for us, here, in the second quarter. Thank you.

Paul M. Todd

It’s relatively unchanged, George, from what we shared with the group earlier in the year. The good news is, both on a price compression standpoint and a lost business standpoint, both of those are about 20 plus percent improvements over 2013. And that’s pretty much what we’ve seen for the first half of this year. So, we’ll track that for the year.

Georgios Mihalos – Credit Suisse

Okay, thank you.

Operator

Your next question is from Bryan Keane with Deutsche Bank. Please go ahead with your question.

Ashish Sabadra – Deutsche Bank AG

Hi, this is Ashish Sabadra on behalf of Bryan Keane. Let me also add my congratulations to both you Phil and Troy.

Philip W. Tomlinson

Thank you.

Ashish Sabadra – Deutsche Bank AG

Just wanted to dig further on that merchant acquiring business, the direct business which slowed down. You mentioned that the national managed account portfolio as well as the net merchant locations were running below your expectations. And I was just wondering if you could provide some more color on the reasons for that and have you seen any big disruptive changes in the industry from reticulated processing or change in the distribution model, which is causing those results to be below your expectations?

M. Troy Woods

Well, not really on the distribution model at all. We did have a couple of hiccups that I mentioned in the subsequent months from our backend conversion. But, it did cost us some revenue. We also are experiencing in out national account base, a much lower organic growth rate than we had expected and anticipated, going into 2014. But, beyond that, there are no other real reasons behind the slowdown of the national account base. It might have been in the third part Ashish that you asked, but I didn’t catch it, distribution, national accounts and was there another part?

Ashish Sabadra – Deutsche Bank AG

No, just the net merchant location ads, so just on that front.

M. Troy Woods

I am sorry, I did not understand.

Ashish Sabadra – Deutsche Bank AG

No, no. I think you’ve answered my question on the direct side of the business, just quickly on the international side, it looks like FX was a good tailwind and it will continue to be a tailwind in the third quarter and the growth rates, once you anniversaried the one time items the growth rate and given all the business development activity looks like we could see a potential improvement in the growth rate. So just going back to your guidance, sort of low to mid single-digit growth for international, could we see an upside to those numbers or more towards the higher end of that range?

Paul M. Todd

I think Ashish, this is Paul. I think that it will be to the higher end of that range, if the currency benefit continues.

Ashish Sabadra – Deutsche Bank AG

Okay, that’s great. And one final question was on the North American segment and I understand given the sensitivity around the plant conversion, you don’t want to comment on the exact month. But given where you are in the process, is there any reason to believe, obviously pending the client decision, but if there any reason to believe that there could be any change in the schedule?

Paul M. Todd

Well, as I indicated earlier Ashish, that when you have got some many accounts lined up for conversion this quarter representing multiple customers. Meaning no go decisions are really in front of us here over the next very short period of time. So I think it’s probably best to leave it at that let’s see how these decisions go. But again based on what we know today, based on the conversations that we have had. We are – where we have indicated we are. So…

Ashish Sabadra – Deutsche Bank AG

Okay. It sounds good. Thanks for the color.

M. Troy Woods

Sure, thank you.

Operator

Your next question is from Darrin Peller with Barclays. Please go ahead with your question.

Darrin D. Peller – Barclays Capital

Thanks guys. Phil, we are going to miss you at the helm. But Troy, we are looking forward to having you in – although it feels like you’ve been very, very active for the last couple of years anyway. So congrats to both of you guys.

M. Troy Woods

Thank you, Darrin.

Philip W. Tomlinson

Thank you, and take it easier, Darrin.

Darrin D. Peller – Barclays Capital

Will do. All right, let’s just jump in. Look I mean on North America revenue growth, I mean just a little bit of a follow-up to George’s question, I guess, really for North America you are already at the midpoint of 8% to 10% g growth, here. Obviously, you’re adding more business in the second half of the year. And so is there any other reason – anything just to be clear – is there and reason why the 8% to 10% is not conservative giving that you are going to be adding new business as you talked about 90 million accounts on file, etcetera. Even of the timing we’re in the fourth quarter, I mean really, 8% to 10% is already where the trend is for the first two quarter, so just want to make sure we’re not missing anything in terms of conservativism here.

M. Troy Woods

No, I don’t think you’re missing anything Darrin, to be honest with you. Perhaps it maybe a little bit conservative when you look at the first half numbers and again, knowing what we know at the moment, that growth rate will absolutely be on the high-end of that range.

Darrin D. Peller – Barclays Capital

Good, okay. All right, just moving forward now, I guess with respect to the overall margin I guess also, I mean I think at the Investor Day, you had said it would be 34% to 36% for the year, but I think you would said that as these accounts roll on, they are accretive, just to be clear, I mean, it could be accretive to the margin, all right. So, the North America margin would be above 36% in the second half, if you were to get these clients rolled on in time?

M. Troy Woods

Well, there are two pieces to that, Darrin. One is what we have said is that due to all types of activity going on in the third and fourth quarter, multiple accounts, multiple conversions, et cetera, and some anniversaries et cetera, et cetera that the margin for the third and fourth quarter for the North American sector would probably beyond the high-end of that range to each quarter, okay.

Darrin D. Peller – Barclays Capital

Okay.

M. Troy Woods

What we’ve also said is that when you look at just say 34% to 36% margin for the segment, what we have said is some of these real big customers coming on board does not produce those kind of margin, so I am not trying to be on the one hand, but does that makes sense, we’ve said before that we’re not bringing our biggest conversion in the history of our business at the exact same range of margins that the North American segment has today.

Darrin D. Peller – Barclays Capital

All right. I think I understand. I appreciate that. And just lastly on EPS cadence, I mean you talked about obviously – you’re maintaining your full-year. So besides the potential ramp-up in North America of new clients, just to be clear in terms of listing out a couple of either key things, we should keep in mind. I mean I guess there has been some headwinds in merchant acquiring that will continue to roll off. Anything else that’s really driving the sequential material sequential pickup in the second half of the year, in terms of EPS? Quarterly earnings power that we should just keep in mind that you can remind us?

Paul M. Todd

Yes, Darrin, this is Paul. I think if you go back to what Troy had given as it related to the specific segments and just kind of follow through that story by segment. I think you kind of get to the added growth there. So it’s not one specific Darrin, I think there is anything being missed. I think it’s just a combination of all of those things kind of by segment and then rollup to a consolidated basis for the added growth there.

Darrin D. Peller – Barclays Capital

All right. That's helpful, thanks, Paul. And then last thing and I will turn it back to the queue. In the merchant acquired business came up a couple of times because of the growth rate, but you are seeing across the industry a lot of emphasis on different types of acquisitions and integrated POS and other types of specialty acquisitions in the space. Is there anything really out there that you think make sense that's beyond just traditional plain, vanilla portfolios to acquire – merchant acquiring? Are there still good properties out there that you think make sense from a specialty either integrated high power strategy or anything else that we should be looking out for?

Paul M. Todd

Darrin there are still some properties and assets out there, they are attractive to us and the spaces that we have and interesting which is primarily as we talked about the empowers and e-commerce, but as you know and we all know those assets are beginning to dwindle both domestically and internationally, but there are still a few that it have our attention.

Darrin D. Peller – Barclays Capital

Okay, all right guys. Thanks very much.

Paul M. Todd

Thank you.

Operator

Our next question is from Brett Huff, Stephens Incorporated. Please go ahead with your question.

Brett Huff – Stephens Inc.

Good evening and congrats to all three of you on the changes. We are looking forward to working with you more as the CEO, Troy and you as CFO, Paul and Phil, we'll miss you.

Philip W. Tomlinson

Thank you, Brett.

Brett Huff – Stephens Inc.

Couple of quick follow-up questions, on the back end merchant transition that you talked about can you just – what was sort of the hiccup that you were talking about A and B what kind of impact that have on the 1% kind of went from 4% to 1% growth, how much – is anything can we attribute, what percent and what kind of checking – change specifically to the back end sort of hiccup?

Philip W. Tomlinson

Well, I would rather not get into the details of what that was Brett, it was significant amount to drop down that just under 1% growth for the direct based on the expectations that we had for that segment, as to what they were again I don’t want to get into those details either they were just when you think about backend processing and think about the things that one needs to do around certain processing and interchange and processing of rejects and chargebacks in those kind of things. We had some hiccups and they are behind us, they are corrected, but on a portfolio of that size it affects our revenue for the quarter.

As I said earlier we are aggressively addressing all of those short comings if you will this particularly one is behind us, so that some of the challenges we had coming out of the backend conversion, but we still need to address as I said earlier that the large merchant growth with the lack there are and some of the other issues we have in the direct segment. Almost all are contained within our legacy TNS direct business.

Brett Huff – Stephens Inc.

Great, that’s helpful. And then on free cash flow seasonality it seems like the free cash flow is little bit lower than we expected this quarter. I think Paul you called out one item related to the JV exiting I think it was a $40 million deal was that the main reason why we had some negative seasonality?

Paul M. Todd

It is, and that’s the main driver there and that’s why called it out and it’s just a one time kind of related to the discontinued ops of Japan.

Brett Huff – Stephens Inc.

Okay, and then last question just on renewals I know we are really focused on getting the new portfolios of card issuing in, is there anything we need to think about kind of vis-à-vis the pricing question it was asked earlier or do we need to think about any maybe second half as we look into 2015 any big renewals that we need to think about whether might be some negotiations going on that that we need to pay attention to?

Paul M. Todd

Not really Brett, we had two very large North American customers that we renewed early in the year which were baked into our forecast for the year. So, those are behind us. There are really no more than one or two in each of our segments for the most part, that are under some type negotiations and whatever they are, they are already baked into our guidance and our numbers.

Brett Huff – Stephens Inc.

The renewals does it get even easier once you get into 2015 and all or is there any kind of trend of that, or is it just kind of we take it as it comes.

Philip W. Tomlinson

Well, when you look at – yes there are two ways to really look at Brett one is just clearly when does a contract expire. And clearly we have all of that laid out by segment as you might expect. Second part of that that was, they don’t always run linear, certain things go on. Sometimes we need to be proactive ourselves and renewing a contract maybe 18 to 24 months before it expires to get an extension and sometimes there are reasons with the customer. We would like to do that or would need to do that. So a point is a little bit difficult and just to go out and look at 2015, and say okay we got these three top 20 customers expiring in this segment and 2015. So those are the three you will have it doesn’t always stack up that way, but the big guys if you will – they’d not address we talk about those last 12 months really. So I don’t have it in front of me, I don’t know of anything of any real significants coming up in 2015.

Brett Huff – Stephens Inc.

Okay, that great. I appreciate your time guys.

Operator

Your next question is from Jim Schneider with Goldman Sachs. Please go ahead with your question.

Jim Schneider – Goldman Sachs

Good evening, thanks for taking my question and congratulations Phil, Troy and Paul. Just a question on North American segment for a second. I just want to confirm that irrespective of whether the conversions happened in the month of August, September, October, that you still expect that you'll get the full 91 million conversions happening by the end of the year, at least. Is that correct?

Philip W. Tomlinson

Based on what you just said, and based on our early comments, the answer is yes.

Jim Schneider – Goldman Sachs

Okay, thanks that’s helpful. And then just want to follow up on the international segment for a second, can you just remind us of where you think longer term, you can take the international segment margins beyond this year and what the cadence would be to get you that goal.

Philip W. Tomlinson

Well, what we have stated in the past Jim is really through 2015 and we’ve said is our current margin improvement plan has those on a trajectory of exiting 2015 at 18%. So we pretty much have stopped there for the moment that will be a Herculean effort to Gaylin and his team to get there from what we started on those plan two years ago. And so, we’ll end this year around 14% in our plan as to and 15% in around 18%.

Jim Schneider – Goldman Sachs

That’s very helpful. Thank you.

Philip W. Tomlinson

Thank you.

Operator

Your next question is from James Friedman with Susquehanna. Please go ahead with your question.

James Friedman – Susquehanna Financial Group

Thank you and let me echo my fairly well comments to Phil and congratulations to Troy and Paul.

Philip W. Tomlinson

Thank you Jamie.

James Friedman – Susquehanna Financial Group

So I wanted to ask also about issuer processing. Troy you had commented on unit economics in some of the businesses. I realize, there is considerable waterfall changes in volumes, but apples-to-apples how would you characterize the current environment in unit economics for issuer processing?

M. Troy Woods

Jamie, I’m not sure I totally follow that on unit economics, you’re talking about per account on file per transaction et cetera, et cetera.

James Friedman – Susquehanna Financial Group

Either of the above Troy, either account on file or I mean I realized there might be a discount because you got a very large issuer, but net of the changes in volume, how would you characterize either on account on file or transaction basis?

M. Troy Woods

We’re not seeing much change, when you think of again the three that we’ve been talking about for so long, one of which is already converted back in the early second quarter and keeping in mind what you said about their size. I think the best way to approach that is just look at our margin profile. I don’t think you see a significant degradation in our margin. Last year we did 36.3% margin in 2013 in North America and this year bringing home – well probably over 100 million for the year, 91 still to go. We’re looking at 34% to 36%. So from that I think you might get deducted for some degradation, but clearly not much to bring home that size to be looking at 34% to 36% or 36.3% last year.

And I think it is also important to remind you Jamie again, and I know you, know this, about a half the revenue in North America only about half comes from our account on file in the transactions. Then we’ve got about 40% of those transactions were bundled. So you have to think of who we’re bringing on board where they may fall and bundled versus unbundled pricing.

James Friedman – Susquehanna Financial Group

Yes. That’s all…

M. Troy Woods

So, okay, maybe that’s helpful.

James Friedman – Susquehanna Financial Group

That is. And then, more qualitative question would be in light of the sort of record activity in that segment, in the year and in the second half, how do you feel that it positions the company competitively going forward for new opportunities going into 2015? I’m sure it’s great to have such a huge referenceable account. Does it create advantages or animosities after you go after that accounts competitors?

Paul M. Todd

Jamie, this is Paul. Can you repeat which segment specifically you’re talking about?

James Friedman – Susquehanna Financial Group

North America.

Paul M. Todd

Staying on the North America, yes. And I think just kind of go back to that question again, I think what you’re saying is after you get a big potential win there, is there any kind of a downward kind of pressure with other competitors in the marketplace. Is that the way you are coming at this?

James Friedman – Susquehanna Financial Group

I wasn’t sure whether it was downward or upward. I’m sure it’s great to have such a referenceable account. I was trying to figure out if I might create animosity with that customers competitors…

Paul M. Todd

I’m sorry, I don’t think we have quite understood it at first Jamie. I’ll take a stab at that. Clearly we don’t think so. If that was a case it’d be a lot of customers, we would not be processing or when you look at the line up of large bank issuers that we already process for, large issuers that we have and the key to get converted and all the regional banks that we processed for, we dominate the financial institution credit card issuance space. So again I think if that was an issue, we wouldn’t be where we are today. And I think another way to look at it to the second part of it is. Even though, we are extremely proud of which we have and what’s in the queue. There is still 60% of the business just in the segment that you’re talking about Jamie that we don’t have. You know that’s in-house, processed at another third-party provider. I think we’re – I don’t think – we are continually encouraged by things that I mentioned earlier about the direct mail offers in the first quarter.

The commentary, the Capital One and JPMorgan Chase have come out with just in the last two days around their robust sales volume and growth of accounts. So, you know, all ships rise I think in that environment and we should certainly rise with it.

James Friedman – Susquehanna Financial Group

Got it. Okay, thank you very much.

Operator

Our final question is from Tulu Yunus with Nomura Securities. Please go ahead with your question.

Tulu Yunus – Nomura Securities International, Inc.

Thanks for squeezing me in. Let me add my congrats to all three gentlemen. I wanted to ask a question first accounts on file, momentum in North America. So, even if I strip out the $5 million that were converted in 2Q, you still saw a nice sequential bump from 1Q to 2Q. Can you just remind us excluding conversions what should you see organically typically in terms of accounts on file development here at your existing issuers to sort of typical seasonality what this one expect?

Phil W. Tomlinson

I'm not sure what that one is Tulu. We are looking at some numbers. Apologize for not having that one right in front of us.

Tulu Yunus – Nomura Securities International, Inc.

Okay. No problem.

Phil W. Tomlinson

Is that your only question?

Tulu Yunus – Nomura Securities International, Inc.

That was one and I can follow-up later if you’d like. That’s no issue. And then the other question, Paul, really was on the topic of financial leverage. Just curious on your thoughts. Some have argued in the past that, perhaps, TSYS has been arguably too conservatively leveraged, in terms of its target of around two times. I’m just more curious around your thoughts and whether you had a point now where perhaps in the near future to sort of rethink the balance sheet flexibility of the company?

Phil W. Tomlinson

Yes, Tulu, I think if I have said in the prepared remarks that from a philosophical standpoint, the philosophical positioning around leverage is similar, I think if you go back to what we did this time last year and took our leverage up to the kind of high two range and then kind of worked our way down to both growth and do deleveraging to get to the lower two range, which is where we are now. You could certainly for the right strategic opportunity, you can certainly see us make a move like we have made in the past that is indicative of something around that level, but any kind of dramatic change is not what we are expecting.

Tulu Yunus – Nomura Securities International, Inc.

Okay, got it. Given the fact that properties are, as indicated earlier in the call somewhat more limited to be able to flex and bounce on the right opportunity would be is sort of good to hear. All right gentlemen, thank you very much I can follow-up on the seasonality question off-line. Thank you.

Phil W. Tomlinson

I think we have an answer to that.

Tulu Yunus – Nomura Securities International, Inc.

Okay, all right.

Phil W. Tomlinson

It looks like, and again I’m not going to go handicap it too much out there but, North America high single-digits international low, low, high single, low double digits. Would be the…

Tulu Yunus – Nomura Securities International, Inc.

Got it.

Philip W. Tomlinson

Organic account on file growth.

Tulu Yunus – Nomura Securities International, Inc.

Got it. Okay thank you very much.

Philip W. Tomlinson

Thank you. All right, we appreciate the call, we hope everybody enjoyed it, everybody knows my phone number, certainly feel free to give me a call later this evening, I’ll be happy to cover anything we didn’t cover or fill over in more detail. Thank you very much and have a good evening.

Operator

Thank you everyone for joining today’s conference call. You may now disconnect.

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