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Total System Services, Inc. (NYSE:TSS)

Q3 2007 Earnings Call

October 23, 2007 8:30 am ET

Executives

Phil Tomlinson - Chairman and CEO

Jim Lipham - CFO

Analysts

David Scharf - FTN MidwestSecurities

Paul Bartolai - Credit Suisse

Glen Fodder - UBS

Tony Wible - Citigroup

Tony Davis - Stifel Nicolaus

David Parker - Merrill Lynch

Glenn Greene - CIBC

Operator

Good morning, ladies andgentlemen, and welcome to the TSYS Third Quarter Earnings Release ConferenceCall. At this time all participants have been placed on a listen-only mode. Wewill open the floor for your questions and comments following the presentation.

It is now my pleasure to turn thefloor over to your host, Phil Tomlinson, Chairman and CEO. Sir, the floor isyours.

Phil Tomlinson

Thank you, Danielle, and welcometo our third quarter earnings call. We are very excited about it. Obviously,before I get started, we wanted to call your attention to the fact that we willbe making forward-looking statements about the future operating results ofTSYS. These statements involve risks and uncertainties. Factors that couldcause TSYS actual results to differ materially from the forward-lookingstatements are set forth in our annual reports filed with the SEC.

I want to open this call bysaying that we're not going to have any comments and we're not going to try toanswer any questions about the possible spin-off of TSYS. The process continuesand it will just continue on until a decision is announced, so that's all wewill have to say on that. We did have a grand quarter. I'm sitting here lookingat these numbers, I'm also sitting here looking outside and it's pouring withrain and we've gone through one of the worst droughts in the history of thispart of the country, so it is a good day all the way around. We have a lot ofpositive things to talk about today. Our results for the third quarter continueto show what hard work, dedication and commitment can do.

Just a few numbers. Revenuesbefore reimbursables increased 4.9% for the quarter and 5.1% year-to-date.

Our net income increased by anamazing number of 26.7% for the quarter, and 18.3% year-to-date.

Operating income increased 26.2%for the quarter, and 19.2% year-to-date, up 300 basis points for the year --I'm sorry, I'm talking about operating margins. Operating margins year to dateincreased 300 basis points from 22.6% to 25.6%, which is rather incredible, wethink.

Diluted earnings per shareincreased 26.5%, to $0.35 for the quarter and 18.4% or $0.97 year-to-date.

Internal growth continues to hiton double digits for the quarter and year-to-date and Jim is going to talk moreabout that later.

As you saw in the earningsrelease yesterday, we continue to expect to achieve our previously-announcedguidance for net income, which is 20% to 22% on the non-GAAP basis, and we'reon track to make our 0% to 2% increase on a GAAP basis. After some massivelosses last year. I can't overstate how pleased we are with our team's abilityto manage expenses, increase organic revenues, and continue exceedingexpectations as well as selling new business.

I also wanted to take a momentand talk about the Royal Bank of Scotlandand their win in acquiring ABN AMRO. As you may or may not know, we process forboth of those banks, and we believe it is a real positive for TSYS. Bank RBSgains a stronger international footprint with this deal, and we believe that wecan expand that relationship as time goes by.

In last quarter's conferencecall, we talked a lot about competition in our sector and I wanted to sharewith you some of our highlights we had in the third quarter. One is, we havehooked up with Discover Financial and signed an issuer processing agreement,and we'll begin processing prepaid and credit card transactions on the DiscoverNetwork, which of course is a business unit of the Discover Financial Services,very similar to what we do with Visa and MasterCard. It just gives us anotheroutlet, another window into some business that we think we can win.

In the UK,our international business continues to impress us. We signed a long-termagreement with Nationwide, who is the world's largest building society. We'regoing to process the credit card portfolio and we're going to build, operateand manage a new customer care center in Coventry.That is a really big deal for us because we're really managing the entireprocess for them. As a result of that scope of services Nationwide, when it isall converted, will rank among our largest clients.

We also had another internationalwin with Tinkoff Credit Systems, a Moscow-based consumer lending bank. ThroughCard Tech, we're going to supply its card management and authorization systems,and the bank that plans to become the first mono-line card issuer in Russiaand will focus exclusively on issuing credit cards.

Also back to the UK,we successfully launched a new money transfer card in the UKthrough Lloyd's. The new silver account from Lloyd's includes an innovativemoney transfer prepaid product, and it's primarily aimed at the growing numberof new immigrants living and working in UK.Commerce Bank in New Jerseyselected TSYS Collections and Recovery to manage its entire collections andrecovery inventory for the bank. This allows the bank to be much more efficientin working all of its delinquent and charged-off accounts including installmentaccounts, automobile loans and mortgages. This is somewhat of a new venture forus and we think there's a lot of great possibilities in this area for TSYS. Wealso announced a multi-year agreement to provide merchant processing servicesto Veracity Payment Solutions headquartered in Atlanta.They will offer a complete electronic payment processing service as well ascard acceptance consulting to businesses around the country.

Talking about international, ourinternational business continues to perform extremely well and the thirdquarter is certainly no exception. International revenues increased 28% for thethird quarter and 38% year-to-date. We continue to be very pleased about whatis going on with TSYS Card Tech in the UKand the great opportunities that we expect from that server-based processingplatform. We're also, I think, making really good progress with our jointventure with CUP Data in China.The momentum is building, we continue to have client wins, and to-date, we havesigned 34 issuers in China.We have signed them or we have letters of intent with 34 different issuers fromtop five banks down to regional-type banks, so we're very excited about thelong-term prospects in China.

Moving on to value-added, ourvalue-add products have continued to be a solid contributor. Revenues increased6.1% in the quarter and 7.4% year-to-date. One of the key strategies we havehere at TSYS is to be able to continue to sell new and current products intoour customer line-up. On the merchant side of the house, we're pleased toreport that TSYS Acquiring Solutions continued its outstanding operating margingains and its operating income increased 20% in the third quarter compared tothe same period last year. And we believe that they're starting to turn thecorner on revenue growth. Jim Lipham is going to give you some more color onthis in just a minute.

Speaking of Jim, I want to goahead and turn it over to him to give you some real details about thesefinancials. Jimmy?

Jim Lipham

Thank you, Phil, and I'll askeveryone to focus on the income statement provided with the press release andI'll try to give you a little color on some of these numbers. Starting with thefirst one, the Electronic Payment Processing Services, obviously that's ourcore processing business and license, and it shows an increase in the quarterof 3.6% or up $8.4 million, and up 4.4% or $29.9 million year-to-date. This isespecially a good growth when you consider that for the quarter we lost $43million of revenue that was in the third quarter of last year, and over $157million year-to-date that was all associated with the deconversions since Juneof '06.

On a pro forma basis, takingthese revenues out of the third quarter of '06, our quarter-over-quarter growthin revenue would be up over 27%, and then year-to-date would be up 35%.Outstanding growth. Our revenue growth really has been fueled a lot by ourinternal growth and as you saw, showing 15% for the quarter and year-to-date.And was changed from what we said last quarter, around 12%, has been theremoval of Chase out of our internal growth numbers. As you know, they tooktheir processing in-house during the quarter. But in addition to the internalgrowth, we had a new business that includes acquisitions added about 12.7% ofour additional growth for the quarter and then 16.6% year-to-date.

Our account-on-file numbers aredown at 357 million. That's 43 million lower than they were prior year. The netdecrease as a result of the loss of 136 million accounts, mainly from these twolarge customers that we lost since the third quarter of '06. This decrease wasoffset by new clients that added about 71 million accounts, and then ourinternal growth added another 32 million on top of that.

Our volumes for the quarter, theywere significantly impacted by the deconversion of Chase's consumer portfolio.We saw our quarterly transactions drop down 12% to 2.2 billion, althoughyear-to-date they're still showing a positive number of being up 3.5% to 7.5billion. On the authorization side for the quarter we're down 13.1% to twobillion and year-to-date we're up 3.9%, or 6.8 billion.

On the international front, Philmentioned it the revenues increased $23.2 million or 28% for the quarter, and$81.4 million, or 38% for the nine months. And this increase as a result ofvery strong growth across all of our geographical regions, as Canada,Mexico, Japan,Europe, and the revenues associated with theacquisitions we made internationally, such as TSYS Card Tech. As you know, wethought those guys were in our third quarter '06 numbers, but for theyear-to-date they're an additional $21 million more than last year in revenuecontribution.

The international revenues alsowere positively impacted, mainly from Europe, by the currencytranslation adjustment, when you consider for the quarter $4.3 million as CTAbenefit. This includes reimbursables and for the year-to-date is $13.5 million.Value-added services, which Phil talked about, grew $12 million or 7.4%. Andfor the year, they still represent around 13% of our total revenues and it'sbeen that way for some time now, so they’re still a very good contributor toour operating income line.

On the Merchant Services line yousee that revenues are flat for the quarter. When you look at -- and they'redown when you look as compared to prior year. But the main item in here is TSYSAcquiring and their revenues actually decreased $1.2 million for the quarterand $7.6 million year-to-date and the decrease is a result of two largedeconversions. We also had a reclass in '07 of revenues as reimbursable items.This is about $2.2 million and they will continue to have the weakness in thepoint-of-sale business that's been going on for over a year now. We also stillhave some price compressions we were suffering through here from therenegotiation of the contracts that we had at the end of '06. And these revenuelosses were somewhat offset by the internal growth that we're seeing from theTSYS Acquiring front-end transaction volumes. They're up for the quarter about8% and year-to-date, they're up about 11%.

Internal growth from customersalso added about $4.6 million for the quarter. We are looking forward toanniversarying these deconversions that we had and the price concessions oflast year, and this all should be happening during this fourth quarter. Weanticipate, again, that the acquiring revenues will stabilize, and we'll seesome growth sequentially over the third quarter, and we fully expect TSYS Acquiringto get back to the historical revenue growth rates in 2008.

A good highlight of positive TSYSAcquiring's operating income for the third quarter, it was up $18.8 million, or19.9%, over the third quarter of '06. And this clearly shows what a great jobthe team's doing there controlling expenses after these deconversions.

On a year-to-date operatingmargin, excluding reimbursables, it's increased to 27.3% in '07 compared to23.5%, almost 400 basis points improvement. When we go back to the consolidatedrevenue line and look at other services for the third quarter, they increased19.4%, or $8.6 million, and then year-to-date, we're up 20.4%, or $27 million.

Approximately 65% of thisincrease comes from the new joint venture, with Dimension Data in Europe,which is TSYS Managed Services, and as you know, we own 55% of that. That'sboth for the quarter and year-to-date. They represent that big of the increase.The rest of it comes from TSYS Royalty. They made up another 17% of thisgrowth, from their redemption business and on their new loyalty platform.

The remainder of the increasecame from growth in our products, such as Profit and Quickremit. There's somegood growth there.

Reimbursable revenues, as we comedown, is kind of flat for the quarter and it is up 4.5% for the year. The mainaddition there as we mentioned earlier, is the reclass of TSYS Acquiring. Thisis really Phase II fees that we have to start reclassing as reimbursable itemsonce we acquired 100% of Vital. And then you’ve still got the treatment of thecourt costs associated with a debt management business, where we are showingthat now as reimbursables. Total revenues for the third quarter increased 3.6%,and 5% for the first nine months of the year and that's good growth in revenueswhen you consider what we lost.

As we go down we’ll talk aboutexpenses a little bit. Our expense growth in employment was 4.2% or $5.8million for the quarter. Roughly $4.6 million of that growth came from theacquisition of TSYS Managed Services. For the year, we're up about $50 million,or 13.1%, and year-to-date you’ve got Card Tech contributing about $10.8million of personnel costs and Managed Services is up $10.7 million. We've hadless capitalization due to contractors and salaries for development of about$16 million year-to-date and it's about $2 million less for the quarter.

On a sequential quarter basis,employment expenses were down approximately $0.5 million dollars, which isgood. Our consolidated head count at the end of September is approximately6,770 people. It's about 13 people less than what it was in September of lastyear. And then, if you exclude the employees associated with TSYS ManagedServices, and Card Tech, that's about 340 more people that we would be downhere in our other operations. We did finish during the quarter the relocationof our Prepaid Manhattan office. We closed it down and moved those folks andthat operation down to Alpharetta. But we continue to look at the allocation ofour people resources and it's quite evident as we've gone through the year ofwhat we've done to manage this cost.

Occupancy and equipment, expensedecreased 11.8% or $9.1 million, to $69 million in the third quarter, and it isdown 12.4% for the year, or $29 million. And both the quarter and year-to-date,we continue to experience this decrease in our software amortization orMIPS-based software and then lower equipment rent expense associated with ourscale-back. If you recall, in the third quarter of '06, last year, we wereoperating at the highest level of MIPS capacity in the history of our company,as we were preparing to convert sizable account portfolios while stillprocessing for Bank of America prior to their scheduled deconversion, so goodreductions there. The other expenses increased 2% for the quarter and decreased7% for the year. And a large part of this decrease is attributable to lowertransaction and delivery costs for TSYS Acquiring and reclassification of thecourt costs associated with TDM, along with lower conversion amortization onTS2.

Looking at operating income, asPhil mentioned, it grew a healthy 26% for the quarter and 19% for the year.When you exclude reimbursables, our profit margin was 25.4% versus 21.1% for'06 very good improvement and then for the year-to-date at 25.6%, versus 22.6%.We do expect our margins to continue to remain in the range of 24% to 26% as wemove forward.

On the other income, it increased$3.6 million for the third quarter and we obviously had increased amounts ofcash available to invest, and they all have increased in the short-terminterest rates have contributed mainly to this increase, as you can see fromthe interest income line.

The effective tax rate for thequarter was 31% compared to 29% last year. We do anticipate our effective taxrate to be around 36%, when you consider prediscrete items and we have had somesettlements on some state tax issues and last year, I think we had a fewfederal tax issues that were settled, so that has caused our rate to come downa little bit. But we do expect the rate without these discrete items to stay in36%, or close to it. Net income for the quarter, it increased 26.7%, or $14.5million, and earnings per share, as Phil mentioned, $0.35, just an outstandingquarter and year-to-date, we're up 18.3%, outstanding.

I want to mention a few things,if you'll flip over to where the balance sheet is and the cash flow statement.Balance sheet just highlights that our unrestricted cash now at the end ofSeptember is sitting at $592.8 million, and that increased about $203 millionsince December, and that's pretty good numbers and we now have approximately $3of cash per share. I will mention down in the liability section we did record anote payable of $67 million. It's a third-party loan that our Europeanoperations secured to help repay a loan that the parent had made to Europeback in the acquisition of Card Tech.

If you look at the cash flowstatement, you'll note our significant contribution in cash generated fromoperating activities at $247 million for the nine months so far. We continue togenerate a lot of cash. We invested $36 million if you go on down in ourproperty and equipment and it's mainly hardware, and then another $20 million,we put in software, and $8 million of it was purchased and about $12 million ofit was developed. And then we also continue to add dividend payments $41million.

And our free cash flow analysisit was at $170.2 million year-to-date and that's an increase of about 16.5%year-over-year. So, that was an overall outstanding quarter and year-to-datenumber. And Phil, I'll turn it back over to you.

Phil Tomlinson

Thank you, Jim. Daniel if we can,we would like to go and open it up from questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions).And your first question is coming from David Scharf. Please announce youaffiliation, then pose your question.

David Scharf - FTN Midwest Securities

A couple of things. Phil, theinternal growth, which continues to accelerate, first, just in terms of themath that 15% figure, the acceleration from last quarter's 12%, and I think Q1is probably closer to 10%, is that primarily because Chase was pulled out ofthe calculation or are you, is seeing an acceleration of some other value-addedsales?

Jim Lipham

This is Jim, David. The bigchange was Chase coming out. We did have about -- I think it was around $4.7million of our CTA growth or profit from CTA that we took out, also. But themain difference is just Chase year-over-year revenues were down and that's whatcaused it.

David Scharf - FTN Midwest Securities

Okay. And any sense for how tothink about that internal growth figure had Chase still been in there? Sort ofcomparable to last quarter probably, or --?

Jim Lipham

Absolutely. It still would havebeen in the 12% range.

David Scharf - FTN Midwest Securities

Okay. And just a little help onmodeling. I know it has been touched on in the past, I guess, is thereobviously your card accounts now have been decreased this quarter to reflectthe Chase license contract. Any way to think about how to model that line item,just to plug it in there, what a good regular way revenue number is for thatsoftware license?

Phil Tomlinson

No, David, there's really not.

David Scharf - FTN Midwest Securities

Okay, we'll back into it.

Phil Tomlinson

I wish I could help you withthat, but I really can't.

David Scharf - FTN Midwest Securities

No problem. Secondly, there's anawfully big laundry list of international wins and achievements. I'm justtrying to get a sense, as we look out -- I know you haven't provided anyfinancial guidance for next year, but any sense of what the overall businessmix is going to look like, domestic versus international? And if you had toguess, looking out one year and two years?

Phil Tomlinson

Well, I don't think we areprepared to give that to you today. But we have said publicly on severaloccasions that by 2011, we want international to be 30%, 35% of our revenuebase, and today, I think it is in the 17%, 18% range.

David Scharf - FTN Midwest Securities

Okay, no change. I was justtrying to get a sense if you were looking at the pipeline and getting anyfeeling to that target may be accelerated?

Phil Tomlinson

Well, we're very optimistic aboutwhat is going on internationally. There's certainly a lot of activity. I thinkwe've built our credibility up in particularly Europewe're starting to build credibility. We've certainly had credibility in the UKand Scotlandand Ireland.But as we build credibility and as we continue to make sales calls, I think wewill be very successful in that part of the world. We did talk a little aboutwhat's going on in Chinaand the growth there. The actual accounts on file has been a very slow process,but I can tell you we're starting, I believe, to dominate that part of theworld as far as signing new issuers. They're all very small at this point.That's more of a debit society, though we believe that we'll take off and webelieve that, as we've said before, long term Chinawill be huge for us.

We've had some luck in Japan.We have a letter of intent from a new issuer in Japan.I'm just not at liberty to tell you who that is today. It's not something -- orsomeone who's going to remove the needle dramatically, but it is an importantwin for us, and we're very excited about that. They're telling me now that ourinternational business year-to-date is after losing Sears, Sears B of A andChase is now up to 22%, so, we may have to raise our goal somewhat. But in Japan,it's been a slow-go, I think everybody that's entered into Japanin any sort of business has found it difficult to get out of the startingblocks. We're starting to see some movement there, but nothing dramatic.Nothing is going to make a real difference any time soon. So, we're veryexcited about Europe. We're very excited about the UK.We're very excited about China.

We have some things going on in Indianow. We believe that we've got to be in India.It's certainly an emerging market, it will be a high-growth card market. So, wedon't have a lot going on in South America. We have justnot been very successful in South America, other than Central America. We've done well in Central America and Mexico.There still are a lot of great opportunities in the U.S.and Canadaavailable. Some really big pieces of business out there, and it's a long sellcycle.

David Scharf - FTN Midwest Securities

Got you.

Phil Tomlinson

I hope that cleared that up foryou.

David Scharf - FTN Midwest Securities

Yes, it does. And just as a quickfollow up on that, obviously we just got through sort of witnessing a 10 yearbattle with First Data for a lot of large domestic accounts. When I read downall of these bullet points of all of these international wins, what is thecompetitive landscape in a lot of these? Are you still bumping up against FDCin most of these situations?

Phil Tomlinson

Yeah, absolutely. They're still avery strong competitor and they certainly have not gone anywhere. We see themeverywhere we go, and most of the time, particularly in Europe,as to what would be the principal competitors, so we wish they'd go away, butthey won't.

David Scharf - FTN Midwest Securities

Are there any other formidablecompetitors just geographically focused that are popping up or is it stillpretty much a duopoly around --?

Phil Tomlinson

No, there's some in Europethat we see, and obviously we've talked about what's going on with some ofthese national processors, if you will. For example, PolCard was the dominantplayer in Poland,they were acquired by First Data. There's still a lot of those types ofprocessors out there and that business is -- we think we can see continuedconsolidation in that part of the world.

David Scharf - FTN Midwest Securities

Okay. And lastly your questionson RBS and ABN AMRO, I wasn't quite sure how to interpret that, particularlywhen --?

Phil Tomlinson

Any time David, any time we haveconsolidation it scares us, because it can upset a great relationship justlike, Bank of Americas the latest example of us. We typically have been winnerson that, but we were certainly a loser on the Bank of America decision. We justsay it is a good thing for us because Royal Bank of Scotlandis a grand customer of ours, a great customer, and so is ABN AMRO. And as theycome together, we think that that will, -- as they have a larger footprintglobally, we think that's going to help us, also.

David Scharf - FTN Midwest Securities

Got you. Okay, I'll let othersget in. Thank you.

Phil Tomlinson

Thank you.

Operator

Thank you. Your next question iscoming from Paul Bartolai. Please announce your affiliation and pose yourquestion.

Paul Bartolai - Credit Suisse

Paul Bartolai from Credit Suisse.Good morning, guys.

Phil Tomlinson

Good morning.

Paul Bartolai - Credit Suisse

First question just on the JPMorgan contract, it sounds like you're not going to get a lot of detail onquantifying the impact, but maybe could you just give us the update on whenthat happened during the quarter and were there any one-time type of costs in there?Or were the margin results kind of a pretty normalized run rate we shouldexpect going forward?

Jim Lipham

During the quarter, Paul, Chaseleft and we did have some license fees, roughly about $3 million for thequarter. But all in total, we lost about $8 million in revenues from that shiftfrom them going in the house, to the license fee. So, I think going forward,you’re obviously going to see better profit margins as we, just running fromthe license perspective, and we have built up for this all through the year, asyou've seen these margins improve.

Phil Tomlinson

Paul, that thing was planned outin every detail, so almost immediately, as they took the accounts in-house, thecomputers left, we had already reduced the staff, and we committed to -- forsome period of time to have a very small staff of people who are available toassist Chase and any time they need some help with issues or problems thatmight arise, but we just don't have a lot of overhead left on that.

Paul Bartolai - Credit Suisse

So, the net revenue loss is $8million in the quarter?

Jim Lipham

That's right.

Paul Bartolai - Credit Suisse

And was that basically the fullquarter of impact or is that --?

Jim Lipham

That's full quarter.

Paul Bartolai - Credit Suisse

Okay. So, as we look at the costside of things, there's obviously been a lot of moving parts the last couple ofquarters, but we roughly at a normalized right now, as a lot of thesedeconversion's done and a lot of the large conversion's done?

Jim Lipham

I think so. I think you'll seepretty much normal. I think when we looked at inform they were up sequentiallyabout $0.5 million for the quarter, and equipment will, once we anniversarysome of the stuff, it'll level out, and won't be showing such a big decrease asit has, and it just should be a little bit more normal.

Paul Bartolai - Credit Suisse

Okay, great. And then youmentioned the currency impact internationally, what was the acquisition impactfor the international business and overall?

Jim Lipham

I think we mentioned Card Techfor the year-to-date it was about $21 million, so I think if you take that andManaged Services for the nine-month period, about $30 million was the impact ofacquisitions.

Paul Bartolai - Credit Suisse

What about in 3Q because CardTech had fully anniversaried, right, for 3Q?

Jim Lipham

That's right. For 3Q that had.

Paul Bartolai - Credit Suisse

Okay, great. And then just toclarify on the tax rate. So, it was a little bit lower for 3Q, so are we stilllooking for roughly 36% in 4Q again?

Jim Lipham

Yes. We should be around 35.8%,somewhere around there, barring no more discrete items coming in play. Thisquarter we ended up with some state items that cleared up some audits outthrough '05, and we still have some things pending out there with some of theother states, but we don't have any indication that that'll happen any timesoon, so our regular rate will be around 35.8%.

Paul Bartolai - Credit Suisse

Okay, great. And then just lastquestion. Just curious to get a little bit more color on this money transferproduct that you launched with Lloyd's. Just curious how that's going to workand what type of role is TSYS going to play in that?

Phil Tomlinson

Paul, I'm not sure I can give youthe details. We can have someone call you with more details on that

Paul Bartolai - Credit Suisse

Okay, great.

Phil Tomlinson

It's just a processing agreementwith us.

Paul Bartolai - Credit Suisse

Okay, sounds good. Thank you.

Operator

Thank you. Your next question iscoming from Adam Frist. Please announce your affiliation then pose yourquestion.

Glen Fodder - UBS

Hi. Actually it is [Glen Fodder]from UBS. Great quarter, guys.

Phil Tomlinson

Thank you.

Glen Fodder - UBS

Just want to know if you couldprovide some color on how your merchant strategy has changed over the last fewquarters, if at all, given the changes in the industry landscape?

Jim Lipham

Glenn, this is Jim. On themerchants, obviously the strategy has been to enhance our product platform toadd some value to this back-end business.

On the front-end side of thehouse, we're seeing a lot of shift from dial transactions over to the SSL. ButI think TSYS Acquiring is focused on the ISO business and how to grow it. We'vesaid before in the past that some day we'd like to get into the Acquiring sideof the house, where we hadn't been before, and I think that's on their radarscreen to try to get there.

Glen Fodder - UBS

So, your strategy is pretty muchas it has been?

Jim Lipham

That's correct.

Glen Fodder - UBS

Okay. And then you said in '08 weexpect to get to a top-line growth that more in line with history, so I seehistory, because of acquisitions, everything a little -- growth rates are alittle choppy. Would that -- would we be looking at that by high single digitsor low double digits?

Jim Lipham

I would say mid, maybe in the 5%to 7% range, something like that.

Glen Fodder - UBS

Okay. Last question, are thereany large merchant contracts up for renewal in the next two years that weshould be thinking about, reflective of what--

Phil Tomlinson

You mean with us?

Glen Fodder - UBS

Of what happened in '06? Yes.

Phil Tomlinson

No.

Glen Fodder - UBS

Okay. Thanks a lot.

Phil Tomlinson

Thank you.

Operator

Thank you. Your next question iscoming from Tony Wible. Please announce your affiliation then pose yourquestion.

Tony Wible - Citigroup

Hi, guys.

Phil Tomlinson

Hi, how are you?

Tony Wible - Citigroup

Good. I was hoping you could helpme out in sizing up Nationwide. You indicated 20 of your larger customers. Willit be breaking 10% or will it be close to 10% of rep?

Phil Tomlinson

No.

Tony Wible - Citigroup

Okay. And the guidance youprovided shows, I guess there's an implied drop in reimbursable items in thefourth quarter. What's behind that and are you seeing any issuers change someof their activities from the USas issues that they've seen on the mortgage side of their businesses?

Phil Tomlinson

Tony, on the reimbursable drop,the only thing that is dropping really is our postage, which was from thestatement being as we had the first part of the year and through the secondquarter, but that big decrease is there. The rest of it is still the courtcosts and attorney fees and then we had, like I mentioned, the Phase II feesthat we had to re-class on TSYS Acquiring.

Tony Wible - Citigroup

Okay. Do you have any sense forthe organic originations that you get what percentage of those are frompreapproval credit products versus somebody proactively going to the bank to apply?

Phil Tomlinson

We really wouldn't have any ideaon that.

Tony Wible - Citigroup

Okay. Last question is on thehardware side, I guess you guys have done a great job being able to managecosts throughout these deconversions. Do you see any need to upgrade some ofthe infrastructure at some point as a result of some of the cost reductionsthat you've done?

Phil Tomlinson

I think that a year or so ago wetalked about building a western data center. I think that at some point youdon't see us do that, but we feel very good about where we're at,hardware-wise.

Tony Wible - Citigroup

And personnel?

Phil Tomlinson

And personnel, yes.

Tony Wible - Citigroup

Okay, great. Thank you.

Operator

Thank you. Your next question iscoming from Tony Davis. Please announce your affiliation then pose yourquestion.

Tony Davis - Stifel Nicolaus

Stifel Nicolaus. Good morning, guys. Just to tie thisaccount-on-file trend down, Phil, you lost 82 million since June and how manyactual accounts deconverted as part of the Morgan program? And then I wonder ifyou could give us any color on the size of the geographical composition of thepipeline?

Phil Tomlinson

I don't have any pipeline numbersin front of me right now, but I would say that we are down, right at 90 millionaccounts as a result of some of these de-conversions.

Tony Davis - Stifel Nicolaus

Okay.

Phil Tomlinson

We've continued to add newbusiness, and it’s probably 80, 90 million. You're right in that range.

Tony Davis - Stifel Nicolaus

Okay. And on another point here,the original goals that you had; I just wonder where you stand right now interms of the cumulative cost take-outs and the head count, either reduction orrealignment that you were looking at a year or so ago. Where are you in that process?Are there any more of these efficiency initiatives, Phil, that remain to beimplemented?

Phil Tomlinson

Well, I don't know that we haveany formal initiatives left. I think we've changed the way we do business here.We had to, and I think it was a very painful, but it has turned out to be avery positive change. We are in the budgeting process as we speak, andhopefully we'll have that done here in the very near future and have a betteroutlook for '08 in particular. But we'll continue to try to be as efficient aswe can.

You've heard me say before, inorder for us to be successful long term, we've got to be faster, better andcheaper. We do believe that we've got the gold standard, if you will, in cardprocessing; we still got to be very, very competitive when it comes to prices.

I think, in light of what we'vegone through and some of the consolidation and some of the efforts that we'veput forward, it has really helped our operations and it's helped the thoughtprocesses of people around here. When you've grown as much as we have over theyears, and then you've had some of this yo-yo effect for lack of a better term.We are looking forward to maybe a year or two where we can have some kind ofnormalcy and hope we can add some big numbers to that.

If you think about the last fouryears, we've had a lot of turmoil in this business and this industry ingeneral. We're looking forward to the future very optimistically.

Tony Davis - Stifel Nicolaus

You could live with a little lessexcitement?

Phil Tomlinson

Yes, we could stand a little lessexcitement. I recall this time last year. If you just think about what we'vegone through, and we don't need, I got tickled at Ken Louis' comment aboutinvestment banking and Wall Street the other day, and we've had about as muchfun with de-conversions as we want to have, also.

Tony Davis - Stifel Nicolaus

One final question. As thequarter progressed, have you seen any evidence over the last several weeks ofany softness in transaction authorization volumes that might be indicative of aretrenching consumer, and how do you feel heading into the seasonally strong,December quarter?

Phil Tomlinson

We feel very good. We don'treally keep up a lot with the dollar amount of transactions. We are veryfocused on the transaction, which is what we get paid off of, and ourtransaction growth rates are still strong, and we feel very good about it. Wecertainly are prepared and looking forward to a big holiday season.

Tony Davis - Stifel Nicolaus

Thanks.

Phil Tomlinson

Thank you.

Operator

Thank you. Your next question iscoming from David Parker. Please announce your affiliation then pose yourquestion.

David Parker - Merrill Lynch

Merrill Lynch. Good morning,everyone.

Phil Tomlinson

Good morning.

David Parker - Merrill Lynch

I just have some follow-ups tosome earlier questions. On the merchant acquiring business, are you stillfocused on moving that business internationally, or at this point are you justtrying to get past the de-conversions and the pricing compression that you'veseen on the domestic side?

Phil Tomlinson

We've got some things workinginternationally and we actually have announced PaySquare, about a month ago. Itmay have been 60 days ago, in Europe. We would certainlylike to do more there. The opportunities we just haven't been able to put themtogether yet, but our goal is still to be, particularly in Europe and the UK,in the processing business on the merchant side. It's a different business overthere than it is in the US,and frankly we have to make some inroads and build some relationships and it'sbeen a long sales cycle.

David Parker - Merrill Lynch

Okay. And then on Nationwide, youstated that it ranked among your largest clients. You also stated that itwasn't going to be a 10% customer. But can you talk about the scope of servicesthat you're going to be providing to that customer?

Phil Tomlinson

We're going to basically runtheir credit card center for them. So, it is pretty well everything. We'reactually building a center, as we speak, down in Coventryand we will be in the credit, collections and customer service business.

David Parker - Merrill Lynch

Okay. And then moving to yourvalue-added products; can you just talk about specifically what products aredoing well in that segment and which ones are not doing as well?

Phil Tomlinson

Sure, I think we can. Well, Ithink when you talk about that, Total Analytics is doing well, Advanced CardDelivery's doing well, Fraud Services is doing very well. The ones that are sortof flat would be our Scoring business.

The Rewards business has dropped,primarily because of the loss of Bank of America and Sears and Chase. We'regoing to have to, it's going to take some time to make that back up. But wealso have had a lot of great help in those areas from Toronto-Dominion, CapOne, and Banco Popular. Profit is continuing to do well. We'll continue to addclients there. Our Loyalty business, we have a world-class product there, andwe're going to do very well there. It's a matter of being able to deliver whatwe can sell. At this point, we can sell more than we can deliver.

We have some new products comingonline that we're not prepared to talk about but we're excited about them. So Iwould, most of this, anything being down is driven around the couple ofde-conversions that we had last year.

David Parker - Merrill Lynch

Okay. Great. Thanks guys.

Phil Tomlinson

Thank you.

Operator

Thank you. Your next question iscoming from Glenn Greene. Please announce your affiliation then pose yourquestion.

Glenn Greene - CIBC

Thank you, CIBC. Good morning. Afew questions here and the first one is just on CUP Data. You sort ofarticulated a pretty good outlook there and a lot of signings and I know it'sreally early, but could you just sort of give us a view, if you sort of lookout two to three years how meaningful this is and just a real quick reminder ofsort of the structure of your JV?

Phil Tomlinson

Well. As you know, CUP is sort ofthe, for lack of a better description. They have the Visa and MasterCard ofChina. And, if you want to issue cards in China,you have got to go through CUP and CUP Data is the data processing facilitythat is owned 55% or so. We own 45% of the joint venture. I can't recall thenumbers off the top of my head, but Chinais primarily a debit card country or issuing country right now.

They do want to issue creditcards. We believe we're in a great position with CUP Data, because it lookslike most people are going to head towards CUP Data particularly the banks. As,I told you a few minutes ago, we've signed 34, I think our principal competitorhas signed one. So, we're feeling pretty good about where we are at.

I hope that before too long, wecan start making some announcements about who these organizations are becausethey are certainly names that you would recognize. They are big organizations.

We've also signed our firstissuing bank that is not Chinese based. We have a letter of intent from a verylarge bank it's not based in China.So, we believe that the growth will be very controlled.

We will not have mass issuance oranything like that. It will be a very controlled process. I think they're stillin the process of building some infrastructure. We take a lot for granted inthe US and Canada,when it comes to credit bureaus and authorization systems that we have builtover the years. It makes it awfully easy to issue credit and issue cards and ina lot of these countries, such as China,all of that is not quite in place yet. But it's coming. So, we're veryoptimistic long-term about our prospects in China.

Glenn Greene - CIBC

All right. That's very helpful.Just real quickly, on J.P. Morgan; I just wanted to go back a little bit. Iwasn't sure what I heard, but it sounded like it was a $8 million net revenueimpact. But did you also say you picked up $3 million of software licenseswithin that net? I just wanted to confirm that number, or did I hear it wrong?

Phil Tomlinson

That's correct. I mean, there was$3 million license fee which made the net at $8 million.

Glenn Greene - CIBC

Okay. And then, just sort ofagain on a big picture view, sort of thinking about your operating marginprofile and I think you said it would stay in that 24% to 26% range, at leastthrough to near term. But given sort of your steady state of business, at leastit appears and are pretty good organic growth profile of ramping up a bunch ofnew contracts and pretty stable operating expense base, I would thinkintuitively that you've got pretty good potential for a margin ramp goingforward, as we go out a few quarters?

Phil Tomlinson

We would like to think so, butwe're certainly not saying that today. We're going to stick with our rangesthat we've put out there. We want to make sure this is not some anomaly.

Glenn Greene - CIBC

Okay. And then, are there any bigcontracts coming up for renewal that we should be aware of in the corebusiness?

Phil Tomlinson

No.

Glenn Greene - CIBC

All right, great. Thank you.

Phil Tomlinson

Thank you.

Operator

Thank you. (OperatorInstructions) Your next question is a follow up from [Glen Fodder]. Sir, yourline is live.

Glen Fodder - UBS

Hi, it's Glen Fodder from UBS,thanks for the follow up. Guys, you said in the past that your businessperformed well in economic downturns. Could you just go into a little bit moredetail on the ‘how’s and why’s’ of this dynamic? Because banks view their carddivisions as sacred cows, and don't cut back efforts or the ability tocross-sell products that a bank might not currently use, like fraud detectionor is it something else? Thanks.

Phil Tomlinson

Glenn, you almost answered it forus. It is the ability to use new value-added products like additional fraudprotection. But historically, what we've seen as times get difficult is peoplewill, in a lot of instances use their cards for more transactions, but lessdollars. So, the transactions help us obviously, the less dollars does not helpthe merchant community. It also creates an environment where banks or issuerswill tend to look at other options, ways to cut costs, ways to be moreefficient, and we see that we get calls during times like that where people mayhave been absolutely will never process with a third party as long as we livetill. When times get tough, maybe we have to look outside and see what's goingon out there and they take a look at us. And at many times, we're successfulwith that.

Glen Fodder - UBS

Okay. And, (inaudible) we talkabout this in more detail on the past calls, but could you just go into detailof what you're doing in the healthcare market? You alluded to it in the lastcall, and during the quarter we saw Microsoft roll out a healthcare database.So, it seems like there is a lot of heat around healthcare given that industryand couple of months here?

Phil Tomlinson

We've got some small initiativesin healthcare. I think you'll see some announcements coming from us in the nearfuture there. Basically, what we're trying to do, is pick a segment in thehealthcare business and that is what we can manage with a card, and whetherthat is the flexible benefits or several other things that you can do withcards. We are learning that business, as we speak. We have now hired anexecutive with deep, deep healthcare experience to come on board, and I thinkyou'll start seeing us make some announcements in the healthcare business. Itis not going to be anything big in the next year, I don't believe. Now, I'dlove to call the next quarterly call to tell you that we've signed somethingreally large, but we've signed a couple of small players. Not small players,but players who can help us get into this business and help us learn thisbusiness and we think, we can develop software as good as anybody in the world.So, it's a transaction driven business and we think we can do well at it.

Glen Fodder - UBS

Okay. Great. Thank you so much.

Operator

Thank you. Your final question iscoming from David Scharf. Sir, your line is live.

David Scharf - FTN Midwest Securities

Hi, good morning. I just steppedoff; I apologize if this has been asked before. Can you just give a littlecolor on what is implied for the fourth quarter by the guidance? Because it istypically a seasonally strong quarter, and I guess the implication is for netincome to be sequentially down, which I--

Phil Tomlinson

David, if you will remember ourcomparable is a $69 million to $70 million termination fee that we received inthe fourth quarter last year and it's hard for us to make that up.

David Scharf - FTN Midwest Securities

No, no. I'm referring to sequentiallyfrom the quarter just completed from about -- the implication is we're goingfrom about $69 million to $60 million from Q3 to Q4. And I think that…

Jimmy Lipham

Yes, David, if you looksequentially at our operating income from second to third you'll see, we’repretty much in line with, I think, where most of the analysts had us. I thinkin the fourth quarter you should see pretty much the same. I would think thatif anything about being down at the bottom line might be in regards to theinterest and in regards to taxes.

David Scharf - FTN Midwest Securities

Okay. Fair enough. Thank you.

Phil Tomlinson

Well, listen, we appreciate youbeing with us today. I hope you can tell we're excited about our business andfeel really good about the third quarter performance and really where we'reheaded into the future. We feel like we're hitting on all cylinders here and wethink we're moving forward. So, stay with us. We appreciate your interest andif you have any questions, please don't hesitate to call us. Shawn Roberts, whoruns our investor relations department, you've got his number. Our salesefforts are going well. Our operations are running very efficiently. And as Isaid earlier, we're very optimistic about the future.

Thank you for your interest andwith that we will close out this call.

Operator

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

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