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Total System Services Inc. (NYSE:TSS) reported first quarter operating net income of $48.8 million or 25 cents per share, against $51.8 million or 26 cents per share in the year-ago quarter. However, earnings per share were in line with the Zacks Consensus Estimate.

Results reflect continued weakness in North America services and higher-than-expected cost of services and selling, general and administrative (SG&A) expenses that also led to the decline in earnings. These were partially offset by increased same client transactions, lower taxes and slight increase in overall transaction volume.

Total revenue for the reported quarter was $429.4 million, up 3.9% as against $413.5 million in the year-ago quarter. However, this was a tad lower than the Zacks Consensus Estimate of $431.0 million.

Excluding termination fees of $23.1 million in the first quarter of 2010, total revenues witnessed a 10.0% year over year growth. On a constant currency basis, total revenue was $426.0 million, reflecting a 3.0% increase from the year-ago quarter. Reimbursable items totaled $66.8 million, down 5.7% year over year.

As per segments, quarterly revenues from North America declined 9.3% year over year to $230.6 million, while revenues from international services witnessed a 14.0% year-over-year growth to $90.7 million. Besides, intersegment revenues deteriorated 1.6% year over year to a negative of $7.6 million.

However, revenue from merchant acquiring services climbed substantially -- 32.6% year over year to $115.8 million, thereby rising from 21% to 27% of consolidated total revenues. Meanwhile, organic growth in the reported quarter stood at 3.9%.

Total System reported a 27.1% year over year surge in SG&A expenses, which came in at $54.9 million. In addition, cost of services increased 3.8% year over year to $301.5 million.

Operating income plummeted 8.4% year over year to $73.0 million in the reported quarter. Excluding termination fees in the year-ago quarter, revenues increased 10.0% while earnings per share increased 35.1%.

Total number of accounts on file as of March 31 was 356.7 million, up 10.3% from 323.3 million at the end of the prior-year quarter. New client growth was offset by a lower internal growth of existing clients. Additionally, same-client cardholder transaction volumes increased 9.6% over the prior-year quarter.

Financial Update

As of March 31, cash flow from operations was $102.2 million, compared with $133.5 million in the year-ago quarter. Cash and equivalents plummeted to $252.5 million versus $394.8 million at the end of 2010. While total assets were $1.78 billion at the end of the reported quarter, total shareholders’ equity was recorded at $1.23 billion.

Additionally, during the reported quarter, Total System bought back 2.0 million shares of its common stock under the share repurchase plan. The company has so far repurchased about 5.0 million shares in the past three quarters.

Guidance Revision

Total System reiterated its guidance for 2011, whereby management projected income from continuing operations in the range of $211-216 million or $1.09-1.11 per share. Total revenues are expected to be in the range of $1.75-1.79 billion, reflecting a 2-4% year-over-year growth. Reimbursable items are anticipated to be in the range of $260-267 million, declining 3-5% over 2010.

However, revenue from reimbursable items are projected at $1.49-1.52 billion, growing 3-5% over 2010. Besides, excluding the termination fees in 2010, the revenues before reimbursable items are projected to be up 6-8%, and net income from continuing operations is projected to be up 20-22%, in 2011. Average shares outstanding are now expected to be 194.5 million.

Business Update

Yesterday, Total System announced that it has renewed its agreement with Advanzia Bank S.A., the largest issuer of credit cards in Luxembourg, to process its more than 1.5 million consumer credit card portfolio.

On January 1, Total System expanded its merchant service solutions by purchasing the remaining 49% of First National Merchant Solutions LLC (FNMS) for approximately $169.6 million. Following the complete acquisition, Total System has renamed FNMS as TSYS Merchant Solutions.

Dividend Update

On April 1, Total System paid a regular quarterly dividend of 7 cents per share to shareholders of record as on March 17.

Our Take

Overall, Total System signals a sluggish improvement in the near-term, given the inefficient cost-cutting efforts, inadequate diversified growth, and interest and currency risk. Moreover, the company has been adversely impacted by the bank consolidation and the slowdown in credit card transaction growth over the past few years.

We expect Total System to incur incremental costs and bear risk as a result of the new regulations being implemented as a result of the Consumer Protection Act and other laws that were passed in July 2010. The company is also vulnerable to increased competition from dominant players such as Global Payments Inc. (NYSE:GPN) and Alliance Data Systems Corp. (NYSE:ADS).

Although the complete acquisition of FNMS and expansion into merchant acquiring services is expected to drive growth, sole dependence on it could be risky for the long term growth. In addition, we do not foresee any other substantial development strategy to drive earnings in the near future. However, we expect Total System to benefit from the improving economy and generate healthy cash flow to achieve the guidance for 2011.

Source: Total System Goes Flat, Budget Tight