Total System Services Q3 2007 Earnings Call Transcript

Total System Services, Inc. (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 Midwest Securities

Paul Bartolai - Credit Suisse

Glen Fodder - UBS

Tony Wible - Citigroup

Tony Davis - Stifel Nicolaus

David Parker - Merrill Lynch

Glenn Greene - CIBC

Presentation

Operator

Good morning, ladies and gentlemen, and welcome to the TSYS Third Quarter Earnings Release Conference Call. At this time all participants have been placed on a listen-only mode. 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, Danielle, and welcome to 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 will be making forward-looking statements about the future operating results of TSYS. These statements involve risks and uncertainties. Factors that could cause TSYS actual results to differ materially from the forward-looking statements are set forth in our annual reports filed with the SEC.

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

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

Our net income increased by an amazing 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 date increased 300 basis points from 22.6% to 25.6%, which is rather incredible, we think.

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

Internal growth continues to hit on double digits for the quarter and year-to-date and Jim is going to talk more about that later.

As you saw in the earnings release yesterday, we continue to expect to achieve our previously-announced guidance for net income, which is 20% to 22% on the non-GAAP basis, and we're on track to make our 0% to 2% increase on a GAAP basis. After some massive losses last year. I can't overstate how pleased we are with our team's ability to manage expenses, increase organic revenues, and continue exceeding expectations as well as selling new business.

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

In last quarter's conference call, we talked a lot about competition in our sector and I wanted to share with you some of our highlights we had in the third quarter. One is, we have hooked up with Discover Financial and signed an issuer processing agreement, and we'll begin processing prepaid and credit card transactions on the Discover Network, 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 another outlet, 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-term agreement with Nationwide, who is the world's largest building society. We're going to process the credit card portfolio and we're going to build, operate and manage a new customer care center in Coventry. That is a really big deal for us because we're really managing the entire process for them. As a result of that scope of services Nationwide, when it is all converted, will rank among our largest clients.

We also had another international win with Tinkoff Credit Systems, a Moscow-based consumer lending bank. Through Card 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 Russia and will focus exclusively on issuing credit cards.

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

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

Moving on to value-added, our value-add products have continued to be a solid contributor. Revenues increased 6.1% in the quarter and 7.4% year-to-date. One of the key strategies we have here at TSYS is to be able to continue to sell new and current products into our customer line-up. On the merchant side of the house, we're pleased to report that TSYS Acquiring Solutions continued its outstanding operating margin gains and its operating income increased 20% in the third quarter compared to the same period last year. And we believe that they're starting to turn the corner on revenue growth. Jim Lipham is going to give you some more color on this in just a minute.

Speaking of Jim, I want to go ahead and turn it over to him to give you some real details about these financials. Jimmy?

Jim Lipham

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

On a pro forma basis, taking these revenues out of the third quarter of '06, our quarter-over-quarter growth in 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 our internal 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 the removal of Chase out of our internal growth numbers. As you know, they took their processing in-house during the quarter. But in addition to the internal growth, we had a new business that includes acquisitions added about 12.7% of our additional growth for the quarter and then 16.6% year-to-date.

Our account-on-file numbers are down at 357 million. That's 43 million lower than they were prior year. The net decrease as a result of the loss of 136 million accounts, mainly from these two large customers that we lost since the third quarter of '06. This decrease was offset by new clients that added about 71 million accounts, and then our internal growth added another 32 million on top of that.

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

On the international front, Phil mentioned 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 of very strong growth across all of our geographical regions, as Canada, Mexico, Japan, Europe, and the revenues associated with the acquisitions we made internationally, such as TSYS Card Tech. As you know, we thought those guys were in our third quarter '06 numbers, but for the year-to-date they're an additional $21 million more than last year in revenue contribution.

The international revenues also were positively impacted, mainly from Europe, by the currency translation adjustment, when you consider for the quarter $4.3 million as CTA benefit. 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%. And for the year, they still represent around 13% of our total revenues and it's been that way for some time now, so they’re still a very good contributor to our operating income line.

On the Merchant Services line you see that revenues are flat for the quarter. When you look at -- and they're down when you look as compared to prior year. But the main item in here is TSYS Acquiring and their revenues actually decreased $1.2 million for the quarter and $7.6 million year-to-date and the decrease is a result of two large deconversions. 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 the point-of-sale business that's been going on for over a year now. We also still have some price compressions we were suffering through here from the renegotiation of the contracts that we had at the end of '06. And these revenue losses were somewhat offset by the internal growth that we're seeing from the TSYS Acquiring front-end transaction volumes. They're up for the quarter about 8% and year-to-date, they're up about 11%.

Internal growth from customers also added about $4.6 million for the quarter. We are looking forward to anniversarying these deconversions that we had and the price concessions of last year, and this all should be happening during this fourth quarter. We anticipate, again, that the acquiring revenues will stabilize, and we'll see some growth sequentially over the third quarter, and we fully expect TSYS Acquiring to get back to the historical revenue growth rates in 2008.

A good highlight of positive TSYS Acquiring's operating income for the third quarter, it was up $18.8 million, or 19.9%, over the third quarter of '06. And this clearly shows what a great job the team's doing there controlling expenses after these deconversions.

On a year-to-date operating margin, excluding reimbursables, it's increased to 27.3% in '07 compared to 23.5%, almost 400 basis points improvement. When we go back to the consolidated revenue line and look at other services for the third quarter, they increased 19.4%, or $8.6 million, and then year-to-date, we're up 20.4%, or $27 million.

Approximately 65% of this increase 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's both 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 this growth, from their redemption business and on their new loyalty platform.

The remainder of the increase came from growth in our products, such as Profit and Quickremit. There's some good growth there.

Reimbursable revenues, as we come down, is kind of flat for the quarter and it is up 4.5% for the year. The main addition there as we mentioned earlier, is the reclass of TSYS Acquiring. This is really Phase II fees that we have to start reclassing as reimbursable items once we acquired 100% of Vital. And then you’ve still got the treatment of the court costs associated with a debt management business, where we are showing that 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 revenues when you consider what we lost.

As we go down we’ll talk about expenses a little bit. Our expense growth in employment was 4.2% or $5.8 million for the quarter. Roughly $4.6 million of that growth came from the acquisition 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 $10.8 million of personnel costs and Managed Services is up $10.7 million. We've had less 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 is good. Our consolidated head count at the end of September is approximately 6,770 people. It's about 13 people less than what it was in September of last year. And then, if you exclude the employees associated with TSYS Managed Services, and Card Tech, that's about 340 more people that we would be down here in our other operations. We did finish during the quarter the relocation of our Prepaid Manhattan office. We closed it down and moved those folks and that operation down to Alpharetta. But we continue to look at the allocation of our people resources and it's quite evident as we've gone through the year of what we've done to manage this cost.

Occupancy and equipment, expense decreased 11.8% or $9.1 million, to $69 million in the third quarter, and it is down 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 or MIPS-based software and then lower equipment rent expense associated with our scale-back. If you recall, in the third quarter of '06, last year, we were operating at the highest level of MIPS capacity in the history of our company, as we were preparing to convert sizable account portfolios while still processing for Bank of America prior to their scheduled deconversion, so good reductions there. The other expenses increased 2% for the quarter and decreased 7% for the year. And a large part of this decrease is attributable to lower transaction and delivery costs for TSYS Acquiring and reclassification of the court costs associated with TDM, along with lower conversion amortization on TS2.

Looking at operating income, as Phil 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 we move forward.

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

The effective tax rate for the quarter was 31% compared to 29% last year. We do anticipate our effective tax rate to be around 36%, when you consider prediscrete items and we have had some settlements on some state tax issues and last year, I think we had a few federal tax issues that were settled, so that has caused our rate to come down a little bit. But we do expect the rate without these discrete items to stay in 36%, or close to it. Net income for the quarter, it increased 26.7%, or $14.5 million, and earnings per share, as Phil mentioned, $0.35, just an outstanding quarter 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 of September is sitting at $592.8 million, and that increased about $203 million since December, and that's pretty good numbers and we now have approximately $3 of cash per share. I will mention down in the liability section we did record a note payable of $67 million. It's a third-party loan that our European operations secured to help repay a loan that the parent had made to Europe back in the acquisition of Card Tech.

If you look at the cash flow statement, you'll note our significant contribution in cash generated from operating activities at $247 million for the nine months so far. We continue to generate a lot of cash. We invested $36 million if you go on down in our property 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 of it was developed. And then we also continue to add dividend payments $41 million.

And our free cash flow analysis it 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-date number. 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 you affiliation, then pose your question.

David Scharf - FTN Midwest Securities

A couple of things. Phil, the internal growth, which continues to accelerate, first, just in terms of the math that 15% figure, the acceleration from last quarter's 12%, and I think Q1 is probably closer to 10%, is that primarily because Chase was pulled out of the calculation or are you, is seeing an acceleration of some other value-added sales?

Jim Lipham

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

David Scharf - FTN Midwest Securities

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

Jim Lipham

Absolutely. It still would have been in the 12% range.

David Scharf - FTN Midwest Securities

Okay. And just a little help on modeling. I know it has been touched on in the past, I guess, is there obviously your card accounts now have been decreased this quarter to reflect the 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 that software 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 with that, but I really can't.

David Scharf - FTN Midwest Securities

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

Phil Tomlinson

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

David Scharf - FTN Midwest Securities

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

Phil Tomlinson

Well, we're very optimistic about what is going on internationally. There's certainly a lot of activity. I think we've built our credibility up in particularly Europe we're starting to build credibility. We've certainly had credibility in the UK and Scotland and Ireland. But as we build credibility and as we continue to make sales calls, I think we will be very successful in that part of the world. We did talk a little about what's going on in China and 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 the world 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 we believe that, as we've said before, long term China will 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 -- or someone who's going to remove the needle dramatically, but it is an important win for us, and we're very excited about that. They're telling me now that our international business year-to-date is after losing Sears, Sears B of A and Chase 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 Japan in any sort of business has found it difficult to get out of the starting blocks. 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 very excited about Europe. We're very excited about the UK. We're very excited about China.

We have some things going on in India now. 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, we don't have a lot going on in South America. We have just not 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 Canada available. Some really big pieces of business out there, and it's a long sell cycle.

David Scharf - FTN Midwest Securities

Got you.

Phil Tomlinson

I hope that cleared that up for you.

David Scharf - FTN Midwest Securities

Yes, it does. And just as a quick follow up on that, obviously we just got through sort of witnessing a 10 year battle with First Data for a lot of large domestic accounts. When I read down all of these bullet points of all of these international wins, what is the competitive landscape in a lot of these? Are you still bumping up against FDC in most of these situations?

Phil Tomlinson

Yeah, absolutely. They're still a very strong competitor and they certainly have not gone anywhere. We see them everywhere 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, but they won't.

David Scharf - FTN Midwest Securities

Are there any other formidable competitors just geographically focused that are popping up or is it still pretty much a duopoly around --?

Phil Tomlinson

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

David Scharf - FTN Midwest Securities

Okay. And lastly your questions on RBS and ABN AMRO, I wasn't quite sure how to interpret that, particularly when --?

Phil Tomlinson

Any time David, any time we have consolidation it scares us, because it can upset a great relationship just like, Bank of Americas the latest example of us. We typically have been winners on that, but we were certainly a loser on the Bank of America decision. We just say it is a good thing for us because Royal Bank of Scotland is a grand customer of ours, a great customer, and so is ABN AMRO. And as they come together, we think that that will, -- as they have a larger footprint globally, we think that's going to help us, also.

David Scharf - FTN Midwest Securities

Got you. Okay, I'll let others get in. Thank you.

Phil Tomlinson

Thank you.

Operator

Thank you. Your next question is coming from Paul Bartolai. Please announce your affiliation and pose your question.

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 JP Morgan contract, it sounds like you're not going to get a lot of detail on quantifying the impact, but maybe could you just give us the update on when that 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 should expect going forward?

Jim Lipham

During the quarter, Paul, Chase left and we did have some license fees, roughly about $3 million for the quarter. But all in total, we lost about $8 million in revenues from that shift from 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 from the license perspective, and we have built up for this all through the year, as you've seen these margins improve.

Phil Tomlinson

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

Paul Bartolai - Credit Suisse

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

Jim Lipham

That's right.

Paul Bartolai - Credit Suisse

And was that basically the full quarter of impact or is that --?

Jim Lipham

That's full quarter.

Paul Bartolai - Credit Suisse

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

Jim Lipham

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

Paul Bartolai - Credit Suisse

Okay, great. And then you mentioned the currency impact internationally, what was the acquisition impact for the international business and overall?

Jim Lipham

I think we mentioned Card Tech for the year-to-date it was about $21 million, so I think if you take that and Managed Services for the nine-month period, about $30 million was the impact of acquisitions.

Paul Bartolai - Credit Suisse

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

Jim Lipham

That's right. For 3Q that had.

Paul Bartolai - Credit Suisse

Okay, great. And then just to clarify on the tax rate. So, it was a little bit lower for 3Q, so are we still looking 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. This quarter we ended up with some state items that cleared up some audits out through '05, and we still have some things pending out there with some of the other states, but we don't have any indication that that'll happen any time soon, so our regular rate will be around 35.8%.

Paul Bartolai - Credit Suisse

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

Phil Tomlinson

Paul, I'm not sure I can give you the 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 agreement with us.

Paul Bartolai - Credit Suisse

Okay, sounds good. Thank you.

Operator

Thank you. Your next question is coming from Adam Frist. Please announce your affiliation then pose your question.

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 could provide some color on how your merchant strategy has changed over the last few quarters, if at all, given the changes in the industry landscape?

Jim Lipham

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

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

Glen Fodder - UBS

So, your strategy is pretty much as it has been?

Jim Lipham

That's correct.

Glen Fodder - UBS

Okay. And then you said in '08 we expect to get to a top-line growth that more in line with history, so I see history, because of acquisitions, everything a little -- growth rates are a little choppy. Would that -- would we be looking at that by high single digits or 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 there any large merchant contracts up for renewal in the next two years that we should 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 is coming from Tony Wible. Please announce your affiliation then pose your question.

Tony Wible - Citigroup

Hi, guys.

Phil Tomlinson

Hi, how are you?

Tony Wible - Citigroup

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

Phil Tomlinson

No.

Tony Wible - Citigroup

Okay. And the guidance you provided shows, I guess there's an implied drop in reimbursable items in the fourth quarter. What's behind that and are you seeing any issuers change some of their activities from the US as 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 the statement being as we had the first part of the year and through the second quarter, but that big decrease is there. The rest of it is still the court costs and attorney fees and then we had, like I mentioned, the Phase II fees that we had to re-class on TSYS Acquiring.

Tony Wible - Citigroup

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

Phil Tomlinson

We really wouldn't have any idea on that.

Tony Wible - Citigroup

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

Phil Tomlinson

I think that a year or so ago we talked about building a western data center. I think that at some point you don'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 is coming from Tony Davis. Please announce your affiliation then pose your question.

Tony Davis - Stifel Nicolaus

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

Phil Tomlinson

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

Tony Davis - Stifel Nicolaus

Okay.

Phil Tomlinson

We've continued to add new business, 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 in terms of the cumulative cost take-outs and the head count, either reduction or realignment 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 be implemented?

Phil Tomlinson

Well, I don't know that we have any 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 a very positive change. We are in the budgeting process as we speak, and hopefully we'll have that done here in the very near future and have a better outlook for '08 in particular. But we'll continue to try to be as efficient as we can.

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

I think, in light of what we've gone through and some of the consolidation and some of the efforts that we've put forward, it has really helped our operations and it's helped the thought processes of people around here. When you've grown as much as we have over the years, 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 of normalcy and hope we can add some big numbers to that.

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

Tony Davis - Stifel Nicolaus

You could live with a little less excitement?

Phil Tomlinson

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

Tony Davis - Stifel Nicolaus

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

Phil Tomlinson

We feel very good. We don't really keep up a lot with the dollar amount of transactions. We are very focused on the transaction, which is what we get paid off of, and our transaction growth rates are still strong, and we feel very good about it. We certainly 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 is coming from David Parker. Please announce your affiliation then pose your question.

David Parker - Merrill Lynch

Merrill Lynch. Good morning, everyone.

Phil Tomlinson

Good morning.

David Parker - Merrill Lynch

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

Phil Tomlinson

We've got some things working internationally and we actually have announced PaySquare, about a month ago. It may have been 60 days ago, in Europe. We would certainly like to do more there. The opportunities we just haven't been able to put them together 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 over there than it is in the US, and frankly we have to make some inroads and build some relationships and it's been a long sales cycle.

David Parker - Merrill Lynch

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

Phil Tomlinson

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

David Parker - Merrill Lynch

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

Phil Tomlinson

Sure, I think we can. Well, I think when you talk about that, Total Analytics is doing well, Advanced Card Delivery's doing well, Fraud Services is doing very well. The ones that are sort of 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're going to have to, it's going to take some time to make that back up. But we also have had a lot of great help in those areas from Toronto-Dominion, Cap One, and Banco Popular. Profit is continuing to do well. We'll continue to add clients there. Our Loyalty business, we have a world-class product there, and we're going to do very well there. It's a matter of being able to deliver what we can sell. At this point, we can sell more than we can deliver.

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

David Parker - Merrill Lynch

Okay. Great. Thanks guys.

Phil Tomlinson

Thank you.

Operator

Thank you. Your next question is coming from Glenn Greene. Please announce your affiliation then pose your question.

Glenn Greene - CIBC

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

Phil Tomlinson

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

They do want to issue credit cards. We believe we're in a great position with CUP Data, because it looks like 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 competitor has signed one. So, we're feeling pretty good about where we are at.

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

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

We will not have mass issuance or anything like that. It will be a very controlled process. I think they're still in the process of building some infrastructure. We take a lot for granted in the US and Canada, when it comes to credit bureaus and authorization systems that we have built over the years. It makes it awfully easy to issue credit and issue cards and in a lot of these countries, such as China, all of that is not quite in place yet. But it's coming. So, we're very optimistic 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. I wasn't sure what I heard, but it sounded like it was a $8 million net revenue impact. But did you also say you picked up $3 million of software licenses within 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 of again on a big picture view, sort of thinking about your operating margin profile and I think you said it would stay in that 24% to 26% range, at least through to near term. But given sort of your steady state of business, at least it appears and are pretty good organic growth profile of ramping up a bunch of new contracts and pretty stable operating expense base, I would think intuitively that you've got pretty good potential for a margin ramp going forward, as we go out a few quarters?

Phil Tomlinson

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

Glenn Greene - CIBC

Okay. And then, are there any big contracts coming up for renewal that we should be aware of in the core business?

Phil Tomlinson

No.

Glenn Greene - CIBC

All right, great. Thank you.

Phil Tomlinson

Thank you.

Operator

Thank you. (Operator Instructions) Your next question is a follow up from [Glen Fodder]. Sir, your line 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 business performed well in economic downturns. Could you just go into a little bit more detail on the ‘how’s and why’s’ of this dynamic? Because banks view their card divisions as sacred cows, and don't cut back efforts or the ability to cross-sell products that a bank might not currently use, like fraud detection or is it something else? Thanks.

Phil Tomlinson

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

Glen Fodder - UBS

Okay. And, (inaudible) we talk about this in more detail on the past calls, but could you just go into detail of what you're doing in the healthcare market? You alluded to it in the last call, 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 industry and couple of months here?

Phil Tomlinson

We've got some small initiatives in healthcare. I think you'll see some announcements coming from us in the near future there. Basically, what we're trying to do, is pick a segment in the healthcare business and that is what we can manage with a card, and whether that is the flexible benefits or several other things that you can do with cards. We are learning that business, as we speak. We have now hired an executive with deep, deep healthcare experience to come on board, and I think you'll start seeing us make some announcements in the healthcare business. It is not going to be anything big in the next year, I don't believe. Now, I'd love to call the next quarterly call to tell you that we've signed something really 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 this business 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 is coming from David Scharf. Sir, your line is live.

David Scharf - FTN Midwest Securities

Hi, good morning. I just stepped off; I apologize if this has been asked before. Can you just give a little color on what is implied for the fourth quarter by the guidance? Because it is typically a seasonally strong quarter, and I guess the implication is for net income to be sequentially down, which I--

Phil Tomlinson

David, if you will remember our comparable is a $69 million to $70 million termination fee that we received in the 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 sequentially from the quarter just completed from about -- the implication is we're going from about $69 million to $60 million from Q3 to Q4. And I think that…

Jimmy Lipham

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

David Scharf - FTN Midwest Securities

Okay. Fair enough. Thank you.

Phil Tomlinson

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

Thank you for your interest and with 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 lines at this time and have a wonderful day. Thank you for your participation.

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