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Total System Services (NYSE:TSS)

Q3 2011 Earnings Call

October 25, 2011 5:00 pm ET

Executives

James B. Lipham - Chief Financial Officer and Senior Executive Vice President

Philip W. Tomlinson - Chairman, Chief Executive Officer and Member of Executive Committee

Shawn Roberts - Director of Investor Relations

Analysts

Bryan Keane - Deutsche Bank AG, Research Division

Glenn Greene - Oppenheimer & Co. Inc., Research Division

Brett Huff - Stephens Inc., Research Division

Jason Kupferberg - Jefferies & Company, Inc., Research Division

Roman Leal - Goldman Sachs Group Inc., Research Division

Darrin D. Peller - Barclays Capital, Research Division

Glenn Fodor - Morgan Stanley, Research Division

Operator

Good afternoon, my name is Casey, and I will be your conference operator today. At this time, I would like to welcome everyone to the TSYS Third Quarter 2011 Earnings Conference Call. [Operator Instructions] As a reminder, ladies and gentlemen, this conference is being recorded today, October 25, 2011. Thank you. I would like to introduce Mr. Shawn Roberts, Director of Investor Relations. Please go ahead, sir.

Shawn Roberts

Thank you, Casey, and welcome, everyone. On the call today, our Chairman and CEO, Phil Tomlinson, will provide highlights of the third quarter 2011 and then turn it over to Jim Lipham, our CFO, who's going to review the financials. After that, we'll open it up to question-and-answer.

I'd like to now call your attention to the fact that we'll be making 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.

Philip W. Tomlinson

Thank you, Shawn, and good evening, everybody. We are certainly excited to report another quarter of positive results in really virtually every category.

I hope you've had a chance to read our release and the details that back it up. Total revenues grew 6.1% over the last year and earnings per share were up 30.6% for the quarter.

Total cardholder transactions, which is a real measure of our health, increased 12.7% in the third quarter, which is the seventh consecutive quarter of growth and the fourth straight quarter with double-digit growth.

Our accounts on file ended at 392 million, and they were up 10%. And if you include prepaid accounts, the total was up 15.7%. Both very, very good numbers for TSYS. With these results and our outlook for the remainder of the year, we've raised our revenue net income EPS guidance for the full year.

Our operational improvements were certainly helped by very resilient card market, increased number of transactions and account growth from our conversion -- our sales and conversion pipeline. Improved operations, lower effective tax rates and our share repurchase saw our outlook for 2011 improve our net income to 11% to 12% range, and for EPS to the 14% to 15% range, an increase of $0.05 a share.

My confidence in the card market was certainly reinforced this quarter with our organic revenue growth year-to-date of 5% in our North America segment and 7.5% in our international segment. While not back to the levels we once saw, North America's organic growth is over 2x higher than it was where we -- well, when I say it was, where we were a year ago at this time.

As an update on our conversion pipeline, we have about 12.5 million accounts scheduled to migrate over to our systems over the next 12 to 18 months. That we'll net out. We've got a couple of things we're going to lose, nothing big, but I think it nets out to about 9 million accounts total.

As you -- I'm sure you probably have seen the 8-K we issued on October 6 regarding the renewal of the Capital One business, which we have talked about earlier. This renewal extends our relationship out until 2017. It calls for TSYS to continue providing processing services for the Cap One North American portfolio of consumer and small business credit card accounts. And it's no surprise to you, according to the 2011 Nielsen report, Cap One is the fourth largest card issuer in the U.S. both by volume and outstandings. We're certainly delighted to have this long-term contract renewal. We have an excellent relationship with Cap One, and they're obviously one of our largest clients.

Regarding any concerns relative to the pricing pressure, I can assure you that the renewal is in line with the range of price compression that we deal with in other large contract renewal. And we feel very good about where we're at with Cap One.

I'd like to move on to just some highlights in North America. In June, we converted the accounts of Simmons First National Bank in the Sony retail portfolio, which was acquired by Cap One. We also added the Citi consumer portfolio acquired by CIBC and converted Silverton Bank to our TPS, our Total Programming Solutions that we have talked about for the past year. Just some highlights.

And on the international side, we added debit card processing at the Bank of Ireland. This program is now fully underway, and the first debit cards will be in the market in late 2011. We are happy to note that we completed the conversions for Swisscard and the Italian group, Cedacri. And we have a few other conversions in Germany and the Netherlands scheduled for the remaining months of this year. But as you know, with the holiday season coming up, with the -- the time frame to get any more conversions plugged into 2011 is pretty short. Very, very few people would be interested in doing any kind of work like that after the Thanksgiving holidays.

I want to bring you up-to-date on Carrefour. It is scheduled for the final phase. We told you this last time. I just wanted to verify it. That should come in, in the mid part of the first quarter of 2012. We are certainly still looking for additional relationships or prospecting for new customers in Brazil, and that's key to our long-term plans in Brazil. We had good strong transaction -- overall transaction growth internationally at 11.7%, and our same client transaction growth was at 7.8%.

On the Merchant Services side, we met at the October deadline for the technical releases, which are part of the Durbin rule changes. And we're readying our systems for the 2012 date. Clearly, Durbin is a focus for anyone in the acquiring business and -- although we don't see the Durbin changes as having a meaningful impact on us financially. Transaction growth, excluding BAMS, was up 4% on the merchant side. We continue to be focused on driving value for our shareholders, and as you probably have read in our release, today our Board approved a 42.9% dividend increase, which takes our quarterly share dividend from $0.07 a quarter to $0.10 a quarter.

As you're aware, we haven't had an increase in our dividend in 5 years now. We believe this certainly demonstrates our ongoing confidence in our long-term strength of our business and the -- and at the same time, rewards our shareholders. We also purchased 2.2 million shares of TSYS stock through our stock buyback program for the quarter for a total spend of $37.2 million. This brings our year-to-date total to 4.2 million shares at a cost of $72.9 million.

In addition to that, we've spent another $40.6 million in dividends for the year. We started 2011 with $394.8 million in cash on hand on our balance sheet. We've generated $297.7 million from operations year-to-date. We spent $64 million on capital items, $209 million on acquisitions, $113 million on our shareholders and $25.4 million on debt and other repayments, leaving us with cash on hand of $281 million at the end of this quarter.

Our continued strategic focus remains on deploying our capital in ways that most benefit the long-term operations of TSYS, which certainly, in turn, creates long-term benefits in shareholder -- to shareholders and shareholder value.

With that, I'm going to turn it over to Jim Lipham, who has a lot of details about this great quarter that he's going to go through, and then we'll open it up to questions, and then I'll close out very quickly. Jimmy?

James B. Lipham

Thank you, Phil. I'll try not to cover some of the things that Phil said. But I would like to say that this is the first quarter in quite a while where we have not had a comparable quarter with a termination fee in it. So we are glad to have that. And as you can see, North America really did drive the growth this quarter.

Before we get into the slides, again, I want to reiterate the equity and income line on the P&L. As you can see, year-to-date, it's got about a 71% growth in it. That's that CUP data that I've talked about last quarter. But we've got a timeline item that's going to flush out here in December, or in this fourth quarter and this thing, CUP, will be up about 19%. So just bear with us. There's a timing item that will correct that discrepancy there.

With that, I'd like to get started with the Slide 6. And it's the P&Ls for the quarter and year-to-date. First of all, on the quarter, as Phil mentioned, revenues were up 6.1%, and revenues before reimbursables was up 7.4%. Just a great quarter with increased volumes, we had good growth in GP Net, CTA was about $5 million, our merchant business up 4.8%. The fraud business, production services, everything was up a little bit and it just contributed to a good growth quarter.

If you look at operating income, we're up 2.9%. We did have about $9.1 million worth of one-time items that hit during this quarter. And I'll talk about those as we go through here. But without those, our operating income would have been up 14.4%. So would've been a real good growth.

Operating margin, we're at 20.8%. Without those one-time items, it would've been 23.1%, which was pretty a good growth quarter for us there in our margin.

When you look at the income from continuing ops, we're up 24.6% at $58 million. One of the big items there is income tax. Our effective rate for the quarter was 29.4%, compared to 36.5% last year. And this is the results of the recording of some discrete items in this quarter. And we do expect, as you look at the right-hand side on year-to-date, we'll be up about 31% to 32% for the year. And our effective tax rate would be that. And -- but it was a good quarter there.

Phil mentioned cardholder transactions up 12.7% at $2.2 billion. So it's just a great quarter. On the right side of the year-to-date, it's up $59 million in revenues at 4.6 million (sic) [4.6%]. Without the termination fee in 2010, those -- that revenue number would be up 7.4%, and then revenues before reimbursables would have been up 9.4%.

Big items for the year, 9-month CTAs about $17 million. TSYS, our Total Merchant Services in Omaha was about $32.8 million and then TSYS Merchant Services Atlanta created about another $6 million. So those are the big items. Brazil is in here for about $4 million of revenue.

Operating income was down 2.4% there. Again, if you add that termination fee out of 2010, you'd be up 13%. And so we still would have been growth in our operating income.

Total transactions at 6,300,000,000, up 13.3% year-over-year. Just continuing to have outstanding growth. We've mentioned, our EBIT on a year-to-date basis was $358 million, it's up 10.2% over 2010. And our margin is still around 31.6%.

Organic revenue growth, on a combined basis, was 4.4%. So that's improving as we go through each quarter.

If you flip over to Slide 7, you'll see kind of a graph of how we got the 6% growth in our revenue numbers, internal growth contributing 4.1%, new class added 2.6%, and acquisitions, another 3.6%, and then currency at 1.5%. The combined 11.8% growth there is -- obviously, is offset with that 2% loss business, and termination fees represented about 3.1%. So that's what brought it back down to the 6%. But then again, some good growth in year-to-date revenues.

On Slide 8, Phil mentioned the growth in the accounts on file. Each category is showing growth for the quarter. And we did have the big growth in the account on file numbers for prepaid at 47.7%. And I had mentioned before how about 6% of these accounts are active and the revenues off of prepaid represent about a 4.9% of our domestic revenues. So we need to keep that in mind. But overall, to have a 10% growth on everything, consumer and commercial, is good growth there in our account on file numbers, and is indicative of what we continue to see during the third quarter that we saw through the first half of the year, so good growth there.

On the North America segment, the story there is good, strong organic growth. Revenues are up $12.4 million at $243 million, and revenues, excluding reimbursables at $206 million are up $13.2 million. And this is pretty much the same. Organic revenue growth of 5% for this segment. And it's just in general, good growth in transactions and authorizations and the account on file.

Operating income at $68 million. Expenses were actually down $2.2 million. So we just had that outstanding quarter for margin improvement for North America, as you can see at 33% for excluding reimbursables and 27.9%. Both of these were up about 500 -- a little over 500 basis points year-over-year. So just outstanding growth there. And then you see the transaction numbers Phil mentioned earlier, good double-digit growth in both the same client and cardholders transactions total.

On Slide 10 is the international segment. Favorable currency of $4.9 million. Revenues were up $14.6; million, or 17.1%. New client revenues, strong organic revenue growth of 7.5% on the international created this growth. And when you get down to the operating income, we're actually at $8.3 million. It's down $4 million from where it was last year.

And this has got our margins at the 8% level. The big items there, headcount is up 276 people or roughly $3.5 million of the $4 million drop. And then we have some processing there during this quarter that helped create the rest of the drop. Without those 2 items, or without the one-time charge on the processing, we would be at 10% on our margin growth there for operating margin.

So a one-time item cost us a little bit there. And we do expect in the fourth quarter to see the margins in international a little north of 10%. So we should be back to there and looking to continue to improve those margins.

Transaction growth, still good. Total card transactions are up double-digit, 11.7%, whereas our same client transactions is up 7.8%. But overall, just a good quarter there. Currency added $4.8 million. As I said, the expense side of the house got $5.4 million added, so it decreased our operating income about $600,000 there.

On Slide 11, we've got our merchant segment. TermNet was a big deal there. Revenues are actually down a little bit, really, 1.8%. And revenues before reimbursables are down 1.9%. TSYS Acquiring was down about $1 million, mainly the result of deconvergence and price compressions, which we have talked about before with the Flying J and Subway and Merchant e.

TSYS Merchant Services is also down about $4 million. It was mainly due to a one-time revenue true up of about $4 million that pertained to 2010. And we have that as a one-time item in the merchant segment that really penalized the margins for the quarter, whereas if you excluded that one-time adjustment, those margins would be almost 1% ahead of where they have been. The 22.3% would be 25.7%, and then the 29.4% would be 34%. Both of those are about 1% higher than they were last quarter.

Anyway, on the $93 million revenues before reimbursables, 61% of that is transaction-driven through TSYS Acquiring point-of-sale business. And their volumes were actually up. If you excluded the deconverted class, they were up 5.4%. And so that's at least good growth, same clients, so to speak, POS business.

The other 39% of the direct merchant ownership, and that's dollar [ph] volume-driven, and it's the part of TSYS of Omaha, TSYS Merchant Services of Omaha and this volume is showing an increase of 10.8% over the third quarter of last year. So it's good growth there.

And I mentioned the margins being down. But without the one-time adjustment, they would've been in line with where they should be.

On Slide 12, we'll look at the cash flow. We, again, had a good cash flow this quarter, with $98.4 million from operations and about $78 million in free cash flow. Year-to-date, Phil mentioned, cash flow from operations is $297.7 million, and then we also had free cash flow was up $68 million, close to $69 million at $233 million.

We continue to generate good cash with evident $473 million in cash from operating activities on a trailing 12-month basis of $407 million. We will see a pickup there in that as we go in the fourth quarter. If you remember last year in the fourth quarter of 2010, we had some capital expenditures of roughly $64 million that came in that quarter that we won't have this year. So that should improve that cash flow for the year on a trailing 12-month basis.

Phil talked about the money that we spend. You do see cash up there, pending cash for the quarter at $281 million. So we have spent our cash wisely, I think, this year on both shareholder return, as well as some good acquisitions for the company's growth.

On Slide 13, it's just our revised guidance. As you can see, we continue to have a good growth that we saw through the second quarter. We did have some one-time items that were hitting us in the third quarter that we were able to overcome because of this continued growth. And so we have ended up changing our revenues now to 4% to 5%, up from 2.4% and -- or 2% to 4 %. And then the revenues from reimbursable items, we raised from 5% to 6% growth, up from 3% to 5% that we had previously.

So overall, earnings per share, $1.14 to $1.15, compared to our original guidance of $1.09 and $1.11. So when you take a look at our share repurchase, this accounted for about $0.015 on our earnings per share growth and the tax number is picked up another $0.03, and then CUP has added about $0.015. So if you take those 3 together, that's pretty much the $0.05 that we raised our earnings guidance up to $1.15.

So with that, Phil, I'll turn it back over to you.

Philip W. Tomlinson

Thanks, Jimmy. Case -- I mean, Case, can I just open it up to questions now, if we can.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Glenn Fodor with Morgan Stanley.

Glenn Fodor - Morgan Stanley, Research Division

I missed some of the beginning comments on Capital One, so pardon me if any of these is repetitive. But I get the sense that pricing is nothing surprising versus other large renewals. But when you look at the final terms of the contract, can you give us any other color on what were the big swing factors versus your expectations, if any? And were there any changes to the terms and conditions that are worth calling out?

Philip W. Tomlinson

Well, we wouldn't -- we would never go into any details. I mean, the -- we're very happy with it. I don't think there were any major changes. There's was a lot of discussion 5 years ago that they had the option to license a software. That obviously, I mean, never came up. It's still there. And we feel like as long as we can do them a good job, keep them happy, and we have a great relationship with them. And I think we are certainly, hopefully, we're exceeding their expectations as that's the plan here every day. But, Glenn, we didn't really give a lot of details, when I was talking about it with the opening. There's not a lot of details of that we could give. But we're very happy to have this behind us. It's something that everybody knew is out there. I think it's a great endorsement. And we -- they're just a great client.

Glenn Fodor - Morgan Stanley, Research Division

Okay. Well the message is clear it was a good renewal for you, so congratulations.

Philip W. Tomlinson

It's a very good renewal for us, and we're thrilled about it.

Glenn Fodor - Morgan Stanley, Research Division

Very good. That just -- okay, so that's a large customer. Just switching to the small ones, if I could, for a minute. Could you just give us an update on your efforts to penetrate small bank market? I mean, there's obviously a lot of tension there. Given the potential share gains they could see as consumers maybe...

Philip W. Tomlinson

Yes. We have several things going there. I talked a little about TPS, a win we had there, we also are starting to talk to a lot of people that historically had been in the card issuing business and had sold out. And we're starting to see more and more people, more and more banks looking at the idea of getting back into the card issuing business. And I certainly think that we'll win more than our share -- our fair share there. We feel good about the ones that we're talking to today, and we're hopeful that we can bring those to closure and go public with them.

Operator

Your next question comes from the line of Glenn Greene with Oppenheimer.

Glenn Greene - Oppenheimer & Co. Inc., Research Division

I guess, my first question is just, obviously given the macro considerations and concerns out there, maybe just a little bit more color on the prospecting pipeline, not the conversion pipeline, but new deal activity and what you may be seeing in terms of sales cycle trends.

Philip W. Tomlinson

Well, I don't know that it's a sales cycle -- you've heard me say for years that the sales cycle in this business is pretty extended. We think it's anywhere on average from 6 months to 18 months. But I do think that, and I think I said this last quarter, that for the first time in several years, the U.S. market seems to be opening up a bit. The U.S. market went dark for a couple of years there, and we continue to do pretty well in the international side. And you may have heard where I talked about we've converted Swisscard and Cedacri, and we're very pleased with that. But I think our prospect pipeline is probably about as good as it's ever been.

Glenn Greene - Oppenheimer & Co. Inc., Research Division

So -- but you're basically -- you're haven't -- you're not seeing any impact from the macro environment and the uncertainty out there, and people aren't holding back on making decisions is what it sounds like.

Philip W. Tomlinson

I think people are starting to make some decisions. I think people are starting to step out and talk to folks like us. And that's why I say I think our prospect pipeline is probably about as a as good as it's ever been. Obviously, you've got to close all those deals, and we'll certainly, I believe, close our fair share of them. But I mean, we're talking to people today that we have been trying to talk to you for a long time, and we're actually getting some traction on some of that, at least, in the talking phases. And which to me means that people are starting to feel at least somewhat more positive about where this economy is at. It's days like today that it just want -- make you want to pull your hair out.

Glenn Greene - Oppenheimer & Co. Inc., Research Division

Clearly, a lot of volatility.

Philip W. Tomlinson

There's a lot of volatility in the market. But I think you have to look at this transaction business that we were talking about. If you look at First Data spend trend numbers or Global's numbers or our numbers, the -- it's very positive all the way around. And so we're starting to become much more optimistic about where this marketplace is going.

Glenn Greene - Oppenheimer & Co. Inc., Research Division

Okay. Maybe a different direction of question, as it relates to Durbin. And obviously, it's very recent that the rate changes went into effect. But are you detecting any sort of change in behavior and I'm kind of thinking potentially a shift in volume more toward credit away from debit or any change in behavior by your customers?

Philip W. Tomlinson

Well, we haven't seen it yet. Obviously, we're less than a month into this. There's been a lot of discussion, a lot of politics around it. But I still think people are going to continue, our banks will continue to issue debit cards. I think consumers like the debit card. I think sure, there's going to some folks that get really mad about fees. But the truth is, fees are a way of life, and you can -- some people will move their accounts. But I don't see debit card going away. And I do think that if you stop and you really think about the credit card product in many ways, it's -- you could say it's superior. I mean, it -- you can do about anything you want to do with a credit card, and it has some great protection there. But I don't -- I think the fact that people are just starting to spend a little bit again is the part that's encouraging to me. But I don't see the debit card going anywhere. I think it's -- the debit card is here to stay. We may have a bubble here in the near future that -- but I would be very surprised personally to see it happen.

Operator

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

Darrin D. Peller - Barclays Capital, Research Division

Just a quick question on the capital structure first, and really, the buybacks. I think you've bought back about 4 million shares, so far year-to-date. And I know you just increased the dividend, which is nice to see. Just when you think about the opportunity, though, I think your authorization still allows for something to the tune of about 8 million shares.

Philip W. Tomlinson

That's right.

Darrin D. Peller - Barclays Capital, Research Division

You have $280 million of cash on the balance sheet now. And I think you have about something to the tune about -- what is it, $180 million of debt?

Philip W. Tomlinson

That's right.

James B. Lipham

Right.

Darrin D. Peller - Barclays Capital, Research Division

And we know you generate a healthy cash flow, and I think it's going up now, given what you just said about next quarter having less CapEx than last year. So obviously, there seems to be a significant amount of opportunities. And I think you also, second quarter, had to hold off, given a potential deal that you were thinking about, at least. So your total buybacks, I would have thought would have been a little more significant during the quarter. Can you just comment on some of the opportunity and plans that you see in place and your thought process around capital return?

Philip W. Tomlinson

Sure. We have had -- we've had some opportunities this year, and we still have several opportunities. But they don't always pan out like you like for them to. We do have $280 million, I mean, in cash. Obviously, we have to operate this company. It's not like all that is available for -- to use for repurchase program. We still have some gas on the current program that we have today out there, the current repurchase program. I think unless something comes to fruition here fairly quickly, you'll probably see us back in the market. I mean, we thought it was time on the dividend payment to kind of raise our dividend, at least to the average of what the S&P 500 is, which is a little over [ph] 2%. We feel good about that. We have always said, Darrin, that we had rather add business to the books as opposed to buying stock back. We have, over the last year, I think we've spent about $113 million buying stock back. We have also, and Jimmy can give you the numbers, I don't have them right in front of me, but we spent an awful lot of money on other things -- well, I think I do have them, we can find that, but we spent well over $250 million or so.

James B. Lipham

$169 million on FNMS, TermNet was $39 million, $72.9 million was share repurchase.

Philip W. Tomlinson

So we -- what' s the total of that now, Jim? $240 million?

James B. Lipham

Yes, $240 million.

Philip W. Tomlinson

So we have not been bashful in spending money. We have these operations scattered around the world, where a lot of that cash is we have in places like England and Japan. And we just need to run day-to-day operations there and serving the U.S. But we're looking at that every day, Darrin. And we're going to be aggressive. We think our operations are in good shape. We think our software packages are in great shape. We feel good about where we're at. And as the opportunities come along, we will jump back in the buyback market. We're pretty proud of what we bought back, frankly.

Darrin D. Peller - Barclays Capital, Research Division

I think your guidance suggests 182 million shares for the year, which I think would probably correlate to about another 2 million shares or so for the fourth quarter. I mean, is that just a placeholder? I mean, do you think there's a possibility you could do more than? And then also...

Philip W. Tomlinson

I thought it was 190 million shares where we're at.

James B. Lipham

192 million.

Darrin D. Peller - Barclays Capital, Research Division

Yes, 192 million.

Philip W. Tomlinson

We thought you said 180...

Darrin D. Peller - Barclays Capital, Research Division

Maybe you meant to say 190 million.

James B. Lipham

Okay, call that 190 million [indiscernible].

Philip W. Tomlinson

I thought he said 182 million.

James B. Lipham

I did too.

Darrin D. Peller - Barclays Capital, Research Division

So 192 million is -- is that just a placeholder or is that a -- should we actually think that there's a $2 million share buyback to be expected there in the quarter?

Philip W. Tomlinson

That's the average about a year, Darrin.

Darrin D. Peller - Barclays Capital, Research Division

Right. But I thought it just worked out to about $2 million for the quarter in all, when you do the math but maybe they...

Philip W. Tomlinson

No, it don't work out just that way, but I think it won't affect the average that much.

Darrin D. Peller - Barclays Capital, Research Division

Last question for me on the accounts on file, when you look at the growth, I mean, it was pretty healthy on the consumer credit side. And on the Commercial side, which obviously is, from what I understand, I mean, is a nice, nice area to grow. I mean, I think the profitability on those cards is obviously much higher than private label.

Philip W. Tomlinson

They just have so much more activity.

Darrin D. Peller - Barclays Capital, Research Division

Right. So what I was just really trying to figure out was when -- get you give us a sense of sort of going forward, how much more do those types of cards and that kind of growth on consumer and commercial positively impact the business then say a private label card would impact?

Philip W. Tomlinson

Well, I think they're substantial. I mean, I don't have the number in front of me. But if you look at, as an example, if you look at your typical Visa, MasterCards, you typically run a credit line of $1,800 to $2,500. On a commercial card, it's higher than that. And if you look at a retail card, it's probably $500 to $1,000. And the fact that you can take a consumer Visa, MasterCard or commercial card and use them virtually everywhere you can buy anything, and a private label card is pretty restricted as to what you can buy and where you can use it. And so it's just the utility of the card is just totally different. And so the transactions -- the highest transactions are on commercial cards and you go to consumer cards and then you -- way down the scale is a private label-type card.

Darrin D. Peller - Barclays Capital, Research Division

All right. Just last question for me and then -- on the Capital One renegotiation, I mean, I know there's probably not much you can comment on this, but as much as you can, I mean, were -- was HSBC at least part of the discussion around the negotiation process?

Philip W. Tomlinson

Well, I can't get into the any of that. I mean, obviously, that deal has not closed, and we've -- it's just not something that we're willing to talk about.

Operator

Your next question comes from the line of Brett Huff with Stephens Inc.

Brett Huff - Stephens Inc., Research Division

First of all, just quick question. Jim or Phil, can you go through the one-time items again? And what I heard was, Jim, I think, that overall, there was $9 million or so in one-time items?

James B. Lipham

Correct.

Brett Huff - Stephens Inc., Research Division

Can you just detail those for me again? I apologize.

James B. Lipham

Yes. We had about a $4.1 million revenue adjustment on the merchant segment for FNMS, which pertained to 2010. We had about a $3.5 million incentive pickup. As our earnings continue to grow, we had to catch up our incentive plans during the third quarter. And that was about $3.5 million. And then we had a processing error in international about $1.5 million.

Brett Huff - Stephens Inc., Research Division

And so all-in, I mean, when I do that math, that added -- that would have added $0.02 or $0.03 to the EPS, is that the math that you're doing?

James B. Lipham

Correct.

Brett Huff - Stephens Inc., Research Division

Okay, so that's thing #1. That's helpful. And then second of all, another just technical question. On the CUP Data, you said that for the year, you expect 19% year-over-year growth in that line all-in?

James B. Lipham

It'd be a little bit small all-in because Mexico's in the plan also. But the CUP itself has got an 18% to 19% growth, it looks where they're going to go and finish this year over last year.

Brett Huff - Stephens Inc., Research Division

Okay. So directionally, that would be correct.

James B. Lipham

Yes, correct.

Brett Huff - Stephens Inc., Research Division

So we can kind of use that as a directional. Okay, that's fair. And on the free cash, I think you said it was $78 million this quarter. If you just multiply that by 4, you get something north of $300 million. And as I recall at the Analyst Day, the sort of longer-term guidance you gave of how much free cash you thought you could make over the next couple of years implied something between $250 million and $275 million. And I just -- I'm trying to square those 2 numbers. Any thoughts on that?

Philip W. Tomlinson

I think it's going to go closer to like $275 million, $300 million as we go forward.

Brett Huff - Stephens Inc., Research Division

And what changed between then and now?

Philip W. Tomlinson

Fourth quarter of last year, we had very little free cash flow generated because of the capital expenditures we had of about $64 million, which was a customer signing incentive, as well as some software we purchased. We won't have that again this year. Once that fourth quarter of 2010 anniversaries, which it will this quarter, you'll see a big pickup in our free cash flow.

Brett Huff - Stephens Inc., Research Division

Okay. And then the, the last -- just last question. When you think about the accounts on file that you said coming. And I think Phil, you said gross 12.5% by that year, ended 12% that are contractually obligated, net about 9%. Is that right?

Philip W. Tomlinson

That's right.

Brett Huff - Stephens Inc., Research Division

Of that, call it, 9% are most of those not prepaid? Meaning, they're the better, more highly profitable cards?

Philip W. Tomlinson

Correct.

Brett Huff - Stephens Inc., Research Division

Okay. And then, I guess, my last question is when you think about your margins for '12, is there any step function of cost that we should see? Anything that will hurt the incremental margins that you guys have historically enjoyed, which have been very good? Is there any you guys see right now on the horizon that will change things as we look into '12?

Philip W. Tomlinson

I don't think so.

Operator

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

Bryan Keane - Deutsche Bank AG, Research Division

Phil, your comments about the prospect pipeline got me excited. You said that it's good as it ever has been. I guess the question...

Philip W. Tomlinson

I'm glad to see someone else is excited about something these days.

Bryan Keane - Deutsche Bank AG, Research Division

No, I'm excited. But, the big but is when can you get it across the finish line? I mean, can we see something by the end of this calendar of an actual deal, big deal signing? Or is it going to take a little longer?

Philip W. Tomlinson

I'd get shot if I answer that thing right now. There's just no way to give that a guess. I'd love to say there's something that could get signed. But truth is, when we get to Thanksgiving, this business sort of shuts down and everybody goes into the holiday mode and not much business gets done, except transactions.

Bryan Keane - Deutsche Bank AG, Research Division

But it sounds like in that prospect pipeline, people are looking at the decision very seriously to outsource. So it...

Philip W. Tomlinson

Yes. I think we have a lot of people that are looking at that. And as I say, even in the U.S., which truthfully, in '09 and '10 and part of '11, just was like pulling the shades down. I mean, there was just nobody home.

Bryan Keane - Deutsche Bank AG, Research Division

And what's driving that, especially in the U.S.? Is that just more regulation and higher cost and people are realizing...

Philip W. Tomlinson

Part of it, I mean, we just finished more regulation with Durbin. We went through the CARD Act. We've had big regulation very similar to the CARD Act in Canada and the U.K. So there's lots and lots of money being spent on the regulatory environment. And I think people are feeling marketing pressures from not only, I mean, from our customers who have a lot of flexibility on what they can do. And I think, again, we're starting to see people who think it's a good idea to be in this business again. We went through a period where it was not the coolest thing to do, was to be in the credit card business. It's starting to be a -- in vogue again, and that can't be anything but good for us.

Bryan Keane - Deutsche Bank AG, Research Division

Okay. And just my last question. What's the -- or how is the existing client base spending on value added services? I mean, are you seeing an uptick in interest in those products?

Philip W. Tomlinson

Well, I think we're seeing some of the volume that we had lost starting to come back. I mean, we actually have people who shut products down because they were just looking for anything to cut expenses. We're starting -- they have good products. They had products that people want to use, that people need to manage these portfolios. But during the most difficult and the darkest days, we saw people shut down products that we had never seen before. And so we're seeing some of that. I don't know that anybody's buying any more than they have historically. But certainly, we're seeing some customers come back, which is a very positive thing for us.

Operator

Your next question comes from the line of Jason Kupferberg with Jefferies.

Jason Kupferberg - Jefferies & Company, Inc., Research Division

So I wanted to ask you a question about the international margins. I know you guys have talked about it last quarter and said that you felt you could get back to the mid-teens range by, I think, Q3 of next year, once the big conversions are done, you'll start layering some revenue on top of the investments that you've made there, and getting some operating leverage. So I wanted to see if that's still your expectation based on how you see some of these conversions playing out?

Philip W. Tomlinson

I think that's still our expectations. I mean, I hope to tell you that we've signed some massive customer in Europe or somewhere, and we're going to spend a little money. But as we see it right now, those are our expectations. We feel good about where we're at. We feel good about these conversions that we're making progress with. And so we're not backing off that.

Jason Kupferberg - Jefferies & Company, Inc., Research Division

Okay, good to know. And Phil, you always have a good kind of underlying gut feeling for where your business is going. I remember back at the Analyst Meeting in May, when you and I were talking, and you definitely had some more spring in your step, but you just felt better about what your clients were telling you and what your pipeline look at. And here we are a couple of quarters later, and you guys are raising numbers. So I wanted to try and tap into that crystal ball a little bit, I guess. As you start to think about 2012, and I know you guys can't offer official guidance just yet. But just what's your qualitative sense on the underlying growth potential of the business? Maybe if you can contrast that or compare it with how you were thinking about 2011 when you were sitting on the Q3 call this time last year?

Philip W. Tomlinson

Well, this time last year and the year before, I really thought all my hair was going to fall out. And most of it has, apparently. But I mean, the economic problems are not over. I mean, I've always felt that we've been in this thing so long that people are having -- a lot of people are having a hard time being optimistic about the sun coming up tomorrow. I'm not having that problem. I think we've got an awful lot to be optimistic about. But we still got some issues that we have to address. We've got some headwinds that we're going to have to deal with, most of which we have certainly talked to you guys about on several occasions. But we do -- I mean, we -- some good things will happen, some bluebird events will happen, and those, we're not talking about bluebird events, those are things like some of the acquisitions that our Canadian banks have made recently. That business moves to us. That's a very, very good thing for us. And it allows us to leverage our operations here in a very strong way. So I'm feeling pretty good about next year. I mean, I wish I could say it was a slam dunk. I certainly don't believe that. If what we're seeing is a trend, and again, if you look at the transaction numbers that First Data puts out or Global puts out, that we put out, it's starting to feel better. And I don't know what's going to happen with this holiday season. And I think the conventional wisdom is maybe a 2% increase, I hope we do that. I think that'll be good for everybody. I really hope we can do more. But at least we're not looking at a negative number, as we have for a couple of years there. So I mean, I don't have a crystal ball, but it's feeling a whole lot better than it did in '08 and '09 and '10.

Jason Kupferberg - Jefferies & Company, Inc., Research Division

Okay, that's helpful. And just last one for me, going back to the accounts on file. The government vertical, I think, was up over 21% here in Q3, which I think is, by far, the best growth you've seen at least this year or year-to-date. Was there any single program or two that you would call out there as driving the growth? And are those cards, for the most part, active cards?

Philip W. Tomlinson

No, it's just a good business. I mean, I don't...

James B. Lipham

About 6 million accounts.

Philip W. Tomlinson

Jimmy said it's about 6 million accounts. But I mean, that's turned out to be a very good business for us, and we want it to grow more. But we're feeling good about that. But I don't think there was any one special thing that happened that I'm aware of anyway.

Operator

Your last question comes from the line of Roman Leal with Goldman Sachs.

Roman Leal - Goldman Sachs Group Inc., Research Division

First, I wanted to follow-up on the growth in commercial and consumer credit. It seemed that the growth was really strong this quarter. Can you give us a little more color on what drove that? Was that mostly existing clients or new clients brought on board this quarter?

Philip W. Tomlinson

Most of it is existing clients who have just gotten more aggressive. Now we -- I don't think we added a commercial client. As a matter of fact, I'm sure we didn't add a commercial client. It's just really all organic. We have added some consumer clients and certainly that's positive, but nothing huge.

Roman Leal - Goldman Sachs Group Inc., Research Division

Okay, good to know. And in terms of consumer or even just, I guess, on the credit side, if you look at what you see in North America and international, are there any big differences there in terms of the type of customers that issuers are looking for? Is it mostly affluent internationally like in North America? Or are you seeing a little bit more kind of diversity in the credits spectrum here?

Philip W. Tomlinson

We're seeing it across the board and everything I'm reading, we're seeing -- I mean, what I'm reading is not only certainly affluent, but even down to some sub-prime issuance. There are some pundits out there that believes the more affluent segment is driving the growth. I wish I knew how to figure that out. It would be helpful.

Roman Leal - Goldman Sachs Group Inc., Research Division

Interesting. And then the last one on prepaid. I think you said that the active -- the percentage of that portfolio that's active is about 6%. I wonder, is that a pretty stable number? Or does it vary a lot? And obviously, any trends in the pickup of activity there?

Philip W. Tomlinson

That's a pretty accurate number. We haven't seen anything that make us believe it's -- there's anything really different this quarter than in past quarters.

Listen, I'll close this thing out. And we appreciate your questions, and thank you for being on the phone with us. We are feeling more positive. We know that we all feel struggles that we continue to see in the financial and credit markets. And really, almost daily economic gyrations occurring in Europe, and we're certainly in Europe. And today, again, as I said earlier, is a good example of that. I know one thing that we believe, and that is that electronic payments is an important part of the global economy. And I think it's going to continue to be a real mainstream, and be a key part of both the developed and emerging markets.

We continue to see solicitations increasing. I hope you see that. These solicitations offer a lot of new products and options from issuers that really are directed at trying to figure out how to get folks to use their cards even more. It's a product that has great, great utility.

We have great confidence in our team, and our team is better today than it has ever been in history. And we think we've got good strategies in place to get us through the future here. We'll continue to be successful in meeting these challenges. And we strongly believe that better days are ahead, not only for TSYS, but for our industry in general.

I want to thank you for your interest in TSYS and your time this evening on this call. And if you have any additional questions, like I told you before, Shawn Roberts is available 24 hours a day, 24 by 7, you've got his number. And he's looking to hear from you.

So again, thanks for being with us today, and we look forward to chatting with you as time goes by. Bye bye.

Operator

This concludes today's conference. Thank you for your participation. You may now disconnect.

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