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Total System Services, Inc. (NYSE:TSS)

Q2 2007 Earnings Call

July 24, 2007 8:30 am ET

Executives

Phil Tomlinson, Chairman & CEO

Jim Lipham - CFO

Analysts

Glenn Waldorf - UBS

Tony Wible - Citigroup

David Charles

Tony Davis - Ryan, Beck & Co.

Paul Badulak - Credit Suisse

David Parker - Merrill Lynch

Glenn Greene - CIBC World Markets

Glenn Waldorf - UBS

Roger Smith - Fox-Pitt Kelton

TRANSCRIPT SPONSOR
Wall Street Breakfast

Operator

Good morning, ladies and gentlemen, and welcome to the TSYS Second Quarter 2007 Earnings Conference Call. At this time, all participants have been placed on a listen-only mode and we will open the floor for your questions and comments following the presentation. It is now my pleasure to turn the floor over to your host, Phil Tomlinson, Chairman and CEO. Sir, the floor is yours.

Phil Tomlinson

Thank you, Kate. Good morning and welcome to everybody on the line to our second quarter earnings call. As I do every time, or as we do every time, I need to go through this Safe Harbor and I want to call your attention to the fact that we'll be making forward-looking statements about the future operating results of TSYS.

These statements involve risk and uncertainties; factors that could cause TSYS’s actual results to differ materially from the forward-looking statements are set forth in TSYS’s reports filed with the SEC.

And it’s a really exciting morning, and many of you may have already seen the 8 AM Synovus press release and 8:15 TSYS press release that was there this morning. And if you haven’t, I want to kind of go over what’s going on there.

Synovus which 80.8% of our outstanding stock will ask its Board of Directors to consider whether to distribute its ownership interest in TSYS to Synovus shareholders in a spin-off transactions.

Synovus will also ask its Board to appoint a Special Committee of independent Synovus Directors to make recommendation regarding the spin-off. In light of the expected consideration of this matter by the Synovus Special Committee, the TSYS Board of Directors will form a Special Committee of independent TSYS Directors to consider the terms of any proposed spin-off by Synovus of its ownership interest in TSYS.

Now, for obvious reasons, we are not going to make any further comment or answer any additional questions about this issue until the Synovus Board has announced a decision, and I think we would, we would do the wrong thing if we didn't focus on the great quarter that we, that we've had.

So, now to the real business at hand, I think the second quarter was another great performance that we can be very proud of. As you saw in the earnings release yesterday, we continue to expect to achieve our previously announced net income growth guidance in the 20% to 22% range on a non-GAAP basis, and 0% to/or flat and up to 2% on a GAAP basis, which, again, we think we've really done a great job with that to get to that point.

I just cannot overstate how pleased we are with our team's ability to manage expenses, increase this organic revenue growth and continue exceeding expectations in general. In addition to that, our prospect pipeline continues to pick-up speed at a fast rate.

All of this has resulted in the expansion of our operating margin, which I think, we told you last quarter we felt like we would be in the 24 to 26 range and then at the end of six months, 25.7%, which is in today's world, is very impressive.

We've been asked by a few investors, and particularly several of you over the last month or so, about the additional card production business that we're doing for Banc of America. We didn't do a press release and thought maybe that the conference call might be the best way to clear that up.

In January of this year, we did begin the production of debit and commercial cards for Banc of America, which is, as you know the largest debit issuer in the U.S. I really believe that this agreement shows that even after the loss of the consumer portfolio in late 2006, that Banc of America continues to have strong confidence in TSYS, as well as continues to add new business. And they certainly are very, very important customer to TSYS.

Some of the financial highlights this quarter; net income increased 14.4% in the second quarter as compared to the second quarter of '06. Revenues before reimbursables increased 6.2 in the second quarter of '07 compared to the second quarter of '06. Operating income was up 13.2% as compared quarter-to-quarter and operating income was up 16% for the first six months of the year.

Our diluted earnings per share increased 14.5% to $0.33 in the second quarter of '07 compared to $0.29 in the second quarter of '06. The internal revenue growth rate, or what we term, our term is called organic growth, increased to 12% in the second quarter, which is one of the real keys and has been a key for us over the past 25 years or so.

I think these numbers are rather amazing when you consider the trauma that we have gone through in 2006 and what we've had to do to be able to get to where we are today. We had some big highlights, particularly with some new things that we've done, new business-wise.

You've all heard a lot about the new Wal-Mart money card. It's issued by GE and reloaded through Green Dot's national reloading network and there's been a lot of speculation about who processes that and that is processed by TSYS.

This product was first offered, or first piloted in November of 2006 and will be available in 2600 Wal-Mart Stores by the end of July. I think this launch of this product could change the face of the prepaid industry. It is a huge event.

Another thing that we are very, very proud of is very recently we were awarded the 2007 global card processor of the year, by cards international and VRL Knowledge Bank. I think it's a great acknowledgment of the continued progress and quality that TSYS is making around the world.

Moving on to China, in China, Cup Data began processing through Huaxia Bank and of course that's spelled a little differently than it looks, than it sounds. This is one of China's largest nationwide banks. Cup Data now provides processing services for three of the four largest issuing banks in China that use outsource suppliers. We continue to be very encouraged about the long-term future prospects in China.

Moving on to the UK, TSYS and Norwich Union launch a new prepaid Rewards card in the UK. Then TSYS Card Tech in London launched a new card management program with existing clients in Qatar, with Qatar National Bank and the Commercial Bank Of Qatar. And those are the first and second largest banks respectively in assets in that country.

They are using our Marquise Software Prime, which is really one of the key reasons that we have bought, that we acquired Card Tech. We believe we've got a real diamond in the rough with Card Tech. This thing is going to pay off for many, many years to come.

We also signed a couple of really nice merchant processing agreements with mPay, which is a gateway in the bank core bank and we renewed some good business with merchant management systems.

On the international side, we continue to perform well and as you know, that's one of our real areas of focus. We were up 42% for the quarter and 44.3% for the first six months. And a lot of that is being driven by Card Tech, but our core or traditional card service business is very strong.

Our prepaid business continues to be very active in Europe in particular. Our value-added products have continued to be a solid contributor. Value-added increased 10.7% in the second quarter compared to second quarter last year, and we continue to improve our ability to sell more products to already existing clients.

Moving on to TSYS acquiring solutions, I hope that you do not getting that static that we are getting back here, but I'll keep going. I am pleased to report that the acquiring solutions had a good quarter on a sequential basis. Revenues increased 6.2% in the second quarter compared to the first quarter. This was mainly due to increase in transaction volume. Jim Lipham's going to give you a lot more color on that in just a minute.

We've got a lot going on, TSYS acquiring, and I'm very optimistic about the long-term revenue growth and we think good things are on the horizon. With that, I'm going turn it over to Jim Lipham, our Chief Financial Officer, who is going to give you a lot more financial details. Jimmy?

Jim Lipham

Thank you, Phil. I've asked everyone, if you would, look at the P&L that was included in the press release and I'll try to add some comments about the various reporting lines there. First of all, looking at electronic payment process and services, that includes our, mainly our core processor services, as well as our license and arrangements, which we have at Card Tech.

This revenue line item's up, as Phil said 5.4% at $12.5 million for the quarter and then again, 4.8% for the year, or $21.6 million. This is especially good growth when you consider the loss of over $53 million that was in the second quarter of '06, then $103.6 million year-to-date, all this being associated with the loss of the two large customers last year.

On a pro forma basis, taking these revenues out of the second quarter of '06 and year-to-date, you would see the growth in our revenues and they are around 36%, both for the quarter and year-to-date. Our revenue growth has been fueled as we mentioned by internal growth, which continues to grow around 12%.

We've had also in the new business area, as well as acquisitions, we've added another 14.9% of additional growth. Our account on file numbers at the end of the quarter are 439 million and this is 73 million above the prior year, which is very good, considering the loss of the 51 million accounts from large customers after the second quarter of '06.

New clients have come on Board. They have added 105.5 million accounts. This is accounts not only in the consumer side, but retail, gift card have had some healthcare accounts, so very good growth in accounts. Internal growth from our other customers have added about 33.1 million accounts, and like we mentioned before, we converted 59.1 million accounts.

We've seen good growth in our transactions. They are up 12.9% for the quarter and 11.5% year-to-date, total for about $5.3 billion transactions year-to-date number. Authorizations also showing good growth, up 13.8% for the quarter and up 12.9% year-to-date. International revenues, as Phil mentioned, when you look at those after reimbursable, they increased $28.8 million, or 42% for the quarter and 58.2% or 44.3% for the first six months.

The increase is as a result of good growth in our European business and revenues associated with our international acquisitions. This is mainly Card Tech, as Phil mentioned before. International revenues, specifically those from Europe, they were positively impacted by the CTA, or currency translation adjustments for the quarter to the tune of about $4.1 million and then for the six months, at $9.2 million.

There again, that does include reimbursables. Our value-added service revenues, they grew $8.6 million, or 8% in '07 over '06 and for the year that represented 13% of our total revenues, including reimbursables, so it's still showing the good growth, or good percentage of our total revenues. On the dropdown on the merchant services line, we're down when compared to last year.

TSYS acquiring revenues decreased $1.9 million for the quarter and $6 million on a year-over-year basis. Large part of the decrease for the quarter is the result of reclassifying certain revenue items of approximately $1.2 million in '07, as reimbursables, when you care back to '06. These reimbursables are re-classed reimbursables is for a fee that we were not being assessed in '06 that we are in '07 and leave the revenues out to reimbursables.

But Phil mentioned earlier sequentially our revenues increased for the quarter over first quarter 5.9%, or 6%. And mainly this is due because of the transaction volumes over the first, for the quarter, over the first quarters, which -- the first quarter, historically is the lowest quarter of transaction volumes historically.

On a year-to-date basis, the decrease of 6 million is a result of two large deconversions. We've talked before about Heartland and Cert Gee. We've reclassified 1.4 million in 2007 revenues as reimbursable items, which I mentioned. And then we continue to have weakness in our TSYS POS systems and services, which is the terminal business that we mentioned before, and it does have a very low profit margin, but it continues to slow and weak.

We've had comprised compressions from the renewal of three of our top five customers, as well as three more of our top 20 during '06. These revenue losses are being somewhat offset by the internal growth in our existing acquiring class. And this is evidenced by a growth in front-end transaction volumes during the quarter of 13.7%, and for the year, 14.5. We did have internal growth from current business during the quarter of about $5 million.

Until we anniversary these deconversions and price concessions, which will be late this year, revenue growth will continue to be restrained. We anticipate TSYS acquiring revenues to stabilize and see some growth sequentially between the quarters for the rest of '07. TSYS acquiring operating income for the second quarter of 07 was 16.2 million, a 9.7% increase over the second quarter of '06. This clearly shows what a great job our team is doing in controlling these expenses after these deconversions of last year.

Operating margins, excluding reimbursables, have increased to 27.8% in the second quarter of '07 compared to 24.5% for the same period last year. So acquiring -- continues to develop new products, including enhanced merchant statement capabilities, contact those payments and give cards and we're anticipating their revenues to sequentially, as I have said before, continue to grow quarter-over-quarter.

We return back to the consolidated revenue and look at the other services in line for the second quarter, increased 23.1%, or $10.3 million. Approximately 60% of the increase is a result of the new joint venture with Data Dimensions in Europe, this is a TSYS managed services, EMEA, and we own, if you remember, 55% of the -- this is constant of business and it’s doing very well.

ESC, our loyalty company, makes up another 33% of this growth and it's mainly attributable to growth in the redemption business and the new loyalty platform. And the remainder of the increase in this category came from our growth and profit product, as more customers have signed on to this product.

I might mention here also, that our -- we've seen good growth in our loyalty income. Its total revenues are up 41% there. TSYS prepaid, seeing some good growth. Our revenues there year-over-year are up 26.6%. So, we're seeing good growth in those areas.

Revenues for reimbursable items have increased 11.2% for the quarter and is primarily as a result of the Phase II fees for TSYS acquiring and the treatment of court costs as a reimbursable items, as a result of the trend associated with renegotiated contract and total debt management. Total revenues for the second quarter increased 7.2% and 5.7% for the first six months of the year.

As we look down the page at the expense lines, few comments there. Our expense growth in employment was 20.8%, or $25.1 million for the quarter. As a result of the acquisitions of TSYS Card Tech and TSYS Managed Services, we had approximately $8.3 million of additional employment expenses. Europe's big growth has impacted employment costs by another $5.2 million, as they increased head count by about 100 people over last year.

We had a reduction in our capitalized salaries and contractor costs around another $7 million, which is less development going on. And on a sequential quarter basis, employment expenses are up approximately $5 million. Our head count at the end of June is approximately 6773 people that’s 231 people more than it was in June of '06.

When you exclude the employees who were associated with Card Tech and Managed Services, we’re actually down 216 people from June of '06. The relocation of our prepaid Manhattan, New York office is on schedule and is to be completed during this third quarter of ‘07 and we continue to look at our allocation of people resources to assure we're properly managing this resource effectively.

Drop down to occupancy and equipment, we are decreased 10.2% for the quarter, $7.8 million and is down to $67.9 million. We continue to experience a decrease in software amortization on MIP’s-based software and we also continue to get good reduction in our equipment and rent expense with the renegotiation of our leases on hardware.

The other expense category is to 11.7% for the quarter. A large part of that being attributable to the lower transaction delivery cost that TSS is acquiring. We’re also -- the reclassification of other expenses, court costs, reimbursables and then again, we've had lower TS2 conversion amortization since the loss of the big customer last year.

When you exclude reimbursables, our operating profit margin for the quarter was 26.3% and as Phil mentioned before, we do expect our margins to continue to stay in that range of 24% to 26% as we finish out the year. Our other income increased $2 million over the second quarter, both of '06. The increase amounts -- the cash available to invest, as we continue to show good growth there and we've had increases in our short-term interest rates also.

Income taxes for the quarter, they are up 14.3%. Effective tax rate for the quarter is 35.3% compared to 35.5% for last year. Our effective tax rate is slightly lower this quarter and we otherwise our effective tax rate to be around 36% for the year. What's attributing to that, if you remember, the first quarter we had the FIN 48 adjustment that caused our rate to jump up to 38% for that quarter.

Net income for the quarter, as Phil said, up 14.4%, or $8.3 million. Earnings per share at $0.33, and up 14.7% over the 29% for the second quarter of last year. Overall, a great second quarter and a great first half of the year. I would ask if you would to flip to the balance sheet and I'll make just a few comments there and then on the cash flow.

Unrestricted cash at $452.2 million obviously increased $63.1 million since December of '06. We now have approximately $2.29 of cash per share. We revised also our analysis of intangibles for the 2006 Card Tech acquisition and it caused the changes to be in the good will and the acquisition intangibles. Outside of that, that's pretty much the major changes on the balance sheet.

Look at the cash flow statement, you'll note our significant contribution in cash generated from operating activities of $120 million for the first six months, and we continue to generate a significant amount of cash for investing in financing activities. We did invest $21.4 million in property and equipment, which is mainly hardware, and $12.3 million in software, which is broke up about $4.8 million purchased, $7.5 million of that's been developed software.

And we also paid $27.6 million in dividends so far this year. In our free cash flow analysis that number now is $76.3 million year to date. With that, I wanted to add one more comment. I know there's some questions about Chase and I wanted to make a few statements there. As you know, they have elected to migrate the consumer portfolio in-house, and go under a perpetual license with a modified version of TS 2, with a six-year payment term.

So they will discontinue the processing agreement at the end of July, I believe it's July 28, and in accordance with original schedule and then they will start licensing the profits of software in the third quarter of '07. We mentioned before the revenues associated with the licensing arrangement are much lower than the revenues associated with the processing arrangement, but the impact of the consolidated results of operations is not significant, as we have planned and implemented during the year, a pairing down of resources dedicated to the consumer portfolio through employee attrition and redeployment, as well as, through equipment lease expirations.

As we go forward, we'll continue to support Chase in processing this commercial portfolio. On our projected net income for '07, and when you compare that back to '06, our revenue -- our net income from Chase is up 5.7% year-over-year.

And with that, Phil, I’d like to turn it back over to you.

Phil Tomlinson

Thank you, Jimmy. As you can feel and hear, that we have an awful lot going on, and we are certainly pleased with our first six months, and we certainly expect to close out 2007 in good fashion.

With that, I'm going to open it up to questions, Kate, if you will, but please remember, we're not going take any questions on this announcement.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question today is coming from at Adam Fritsch. Please announce your affiliation, and then pose your question.

Glenn Waldorf - UBS

Actually it's Glenn Waldorf from UBS. Congratulations on another great quarter.

Phil Tomlinson

Thanks, Glenn.

Glenn Waldorf - UBS

Talking about the pipeline, you said it's picking up. I was wondering if you could characterize the make up of it. For example, between banks, non-banks, small banks, large banks, and/or -- how has this makeup changed versus how it's historically looked?

Phil Tomlinson

I think it's, I can't say that I'm, I feel any real difference. Obviously we -- there is certainly more activity on an international basis. The -- I think the, obviously the news in the market with, the LBO’s, First Data, Alliance Data, would create some, if nothing else, consternation among those -- among those client bases.

But what we are -- we are very, very encouraged by what we're seeing today. But it's -- Glenn, it's -- what we're seeing is across the Board. It's not only in the card holder business; it's in the merchant side of the house. Even with our value added products such as profit, we're seeing a lot of activity where people want to pick up that product and, we’ve -- they think they can save themselves a lot of money and evident and provide a higher level of service.

It just gives us a lot of encouragement. Now, I'm I don't mean to imply that we have some massive announcement that's coming soon because I don't think that's the case. But we are moving forward and we are doing good with, perhaps our current clients and certainly prospects around the world.

And I wouldn't want this, Huaxia bank in China to go unnoticed. That is a really big win for us, that's a top 10 bank. We think we're picking up speed in China, there's still not a lot of activity going on in Japan. But we're very encouraged in China; we're very encouraged in Europe. We have some good things going in Canada, and we have a lot going on in the U.S. Not really anything to speak of in South America.

Glenn Waldorf - UBS

Great. And then, while we're on the China subject, appears that CUP has been working on expanding its ownership base, bringing in more investors. Can you talk about how you see that impacting you, and perhaps the China card market overall?

Phil Tomlinson

Well, we are very close with CUP and CUP data, and we are, we feel good about the moves that they are making. They are trying to expand their footprint, and we think as that happens, that's going to be long-term, that's going to be good for TSYS.

Glenn Waldorf - UBS

Okay, great. Thank you very much.

Phil Tomlinson

Thank you, Glenn.

Operator

Thank you. Our next question today is coming from Tony Wible. Please announce your affiliation, then pose your question.

Tony Wible - Citigroup

Morning. I have a few for you guys. I was curious if you could talk about the Canadian market. It's doing quite well, and I was just curious what's driving a lot of that performance in the portfolio.

Phil Tomlinson

Well, our, you know, we have, we have a pretty large market share in Canada and so we are certainly very involved in Canada. I think that, you know, from what we can see, their economy's doing well, they have certainly always been a big debit market. We, you know, as you know, we signed -- Dominion last year, late last year. We converted them late last year.

That was a big win for us. There's a couple more up there we would certainly love to talk to and we love the Canadian market. You know, I hope nobody takes this wrong, but we just think it's certainly a much more civilized market than the U.S. is and they are just fun people to do business with. They are good business people, but -- and I think that they are really getting into the card business.

I mean chip and pen is coming. All of them are sort of pulling together on, in that area, and they are pretty excited about what's going on in that market up there. I, I can't really tell you anything specific that would make you feel good about that, but overall, they are just a very enthusiastic group of issuers.

Tony Wible - Citigroup

Right, and if we look at the international part of the business in whole, how big do you think that business can be in three years, and what are the key catalysts for growth that you're looking for?

Phil Tomlinson

Our goal is by the end of 2010, that it will be 30%, 35% of our business. That's up from -- that would be up from 17%, 18%. Obviously the keys would be some, some -- to win some, some big clients, not only in the U.K., but on the, on the mainland of Europe. You know, we, we're watching this ABN Amro issue, that's ongoing, RBS is our largest customer in Europe. We do a lot of business with Barkley.

We don't know how that's going to turn out. We hope that we'll win in that transaction. That's the one thing that we always worry about, is consolidation. But, you know, we think at some point we'll be able to take merchant processing to Europe and to other parts of the world. We have, we have done a much better job of having a full array of services, as you recall last year we announced this joint venture with Dimension Data.

It puts us in a lot more businesses than we've been in previously, and it was an area that after continued conversations with a lot of European customers, that we felt like we had to have that span of products in order to be successful long-term and we've done that. I mean our plan is to, is to move into the countries that we would like to be in a big way, would be Spain, Italy, Germany, the Netherlands, all up through there.

We're a very optimistic group and certainly if things pop up in other places then, we'll certainly go after them. We think there will be some more consolidation of processors in that marketplace. You've seen several of them fall already. You know, we would like to play in that arena, if possible. I mean we, we really have been disappointed in what has happened in Japan so far, as -- when it relates to, as to being accessible in signing car issuers there, we've got a very good merchant business there.

We've done well in prepaid there. We've done a little processing with Toyota, Nikko Cordial, but just haven't been able to hook the big one and we'll certainly continue to try there. As I just said earlier, we just have not been able to grab that brass ring in South America for a lot of different reasons, and we have opened an office recently in Brazil. You know, there's two or three countries that you would really like to be in South America and certainly Brazil is by far the largest.

We are very encouraged by what's going on in Europe and in the U.K. right now. A lot of discussions, a lot of prospects, and we think we're going to win more than our share. So international is going to continue to be a huge push at TSYS. We think it is one of the real high growth areas that, we're going to be after over the next three to five years, and beyond that.

Tony Wible - Citigroup

Thank you.

Phil Tomlinson

I don't know I can tell you a lot more beyond that.

Tony Wible - Citigroup

No, that was really helpful. I guess this last question acts on a little bit to that, but also more broadly speaking. As we think about M&A and strategic considerations, when did you know you have a lot of opportunities ahead of you, covered a lot of ground even on your international question.

What kind of size deal would you feel comfortable doing at this point? Are you looking at still small maybe tuck-in acquisitions, or would you be looking at larger deals that put you in a new area?

Jim Lipham

Well, I think at this point, we're looking for smaller deals. I mean, you know, we've got a lot of cash sitting there. But basically we're in the cash acquisition business, and so that's what we're looking for, something that makes sense, and, there's some deals out there to be made. It's just like Card Tech.

I mean as I said earlier, this Card Tech thing is turning out to be better than what we had hoped, and you'll be seeing some announcements coming out of that area. I mean we had the one out of Qatar this month, but there's some others in the works.

They are not huge, but they get us into countries and they get us into banks very quickly and in some ways, it's much easier to take that Prime software into these emerging and developing countries than it is to take TS2, which is just this massive software that is really built for large issuers. So we're very excited about what's going on with Card Tech and think it's a real, really, a real add-on to TSYS.

Tony Wible - Citigroup

Okay. Thank you. Appreciate it.

Jim Lipham

Thank you, Tony.

Operator

Thank you. Our next question today is coming from David Charles (ph). Please announce your affiliation. Then pose your question.

David Charles

All right, good morning.

Jim Lipham

Hey, David.

David Charles

Couple of things, some terrific results this quarter. I just wanted to clarify after all these quarters. The 12% internal revenue growth, organic growth, is that just from your installed base of clients, or does that include your installed base growth plus new clients and excluding acquisitions?

Phil Tomlinson

It's just the installed base, David.

David Charles

Okay.

Jim Lipham

It's sort of like same-store sales.

David Charles

Got you, so arguably, internal growth, if we could find that, is everything excluding acquisitions, because even higher than 12%. Can you give a little more color or granularity on what's driving such strong growth on your installed bases is it internal Card account growth is it value-added services? You know, that's just a tremendous figure in this kind of credit environment.

Jim Lipham

I think you answered your own question. I mean there's a lot of new products coming out. I mean when you think about the fact that we, we added that loyalty business, which is turning out that's going to be a really good add for us. It was a little tuck-in acquisition and they have come along very nicely.

I mean as an example, with that business, I mean they -- I'm not going to go into the clients that use them, but I mean we've added -- I say we've added, four or five of our very largest clients have signed up for TSYS loyalty. I mean it is a -- you know, it's a big number.

Profit, I talked to you about earlier. Profit is one of the neatest systems in the world, we believe, and you've heard me say a couple of years ago that frankly at some point I think we could sell it to people other than the bank card industry and I still feel that way, but we're really trying to focus on our customer base. It is a really neat product. I think people are still excited about the card business.

David Charles

Are you…

Jim Lipham

Obviously the, you know, just new services, the numbers there -- can I tell them this number?

Phil Tomlinson

Yeah, that's fine.

Jim Lipham

New services in 2007 is right at $30 million, and new services includes all those things that I was talking about earlier and a few more. But it's, kind of a neat way to do business. People just keep buying product from you.

David Charles

Got it. Are you able to quantify or, get a sense for what potential drag in the second half just be subprime environment might be?

Jim Lipham

Well, again we worry about consolidations. We worry about the economy in general, particularly housing. I mean if the consumer gets in trouble with housing, we haven't seen a lot of that yet and we haven't heard a lot from our customers on that issue, but we know there's some -- it's going to some degree.

Our business is sort of -- and I hate to use the R word, but it's almost recession-proof. We've gone through, in the past 30 years, several downturns in the economy and our business really never has been badly hurt in the process. So, we're keeping our fingers crossed that folks will stay positive about the economy and what's going on. We do worry about our legislation and what the politicians might have on their mind and that's always something that everyone in this business needs to be worried about.

David Charles

Got it. Last question. Can you talk a little more about the prepaid business in general? Obviously the Wal-Mart product is a significant milestone, but just in terms of the, card economics, the processing economics of prepaid versus a traditional consumer credit card and perhaps a little more color on how all these various parties, including Green Dot, who is really loading these, split up the fees, because it's still a little uncertain on the value chain here?

Jim Lipham

Well, I am processing, I am not going to get into the Green Dot side or the GE side, but our processing of revenues, they would not be as high on a per account basis, or per transaction basis as a traditional credit card, at least at this point.

Now, we think that this market is, is on the verge of explosion. We think there will be a lot of consolidation in this market as far as the processors. There are a lot of people that are processors that are making their money on the breakage, if you will, from the gift cards and prepaid cards and breakage is nothing more than the money that is not used on the card and just sort of goes away.

So we, we're not in the breakage business, so you can rest assure order that. But we feel, we feel like this business is about to explode. We are working on some more deals that are household names that you would certainly recognize, and to date, it has not been a great business for us.

But we think as consolidation occurs, as these cards are more readily accepted as more branding occurs, that, 30% of this country is unbanked and we think this is a great way for people to get paid, to be able to manage their money, to be able to transfer money, and I think it's just going to take time.

I was talking to some people the other day and it took us about 20 years to get people to use a debit card, and I can remember talking about debit cards forever, that this was something that was, it was common and then when it got here, it was going to be big.

Everybody's got a debit card today. You're starting to see a prolipheration of prepaid cards. I think that when you see folks like Wal-Mart, who is the largest retailer in the world, issuing these cards and certainly you're going to see others issue them, it is a, it's a great way to get the consumer back in the stores and it certainly will help folks feel like that they've got a regular Visa and or MasterCard.

So it's a business whose time has come. As I say, we think there will be consolidation. I mean in today's world when you, we're dealing with regulators and PCI and Visa and MasterCard and we just don't think that there's a lot of people in the prepaid business, who in long-term will be able to stand all that pressure that comes along with doing business with banks or financial institutions and all of the requirements associated with that.

So, we think we're in a pretty good seat. Now, it is a profitable business. It's a business that we can make a lot of money in. I mean, obviously, this move from New York to Atlanta, Alfredo was not something that we originally planned and we had rather not have gone to that expense.

Once we get that behind us, it's going to help to streamline our business, but we are very optimistic about where this business is headed. Now, if it doesn't paying out, I've been so optimistic with our Board, if you see me get running off, it's probably over the prepaid business.

David Charles

Got you. Very well. Thanks so much. I'll let others hop on.

Phil Tomlinson

Thank you.

Operator

Thank you. Our next question this morning is coming from Tony Davis.

Tony Davis - Ryan, Beck & Co

Okay. Good morning, Phil, Jim.

Phil Tomlinson

Hey, Tony. How are you?

Tony Davis - Ryan, Beck & Co

Good quarter.

Phil Tomlinson

Thank you.

Tony Davis - Ryan, Beck & Co

Just wondering if you could fill in a few numbers here. What, if you could define, what the Card Tech revenues were or what the growth in revenues were last quarter internationally, excluding them? And then secondly, on the merchant side, the percent of revenues, I guess, at that division, Phil, that are derived from contracts will be expiring over the next couple of years.

Jim Lipham

Tony, this is Jim. And on Card Tech, their revenues for the quarter, including the reimbursables were about $9 million, year-to-date’s about $18 million.

Tony Davis - Ryan, Beck & Co

Okay.

Jim Lipham

Vital -- excuse me, TSYS acquiring, I don't have that breakout here with me.

Tony Davis - Ryan, Beck & Co

Okay.

Jim Lipham

Or if contract renewals --

Tony Davis - Ryan, Beck & Co

Okay. We'll circle back.

Jim Lipham

All right.

Tony Davis - Ryan, Beck & Co

And Phil, you talked about transaction size. I wonder if you could give us a little bit more color of your thoughts on the M&A front, in terms of vertical or geographic markets that you're really actively considering here.

Phil Tomlinson

Well, I don't think that we're saying we've got anything imminent here, Tony. I mean, we'll continue to look for things that make sense for TSYS. Obviously, they’ve got to be in our range of, our business range. As an example, we have really cranked up our healthcare efforts around here. There's a lot going on in the healthcare business.

We would like to do more in the merchant acquiring area. And I think our acquisitions will continue to be in the same range they’ve been in the past years.

Tony Davis - Ryan, Beck & Co

Okay. Jim, and one final question for you.

Jim Lipham

Okay.

Tony Davis - Ryan, Beck & Co

You had identified some expense savings a while back from reassignments, support, consolidation and things like that, and also hardware, software expense saves. Any more color on kind of where you are and all that?

Jim Lipham

Tony, I guess where we are now is most of everything is in place. We do have some equipment benefits coming next year. The rest of it has to do with the attrition on our employee base and as we have said before, it's still -- today it’s down 216 people year-over-year, and I'm just not sure how much more growth we’ve got, or benefits we’ve got as far as the head count reduction. But we do have a little bit more in equipment for '08 coming.

Tony Davis - Ryan, Beck & Co

Okay. Thanks again.

Phil Tomlinson

Thank you, Tony.

Operator

Thank you. Our next question today is coming from Paul Badulak. Please announce your affiliation then pose your question.

Paul Badulak - Credit Suisse

Thanks. Paul Badulak from Credit Suisse. Just a follow-up on the margins. You guys have obviously done a pretty good job in taking the costs out and already are at the high end of your target range. And maybe you just answered this, but with already being at the high end of the range, any benefits that we'll see in the back half, or are you kind of through all the cost savings benefits, or just I guess any other color on things in the back half that might impact margins?

Jim Lipham

Paul, in the back half of this year, I think everything is pretty much in place. I think you'll see margins in this quarter will probably be the highest as they were going to be all year and so, we'll see a little bit of comeback on that margin growth in the third and fourth quarter.

Paul Badulak - Credit Suisse

Okay. And I mean, the chase moving in-house, I mean that should benefit margins, right?

Jim Lipham

It will.

Paul Badulak - Credit Suisse

Okay. And all the Chase stuff, revenue declines, that's already in the guidance?

Jim Lipham

Yes, it is.

Paul Badulak - Credit Suisse

Okay. And then just switching gears on TSYS acquiring, I mean the margins have been pretty impressive there, given the price competition you've seen. I mean any outlook on the margins in that business? Can you continue to maintain this level of margins given the pricing pressure you're seeing?

Jim Lipham

I think we can hold those margins. A lot of it comes from the transaction delivery cost and that's in place. It's volume-driven and then we've seen a lot of I guess employee decrease, employment expense decrease. I think that will remain.

Paul Badulak - Credit Suisse

Okay. And then on CUP data, you guys have seen some nice activity there. Have you guys given any sense of the size of that business and where you are in terms of margin in that business? Is there opportunities there to improve the processing and then take over that business?

Jim Lipham

Well, we certainly think there are opportunities to improve. We just do not believe that the government is going to let the hard business expand or grow sort of out of control, if you will.

I think our growth there will be very methodical and very controlled and every day we learn more about how you do business in China and it's very different than the U.S. and really any other part of the world that we're in, but we, we feel very strongly that we'll look back in five years from now and think that's the smartest thing we've ever done.

We think there will be good long-term growth in China. It's one of those markets that you just cannot be in if you're in the card business.

Paul Badulak - Credit Suisse

Great, thank you.

Operator

Thank you. Our next question today is coming from David Parker. Please announce your affiliation, and then post your question.

David Parker - Merrill Lynch

Good morning. It's David Parker of Merrill Lynch. Just following up on the Chase deal, you announced the timing on the migration is this weekend.

Is this simply something that you can handover the service portion of this deal to Chase, or is there going to be a period of transition as you help them migrate over? Where we might see some additional revenue?

Phil Tomlinson

It's pretty much, we've obviously been working on it together for months and months and months, but it's pretty much a transition over the weekend and certainly we will have for some period of time a group of people that is dedicated to helping make sure that that goes well.

We expect it to go well. I think they feel good about it and we feel good about it and I think it's been a grand partnership. And overtime we will have fewer and fewer people dedicated to that and certainly that number is down dramatically from what it was six months ago, but it's more of a, know, a data transfer.

David Parker - Merrill Lynch

Okay, great. And then on the acquisition side, it looks like the E-Funds might have been a good fit for you guys. Did you have any interest in those assets?

Phil Tomlinson

Well, not, not really. We had looked at E-Funds a couple years ago and they were a little prouder of what they were doing that we were willing to write a check for, so we didn't, we didn't look at it, but we wish those guys nothing but the best.

David Parker - Merrill Lynch

Okay, great. Thank you, guys.

Phil Tomlinson

Thank you.

Operator

Thank you. Our next question today is coming from Glenn Greene. Please announce your affiliation.

Glenn Greene - CIBC World Markets

Thank you, good morning. Just a couple quick questions, I was wondering if you could give us a little bit more color on the Wal-Mart money card program, maybe highlights from the pilot and sort of any way to think about sort of your expectations as we sort of proceed through the next year? Then I have got a follow-up.

Jim Lipham

I'm not sure we could give you a lot. We would probably prefer that you go to the owners for that. I mean, we are obviously just doing the processing, but we are excited about it. We, when you see something that big rollout into a business that has been okay, we think that is, that is a good for business.

And so, we're excited about that. We don't have any numbers yet. The pilot was pretty small really and the pilot took place over the holidays and, I'm just not at liberty to give you any details on it.

Glenn Greene - CIBC World Markets

Probably fair to say you haven't baked much into your expectations for it this year or anything like that?

Jim Lipham

That is correct.

Glenn Greene - CIBC World Markets

Okay. And then have you quantified at all the adverse revenue impact sequentially from the J.P. Morgan situation?

Phil Tomlinson

No. We have not quantified it publicly.

Glenn Greene

Is that something you would do?

Jim Lipham

Well, I think from our comments we made, that, the revenues are going to go down, but we didn't quantify that. And then we’ve mentioned that the net income is going to be fairly insignificant.

Glenn Greene

I'll leave it at that. Thank you.

Operator

Thank you. Our next question today is a follow-up from Adam Fritsch.

Glenn Waldorf - UBS

Hi, it's Glenn Waldorf again. Just looking at the top line, the inquiring solutions segment, you're talking about anniversarying those, the attrition effects and such throughout the rest of the year. So, if I were to model this here, we had a decline in revenues year-over-year a little over 2% in the second quarter. Would you say the third quarter would still be negative, and then we’d reach a sort of positive comp by the fourth quarter?

Phil Tomlinson

Just trying to think if I had the third quarter. Now, I mentioned in the presentation that sequentially we'll see some growth in the third over the second, as well as, the fourth over the third, and thinking about year-over-year. I believe it's still -- it's still going to be positive in the third and the fourth quarter.

Glenn Waldorf - UBS

Okay. Other than you alluded some of the other answers about, some consternation of customers at First Data and Alliance Data systems, given what's going on there. Can you talk about any opportunities those transactions may have created for you, or anything you're seeing in the market as a result of them?

Jim Lipham

Glenn, we don't talk about active prospects, but I made that comment just -- you would think there would be certainly consternation about ownership of your processors and what will happen in an environment like that. It's sort of -- sort of new in a lot of respects. And certainly it's caused a lot of conversation in this industry.

Glenn Waldorf - UBS

Okay, great. Thank you.

Phil Tomlinson

Thank you.

Operator

(Operator Instructions) Our next question today is coming from Roger Smith. Please announce your affiliation. Then pose your question.

Roger Smith - Fox-Pitt Kelton

Yes, it's Roger Smith from Fox-Pitt Kelton. I know there was a lot of questions on the M&A. I just want to go over a couple of quick things. You mentioned a lot of stuff that you wanted to get done in Europe and Spain and Italy and Germany and the Netherlands and as well in South America.

And, I just wanted to try and gauge what the acquisition availability is right now in terms of your capacity. And how much you could end up using in the next couple of years, and really kind of what would this timeframe sort of look like from an acquisition point of view? Is this something that we would think of as a 10-year plan or a 3-year plan?

Jim Lipham

Roger, just off the top of my head, I’d say we're looking at a, over the next five years, when you think about it, we've only been in the international business in a significant way for six years now and we've done, I think very well, and I think, we'll continue to do well.

But we have learned that doing business internationally is different and it's a -- I don't know this any harder, but it's certainly different and you have to -- you have to learn the way of the world, where you're at. When it comes to acquisitions, we -- if you think about it, we've never been very acquisitive. We've typically built from the ground up and signed one customer at a time, which is a wonderful way to do it, if at all possible.

And that’s would certainly be our preference. We don't think that that is necessarily the way we're going to have to do it this next go around. So, I think we'll certainly be looking at what's available, in most every country that you could name, there are certainly people that could jump-start into that business.

What we have to be careful of is we don't buy something that just buries us with problems, and quality and is very difficult to manage to the standards that we have with our current customer base. And you see a lot of that with acquisitions. We want to be the absolute best at what we do and sometimes it's very, very difficult to take these small acquisitions -- I've told our Board in some ways it's almost like being in the adventure capital business. It's, you know, they just -- we have to bring them up to the standards that I talked about a minute ago in the prepaid business with PCI -- and SAS 70 and Sarbanes-Oxley and all of the things that we have to deal with.

When you start talking about all of that with these small companies that have never been exposed to it, their eyes just glaze over. So it's, it's a long, hard process. I think really we’d like to do, you know, larger acquisitions and -- with folks who are established and understand all the things that you have to do to be really good at this business.

Roger Smith - Fox-Pitt Kelton

Great, and I mean at one point I think about a year ago you had talked about being able to do a billion dollars worth of acquisitions. Is that a number that I should still think about as a range of possibility?

Jim Limpham

Yeah, I think it's possible. You know, if the right deal -- but I remember that and I just wondered if I had been drinking the night before or anything. I mean, I've got our general counsel over here looking at me kind of funny, but, yeah, we think we're going to have to be in the acquisition business and, and we are going to do it. We've got -- I mean it's a business, though, that we've got to learn and we've got to do well and it's -- for to us do a really big one like that, -- it's got to be something that we've really got to have bad obviously.

Roger Smith - Fox-Pitt Kelton

Great. Thanks a lot for your time.

Phil Tomlinson

Thank you. Okay. With that, I think we're going to cut off the questions and let everybody go back to work. We really do appreciate you being on the phone this morning. Obviously there's an awful lot going on and I know you have probably got a lot of follow-up questions that you can call us, call or e-mail Shawn Robert. Shawn runs our Investor Relations department. His number is 706-644-6081.

Thank you for your interest. Thank you for bearing with us. If you haven't noticed, we are very excited about the progress we've made. When I step back and think that last May, I hosted an Investor Relations meeting in New York and told you that we would be down 15% to 17%, or 17% to 15%, I think it's rather incredible what our people have been able to accomplish and they have really done a great job and we haven't sacrificed quality.

This is still a great place to work and so we are very bullish on our future. Thank you for being with us. Thank you for your interest and thank you for your support.

Operator

Thank you ladies and gentlemen. This does conclude today's conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.

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Source: Total System Services Q2 2007 Earnings Call Transcript

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