Global Payments F2Q08 (Qtr End 11/30/07) Earnings Call Transcript

Jan. 3.08 | About: Global Payments (GPN)

Global Payments Inc. (NYSE:GPN)

F2Q08 Earnings Call

January 3, 2008 5:00 pm ET

Executives

Jane Elliot - Vice President of Investor Relations

Paul Garcia - Chairman,President and CEO

Jim Kelly - Senior EVP and COO

JoeHyde - EVP and CFO

Analysts

Tien-Tsin Huang – JP Morgan

LizGrausam – Goldman Sachs

Andrew Jeffrey - SunTrust Robinson Humphrey

Adam Frisch – UBS

Kartik Mehta – FTN Midwest

Paul Bartolai – Credit Suisse

David Koning - Robert W. Baird

Mark Sproule – Thomas Weisel

Greg Smith – Merrill Lynch

Robert Dodd – Morgan Keegan

Operator

Welcome to Global Payments second quarter fiscal 2008earnings conference call. (Operator Instructions) Atthis time, I would like to turn theconference over to your host, Vice President of Investor Relations Jane Elliot.Please go ahead.

Jane Elliot

Thanks, Connie. Good afternoon and welcome to GlobalPayments fiscal 2008 second quarter conference call. Joining meon the call today arePaul Garcia, Chairman,President and CEO; Jim Kelly, Senior EVP and COO; and JoeHyde, EVP and CFO.

Before we begin, I would like to remind you that some of thecomments made by management during theconference call contain forward-looking statements that involve anumber of risks and uncertainties. For these statements, we claim theprotection of the safeharbor for forward-looking statements contained inthe Private SecuritiesLitigation Reform Act of 1995.

While these statements reflect our best current judgment,they are subject torisks and uncertainties that could cause actual results to vary, which arediscussed in ourpublic releases, including our most recent 10-K. We undertake no obligation to revise any ofthese statements to reflect future circumstances, or theoccurrence of unanticipated events.

Inaddition, some of thecomments made on this call may refer to normalized results which arenot in accordance withGAAP. Management believes that normalized results more clearly reflectcomparative operating performance. For afull reconciliation of normalized to GAAP results inaccordance with Regulation G, please seeour press release filed as anexhibit to our Form8-K dated today, January 3, 2008 which may belocated under theinvestor relations area on our website atwww.GlobalPaymentsInc.com.

Now I would like to introduce Paul Garcia.

Paul Garcia

Thanks, Jane. Good afternoon, everyone and Happy New Year.We are quite pleasedwith our second quarter results. For thesecond quarter, our revenue grew 18% to $308.8 million and our normalizeddiluted earnings pershare grew 14% to $0.48.

Our growth was driven by solid performance inour merchant services segment, while our money transfer segment continued to beimpacted by lower year-over-year pricing, both of which I will discuss injust a moment.

Starting with our merchant segment, our ISOs continued todrive strong organic growth inour domestic direct channel. We continued to have success inretaining our customers and insigning new ones, including two new ISOs signed inthe past quarter.

Our credit and debit card transactions grew 28% for thequarter, with revenue growth of 25%. Due to thecontinued success of our ISO channel, we areraising our expectation for fiscal ’08 revenue growth to thelow 20% range for ourdomestic direct channel.

In Canada,I am very pleased withthe long-term merchantreferral agreement with HSBC that we signed and announced during thequarter. This agreement demonstrates ourcontinued success inthis market. For thequarter, our Canadian credit and debit card transactions grew 4%, while ourrevenue grew 20%, driven largely by afavorable Canadian currency exchangerate.

While we anticipate acontinued year-over-year currency benefit for theremainder of this fiscal year, our third quarter revenue growth for thischannel is expected to bein thelow double-digitpercentage range.

This expected growth is lower than our second quartergrowth, primarily due to non-recurring card association incentive revenuerealized during our fiscal ’07 third quarter. For fiscal ’08, we areraising our revenue growth expectation to thelow to mid-teen rangefor our Canadian channel.

Our AsiaPacific channel had strong revenue growth of 24% for thequarter. Due to these results, we areincreasing our expectation for fiscal ’08 revenue growth for this channel to33% to 40% on areported basis; or, thelow to high teenpercentage range on a proforma basis. This growth reflects solidmomentum gains from our continued sales initiatives and investments, and apositive turn in ourrevenue growth from Taiwan,as previously anticipated.

We continued to make operational progress on our goal to befully converted from HSBC’s back and front end systems platform by calendar2010. As of today, we have convertedboth the Macauand Hong Kongback end platforms onto our U.S.-based platform.

Our Central and Eastern European merchant channel hadrevenue growth of 7% inthe second quarter,with growth in creditand debit card transactions of 10%. Our revenue growth was primarily driven by afavorable year over year Chec currency exchangerate; the impact ofour November 2006 Diginet acquisition; and, importantly, solid transaction growth.This growth was partially offset by adeconversion of thepreviously discussed large customer, and to alesser extent, price reductions granted on contract renewals.

We continue to expect this deconversion to have amid single-digit unfavorable impact on our fiscal ’08 revenue growth inthis channel. Based on thecontinued strong Chec currency exchangerate, we are raisingour fiscal ’08 revenue growth expectations to thehigh single-digit to lowteen percentage range.

Our domestic, indirect and other revenue declined 7% during thequarter, but as anticipated, primarily due to industry consolidation. We expecta fiscal ’08 revenuedecline in themid single-digit to high single-digit percentage range for domestic, indirectand other.

Moving on to our money transfer segment, inthe U.S.our transactions grew 8% for thequarter, while our revenue declined 5%, which reflects thecontinuing impact of acompetitive domestic pricing environment. Transaction growth was driven by same-store sales growth and branchexpansion compared to theprior year.

We ended thequarter with 879 domestic branches compared to 855 locations last year. During thesecond quarter, we closed anumber of unprofitable domestic branches, which caused asequential decline compared to thefirst quarter of this year.

In Europe,we ended the quarterwith 71 branches compared to 53 locations last year. For thequarter, we achieved 39% transaction growth and 48% revenue growth inthis channel. We continue to expect thesecond half of fiscal ’08 to benefit from theanniversarying of last year’s domestic pricing trends; although this benefitwill be less than wepreviously anticipated, given thecontinued concerns over immigration domestically, and thesharp decline in newhome construction.

For fiscal ’08, we anticipate money transfer segment revenuegrowth in themid to high single-digit percentage range.

I will now ask Joeto further discuss our financial results.

Joe Hyde

Thank you, Paul. Our merchant services segment operatingmargin was 25.9% for thequarter, which reflects adecline compared to last year, primarily due to thecontinued high growth inour lower margin ISO channel; theongoing impact of investments inour Asia Pacificchannel; the customerdeconversion in Europe;and duplicate expenses inconnection with our facility consolidation plan.

Additionally, our check guarantee channel experienced higherthan expected losses toward theend of the quarter dueto higher loss rates coupled with lower collection rates, which we believe isrelated to the currenteconomic environment.

Although this trend did not have ameaningful impact on our second quarter earnings growth, we anticipate arelatively larger impact on our third quarter growth, especially due to strongcollection rates achieved during thethird quarter of fiscal ’07.

Our merchant services margin was favorably impacted during thequarter by credits we received from acard association and from our domestic health insurance carrier, both of whichrelated to prior overbillings of certain fees.

Lastly, due to strengthened foreign currencies compared to theU.S. dollar, we received abenefit during thequarter of $11 million inrevenue and $0.04 indiluted earnings pershare, most of which relates to our merchant services segment.

Looking ahead for this segment, we expect amerchant services operating margin of between 25.1% and 25.4% for fiscal’08. For thethird quarter, we areexpecting our merchant services operating income dollar growth to range from alow single-digitpercentage decline to alow single-digitpercentage increase, primarily due to thenon-recurring card association incentive revenues realized during our fiscal’07 third quarter.

Due to thenon-recurring nature of this impact, however, we expect areturn to stronger growth inour fourth quarter. To alesser extent, we also expect our third quarter earnings growth will beimpacted by our year over year check guarantee results as previously discussed.

Inaddition, due to thetiming of certain HSBC interchangepricing adjustments last year inour Asia Pacificchannel, we expect amodest headwind in ourcurrent year third quarter and asimilar tailwind inour current year fourth quarter. Lastly, we arealso expecting apositive impact in ourfourth quarter from anticipated changesin theCanadian market interchangestructure.

As aresult of these factors, we areexpecting third quarter diluted EPS of between $0.39 and $0.42, and fourthquarter diluted EPS of between $0.48 and $0.52.

Moving to money transfer, this segment’s operating marginwas 3.6% for thecurrent quarter, which reflects asignificant decline compared to theprior year, primarily due to thefactors that Paul discussed, combined with our branch-based, high fixed costmodel.

For fiscal ’08, we areexpecting a moneytransfer operating margin ina mid to highsingle-digit percentage range. Our corporate expenses increased 4% during thequarter, and we continue to expect fiscal ’08 expense growth ranging from zeroto growth in thelow single-digits.

During thequarter, we completed thefacility consolidation plan that we announced inMarch 2007 and incurred amodest amount of related restructuring charges.

Based on our segment guidance, we expect afiscal ’08 total company operating margin of 18.8% to 19.1% compared to anormalized fiscal ’07 operating margin of 20.8%. These amounts include theimpact of stock option expenses inboth years, but exclude theimpact of restructuring and other charges.

Moving now to our non-operating line items, we expect $12million to $14 million inincome from the net ofour interest and other income, and interest and other expense during fiscal’08.

Also for fiscal ’08, we expect minority interest net of taxof $8 million to $10 million and aneffective tax rate ofbetween 33.5% and 34%. Lastly, we expect average diluted shares outstanding forthe fiscal year to bein therange of $80.8 million to $81.5 million.

During thequarter, we completed $19 million inopen market share repurchases atan average price of$40.09 per share,including commissions paid. Capitalspending for thequarter was $13 million, which primarily related to technology spending,including for our new G2 platform inthe U.S.,in addition tomerchant terminal spending and our facility consolidation plan.

For fiscal ’08, we continue to expect capital expendituresof $40 million to $50 million. The$9 million on our business acquisitions line for thequarter primarily represented our Discover merchant portfolio acquisition,money transfer branch acquisitions, as well as acustomer list and long-term merchant referral agreement inour Canadian channel.

Moving to thebalance sheet, our reported cash increased due to strong cash flowgenerated during thequarter, which included $52 million related to settlement processing. Themajority of this $52 million relates to temporary timing differences, partiallydue to our Hong Kongback end system conversion. These timing differences will likely reverse duringthe second half offiscal ’08.

As previously discussed, our cash balances include amountsthat we hold related to merchant reserve funds which totaled $127 million atthe end of thesecond quarter. This reflected anincrease of $15 million compared to theend of the firstquarter, primarily due to our Hong Kongback end system conversion. Prior to this conversion, HSBC was holding thiscash on its balance sheet inconnection with our transition services agreement.

Inaddition to merchant-related reserve funds, our cash balances include otherforms of operating cash that is either needed to manage our business or thatreflect timing differences such as cash inour money transfer branches or cash related to settlement processing. Theremaining non-operating cash that is available for acquisitions, sharerepurchases or other strategic initiatives was approximately $130 million atthe end of thesecond quarter. Our primary strategy for this excess cash is to focus onseeking new acquisitions which we believe represents thehighest potential return for our shareholders.

Paul will now discuss our fiscal ’08 guidance.

Paul Garcia

Thanks, Joe. Based on current trends and our ongoing growthstrategy, we areraising our revenue guidance for fiscal 2008 to arange of $1.231 billion to $1.257 billion, or approximately 16% to 18% growthover $1.062 billion.

We arealso raising our fiscal ’08 diluted EPS guidance to arange of $1.89 to $1.96, reflecting 7% to 11% growth over our fiscal 2007normalized diluted EPS of $1.77. Thisguidance includes stock option expense but does not include any othersignificant acquisitions or potential restructuring and other charges.

When I consider thelong-term growth prospects of Global Payments, particularly theemerging Asian and Central European markets, and thestrength of our ISO channel, I continue to bevery optimistic about our future.

Operator, we will now go to questions.

Question-and-AnswerSession

Operator

Your first question comes from Tien-Tsin Huang – JP Morgan.

Tien-Tsin Huang – JPMorgan

Happy New Year. Let’s drill down on money transfer, the4% operating margin was abit of a surprise. Itlooks like the impliedoperating expenses there actually climbed alittle bit sequentially. I amjust trying to better understand what drove thechange. Was thatcommission pressure? Were there some branch closing costs there as well?

Joe Hyde

I think most of it, because themodel is different than theAsian model where transaction growth rates work to our favor, as therates of growth have slowed from years prior and we have remained competitiveon pricing has abigger impact on thebottom line, we did close afew more branches – or alot more branches – than we would have historically.

If anything, we have been reducing expenses, not increasingexpenses so this isreally a pricing issuein themarket, coupled with thefactors that Paul outlined inhis comments.

Tien-Tsin Huang – JPMorgan

Sohow has pricingcompetitively changedhere over the lastquarter or so?

Jim Kelly

I think over thequarter there hasn’t been as dramatic achange. As we havesaid on previous calls, we had alarge changeDecember prior so we arethrough that large increase, but as Joesaid in his comments, theoutlook for thebusiness continues to beuncertain as itrelates to the overallmarket, because pricing continues to bea pressure because ofimmigration issues together with construction and other factors that again,Paul mentioned.

I wouldn’t saythat it hasstabilized. I would saythat it hasslowed in terms ofdeclines, but it hasnot abated entirely.

Tien-Tsin Huang – JPMorgan

I had acouple of questions on thebroader income statement. First, thecost of service linewas flat sequentially which was obviously apositive surprise. Any one-time items there worth calling out?

Joe Hyde

Other than thecouple of credits that I talked about that we received inthe quarter that wouldhave helped that line, but I think thebiggest impact was in thesecond quarter it grew10%; in thefirst quarter it hadgrown 18%; the biggestdifference there is theannualization of the AsiaPacific acquisition, which is heavily concentrated incost of service.

Other than that, there is really nothing else driving that.

Tien-Tsin Huang – JPMorgan

Check and gaming, I amassuming that is inthat line as well, did you call out thedollar amount? Also, can you just remind us how bigyour check and gaming business is inthe aggregate and howthat is growing, and how themargins compare to thegreater firm average?

Jim Kelly

I will start with your last question first. Thecheck and gaming business is not something that we have broken out. Itis a smaller part ofour business, it isless than 10% of our revenue. We mention itnow because the losseshave gotten a littlebit higher and itprobably will cause agrowth impact in thethird quarter because thethird quarter last year was just anunusually strong quarter; I actually mentioned itin my comments on lastyear’s third quarter call.

Themargin on the businessis very good, but itis a type of abusiness where therevenue kind of stays thesame and the earningsis dictated by thesuccess of your collections. Our collections have not been as successful as wehave been, and themargin lowers as aresult.

We areattempting to manage thesituation, go back to some of themerchants that we have and look for higher pricing to compensate ourselves for thelower risk, but it ishard to do thatquickly.

Joe Hyde

Just to comment on therevenue side, I think as we have announced inthe gaming inparticular we have had anumber of strong signings of thegrowth rates both for thecredit card, cash advances, together with thecheck cash advance business which together comprise our gaming business aredoing well from arevenue standpoint and we view this as really acyclical issue for theeconomy more than anything else.

Tien-Tsin Huang – JPMorgan

Any way just to quickly quantify thedollar exposure on thepotential losses on thecheck guarantee side?

Jim Kelly

Itis not like a reservethat is sitting out there inthe conventional senseof a credit cardbalance; these arelosses that come from, as Joesaid, we guarantee checks and if thechecks bounce we collect thechecks and we provide areserve in theevent that we don’t collect thecheck. Those rates of collection improve and decline, and they have for thelast ten years andthey will continue to. This is more of ananomaly than a trend.

Operator

Your next question comes from LizGrausam – Goldman Sachs.

Liz Grausam – Goldman Sachs

Some questions on theoverall merchant services margin. Alittle bit surprised to seeyou bring down theexpectations for themargin for that group overall from your previous guidance, given how muchstrength you areseeing on your revenue line and given how much currency benefit you had out inCanada. If you could walk us through, how much of itis the business mix ischanging themargin profile of that business? How itis you think about potentially reinvesting some of thegains that you getfrom currency and managing themargin in thatbusiness? And, give us some perspective on where you seethat directionally moving, if you can, into ’09?

Joe Hyde

Well interms of the marginguidance for the year,some of the decline orthe pull back from ourguidance that we had inthe first quarter wasdue to just stronger ISO growth, more ISO revenue; theISOs continued to dovery well and that creates more earnings, but ithas animpact on themargin.

Thecheck guarantee losses, as we talked about, was not something that I wasanticipating as of thefirst quarter and that had animpact on the margin.

We arestill investing internationally inboth Europe and inAsiaand that also has animpact on the margin.

Lastly, thefacility planned consolidation, we took alittle bit higher duplicate expenses inthe course ofintegrating the twofacilities that we had there, and that hasa temporary impact on themargins as well.

I don’t think we arein aposition or are justnot ready to go into fiscal ’09 guidance. Obviously our intent is to continueto invest internationally and getsome gains from those investments; theISO channel will likely continue to growand likely will cause some level of margin impact there, but as we getcloser to the year wewill talk more about that.

Liz Grausam – Goldman Sachs

On your money transfer business, obviously adrag to growth and adrag to the overallfirm’s margin and profitability. Is there any inflection point that you seeon the horizon? Itsounds like you aregoing to anniversary some pricing changes.Has theunderperformance and greater cyclicality of this business brought you to thinkabout more strategic options for this business going forward or areyou still fairly committed to themoney transfer segment?

Paul Garcia

Let metackle that one, Liz. We arenot pleased with theperformance. I mean, 8% transaction growth inthis environment domestically is actually not bad. We arequite pleased with our performance inEurope, but overall you areright; it is adrag, particularly on theearnings and theanemic margins we had inthe business clearlyhurt us overall.

This was abusiness that was accretive to our growth rateand produced excellent margins, sothis has been asteady deterioration and I think we allknow the reasons. Doesthat result in usdoing something with this asset? I think we look atevery single asset we have and itis our responsibility to make those decisions. I amnot prepared to sayanything at thispoint. We continue to becommitted to themanagement team there, I think they arevery smart. I think we still have thebest product out there – truly thebest product out there – but I would bedisingenuous to tell you I ampleased with theresults. I am not. Itis an activediscussion.

Operator

Your next question comes from Andrew Jeffrey - SunTrustRobinson Humphrey.

Andrew Jeffrey -SunTrust Robinson Humphrey

Paul, could you talk alittle bit more about Asia, both from arevenue growth standpoint and from anongoing investment standpoint? Obviously you had avery strong quarter, theguidance you gave for thefull year implies not as comparably robust asecond half. Maybe you could touch onthat.

Then I think inpast discussions you have talked about ’08 as being thefocal point of your investment inAsia. Is itright to think about themargins expanding as we moveour way into ’09, without getting into specific guidance issues there?

Paul Garcia

Andrew, I would saywe are clearly runningthis business for growth, not for margin expansion atthis point. While I have said publicly and I will behappy to say againthat ultimately I think theAsian business produces accretive margins, and I will stick to that. Itis going to be along time. I wouldthink it would benot wise to think we aregoing to expand these margins aggressively getting into fiscal ’09. Itis a longer investmentcycle; we are juststarting to make some serious investments inMainland China. Having just come back and seeing thatfirsthand, it is goingto be awhile before those investments payoff.

That is one of thereasons that Joepointed to for deteriorating margin inthe merchant servicessegment and some of theguidance you areseeing that we aregiving going forward.

I would saystay tuned on that. I amvery bullish on where that growth is going. I think there area couple gives andtakes right now; we arestill ridding ourselves of some merchants and that is why you areseeing a littlelumpiness in some of thegrowth, unprofitable merchants arehaving an impact onsome of the revenues,but overall I am verybullish on that and I think you will seesome margins. I amjust not going to bepinned down right now as to when we will seethat expansion.

Andrew Jeffrey -SunTrust Robinson Humphrey

As far as thesecond half revenue growth is concerned, is theimplication that there were some non-recurring revenue benefits inthe second quarter?

Joe Hyde

In Asia,the comment that Imade was – well, in thesecond quarter we did have asmall amount of card association incentive revenue that provided abit of a lift.

Paul Garcia

I think hewas unclear as to – Andrew, I think theanswer to the questionis that you were unclear about why itlooks like there is some revenue moving around. Itwasn’t, as Joe talkedabout, headwinds and tailwinds inthe third quarter and thefourth quarter. There were some interchangeadjustments as this thing settles in; there were some bucketing issues that we aredealing with.

Joe Hyde

Right. Inthe course of thetransition services agreement for HSBC there was some variability inthe interchangethat was applied to thebusiness in thethird and fourth quarter. Essentially theshort story is that thethird quarter last year was abnormally high; thefourth quarter was abnormally low. Sofor the AsiaPacific revenue over thenext two quarters, you may seea small slowdown inthe third quarter, atailwind in thefourth quarter; net result for thefull year is anon-impact and we just wanted to give you that sensitivity before we got tothose two quarters. But itis not a materialimpact to the totalcompany, it just mayplay with growth in Asiafor the next couple ofquarters, that’s all.

Paul Garcia

One of thethings around my favorite subject, Asia, I believe that we arebetter – this is astrong statement – I think we arebetter positioned in Asiaand China inparticular than anyone, truly. We have more of aninfrastructure already, we have more of afocus and quite frankly although itis small because of thenature of the beast, Ithink we probably have alarger portfolio than anybody. Soit is agreat business.

Andrew Jeffrey -SunTrust Robinson Humphrey

Thedomestic merchant business, where you clearly continue to take share, any changesin thecompetitive environment? Any pricing concessions on these two new ISOs yousigned in thequarter? Or are wejust seeing theover-execution or out-performance of your book of business?

Paul Garcia

I think itis two things happening. You have thelatter; you have our bigISOs, our whole ISO portfolio but primarily driven by our bigISOs, continuing to just go from strength to strength doing extremely well,with a lot ofaggressive things they aredoing like free terminals, etc. These arevery entrepreneurial managers and they aredoing a great job.

Thetwo ISOs that we signed, quite frankly, aresmaller so they wouldactually not enjoy thefull rate that thebigger guys do. Soalthough they have very competitive rates, our ISOs, thelarger they become, thebetter the rates theyenjoy.

Sothere is a bit of apressure always as your ISOs grow, but then you offset that with new ISOs,quite frankly at ahigher rate until theyproduce those kind of volumes. Itis producing a niceend result.

Operator

Your next question comes from Adam Frisch – UBS.

Adam Frisch – UBS

I wanted to make sure we have theright picture on themerchant side. Obviously check is causing alittle bit of volatility with themargins, if it is aquarter here and aquarter there fine, itis no big deal; but Iwanted to just make sure on themerchant processing business, which is thebusiness that everyone focuses on because itis your largest, that theformula or the way ofthinking is still thesame; the U.S. isfairly stable and growing, and you areinvesting in Europeand Asia who willeventually become more profitable with better growth infuture years.

Hasanything changedfrom that general formula?

Paul Garcia

Adam, I couldn’t have said itbetter. That is exactly what thestory is. We have solid growth with alot of visibility domestically; we have solid opportunities inAsiain Europe;we are ina significantinvestment mode inboth of those. When we saydomestically, I really should sayNorth America because we arereferring to Canadaas well. So that isexactly the story.

Adam Frisch – UBS

And themargin on the U.S.business, fairly stable from thelast couple of quarters to where we arelooking going forward? Nothing haschanged thereeither?

Joe Hyde

No, there is really no bigchange other thanwhat I have highlighted.

Adam Frisch – UBS

And thenatural follow up then, if check cashing is causing some volatility on themargin side, we’ve seen First Data getout of the business –or attempt to, atcertain points – what areyou guys thinking about your check cashing business? Would you consider scalingit down or getting outof it?

Paul Garcia

Adam, we have acouple of different businesses within check; we have our gaming business andthat, quite frankly, is doing terrifically; although we areseeing a little uptickthere, it is amore collectable amount and really, itis a business that we arecommitted to.

Theguarantee business, which is mostly for smaller merchants and itis just what itimplies, it is aguarantee on a check,that business dynamic haschanged dramaticallyover the last 15 or 20years and the qualityof the check writertoday, quite frankly, hasdeteriorated.

Soyou are having ascenario where a checkguarantee was significantly less expensive than abank card rate; now they aresignificantly more expensive than bank card rates because of thewhole volatility.

Then when you go through aneconomy, those riders aretypically the onesthat are impacted bythings like mortgage crises. Sothat is a business, itis small though. I mean, we haven’t given ahuge amount of guidance on that, but itis a very smallbusiness to us and itis having some impact, but I would tell you, if thewhole thing went bad itis not a major dealhere for us.

Adam Frisch – UBS

I just want to make sure, theimportant parts of thebusiness are thesame story. Then I just wanted to focuson interchange for asecond. Have there been any material changesthere in thelast few months or any anticipated inyour fiscal second half that could help you on thegrowth and/or margin side?

Paul Garcia

Now that we area global company,interchange is apretty complicated subject because you have interchangeimplications in theEU, you have interchangein Canada,interchange inAsia.

Adam Frisch – UBS

Maybe just focus on theU.S. since thatis your biggest market.

Jim Kelly

There were changes,both MasterCard and Visa this past summer, nothing inthe fall but for thespring, at least todate, Visa is talking about some increases on their premium cards, thesignature cards; MasterCard hasn’t announced anything as of yet and as well,Discover, now that we arean acquirer forDiscover consistent with theVisa/MasterCard structure, there aregoing to be some changesthere as well. They arenot anything close to what you saw years prior, but they will have some impact.I think it will beimmaterial for this fiscal year.

As Joementioned, theCanadian market on theVisa side is going through some pretty substantial changesto align more to a U.S.model than theexisting Canadian model, and that will likely have some positive impact.

Paul Garcia

Let medo one follow on, to beclear. I said thewhole business could go bad inguarantee, that would bea little bit of anover-statement. What I mean is that thebusiness could experience some significant write-offs as apercentage but because itis a relatively smallpiece of our business, itwouldn’t have a majorimpact.

Operator

Your next question comes from Kartik Mehta – FTN Midwest.

Kartik Mehta – FTN Midwest

Paul, I just wanted to make sure I understood some of thecomments you have made. I think, Joe, you indicated there were four primaryreasons you gave for themerchant margins being alittle bit lower: stronger ISO growth, thecheck guarantee losses, investment internationally and I think facility consolidationsis what you said.

If I understand right, you had already anticipatedinvestment internationally infacility consolidation, and after hearing your thoughts on thecheck business, Paul, itseems like the reason themargins are going to bea little bit less thanyou anticipate is just because theISOs have been really strong and that would bethe primary reason.Would that be correct,Paul?

Paul Garcia

That is theprimary reason. If we had to list them interms of 1, 2, 3, 4 then ISOs is theprimary reason. But as itrelates to thefacility consolidation, there were expectations of duration, we would complete itand it ran anextra month or solonger than we had originally planned. Ahost of reasons that have aperiod expense which would have been higher than what Joewould have originally expected.

Kartik Mehta – FTN Midwest

Would that bethe second then, Joe, thesecond biggest reason?

Joe Hyde

I don’t know that I can rank it,Kartik –

Paul Garcia

That was aslippery slope I started there, sorry.

Joe Hyde

I would saythat it wasn’t – whilewe forecast, we allhave expectations. Sometimes we meetthem, and sometimes we were late. We were more focused on theservice side of our customers and making sure that itwas a smoothconversion, and that is why itended up running alittle higher in termsof expense than we had planned, but I don’t think itwould be easy to rankthem all just here on thephone.

Jim Kelly

Far and away thelargest year over year impact is theISOs, far and away thelargest.

Kartik Mehta – FTN Midwest

Just to understand theguarantee business, I think, Jim, you said this is not ananomaly, the losses. Thelosses you have already incurred, does that mean inthe coming quartersyou could recover those and they will bea positive and this isjust somewhat of atemporary loss on theguarantee side of thebusiness?

Jim Kelly

My comment, Kartik, relative to ananomaly is that this will occur from time to time. We record losses based on ahistorical rate ofcollections. When those collection rates decline we increase theloss rate that werecord in theincome statement. I don’t anticipate that we aregoing to collect at ahigher rate inthe next quarter tooffset what we have just charged off, largely because theeconomy has turned andbusinesses like thecheck guarantee business aregoing to feel that.

Paul Garcia

One of thereactions we do have,instead of – and there was aquestion earlier about arewe going to get of thebusiness, or if we were to dosomething – what we can doin theguarantee side which, quite frankly, we dodo and sometimes itdoes result incustomer loss, is that we approach customers and raise therates, sometimes dramatically, if you have been experiencing Xloss factor and now itis X plus Y, we factorthat in and go back tothe merchant. Theyeither accept that increase or we no longer provide theservice.

Kartik Mehta – FTN Midwest

Afinal question, Paul. You’ve talked about thegaming business and itis doing well. Obviously abig competitor ofyours had some issues here; another competitor is trying to getout of the business.Does that provide opportunity for you to increase market share, or is themarket so competitivethat might not necessarily bethe case?

Paul Garcia

We actually arepicking up some customers. We have been successfully competing for some time,but I think our biggest competitor having some issues is not something that wehave been reveling inby any stretch of theimagination, but where that offers market opportunities we will take advantageof them. Quite frankly, we have signed acouple of notable customers recently.

Operator

Your next question comes from Paul Bartolai – Credit Suisse.

Paul Bartolai – Credit Suisse

Thanks and good afternoon. We have talked abit about the benefitsthat you received in thequarter. Any chance, given we have anissue with year-over-year comp coming up in3Q, could we maybe quantify some of thebenefits you received in2Q of this year from thecredits you received?

Joe Hyde

They arenot large enough to go through one by one and try to quantify it. Thepoint there was only to let you know that they areout there. I think thebiggest year-over-year impact is theCanadian Card Association incentives that we got inthe third quarter oflast year. I have spoken about ita few times over thepast 12 months. It wasa multimillion dollarrevenue and earnings impact, as I said on thelast quarter call. Out of respect for thecard association and just for competitive reasons, we arenot able to quantify that.

One of thecredits we got was actually from acard association and we would prefer not to quantify that. I would like us to dothat, but we are justnot prepared to break that out atthis time.

Paul Bartolai – Credit Suisse

But what about in2Q of this year? Thebenefits that you received, any chance you could – I mean not even one by one,but maybe just inaggregate so we could getsome magnitude of theimpact?

Joe Hyde

No, we arejust not prepared to break that out atthis time.

Paul Bartolai – Credit Suisse

We have talked alittle bit about thecheck business. Maybe if we could just go alittle bit broader and talk about themacro impact ingeneral. It certainlyseems like the economyis something that could impact thecheck business and maybe some of theother businesses over thenext few quarters. Any comments on what you areseeing in thebusiness in terms of themacro outlook?

Joe Hyde

We aretalking about the U.S.macro outlook?

Paul Bartolai – Credit Suisse

Any changeyou are seeing inspending habits, volumes or anything like that?

Joe Hyde

Aside from thecheck business itself, I wouldn’t saythat we’ve seen a bigimpact. Our December was strong growth; itwasn’t as strong as November somaybe we were off just alittle bit there. But itis only January 3 and we haven’t reviewed thefull set of reports for themonth. I amnot seeing any major impact or new trend inour domestic business as aresult of the economicenvironment.

Paul Garcia

Paul, let merepeat that because I think that is animportant point. We did seea pretty blockbusterThanksgiving period, and we did have agood Christmas, but not to that level. Sowe are kind of seeingwhat you are readingabout, a little bit ofa consumer slowdown.Still, because there is alot of conversion from cash and check into credit we arestill getting that uplift, and thegrowth was still really, really good. Itwas just really good around Thanksgiving and not as strong inDecember.

Paul Bartolai – Credit Suisse

Okay, great. Then just alast question, I think we’ve beaten this to adead horse but I amgoing to do ita little bit moreanyway. When you look atthe merchant margins,I understand some of theimpacts and there aresome give and takes. Just given some of thestrong volumes you areseeing and thecurrency benefit, I amstill a little bitsurprised at thelowering of themerchant margins. You even mentioned that thegaming business is not that significant. Hasanything else changedin thebase business? Specifically theU.S. merchantbusiness from when you gave guidance atthe beginning of theyear?

Itjust seemed that with currency and some of thestrong volumes, we arenot seeing maybe as much leverage as we’ve seen inthe past inthat business.

Joe Hyde

Again, theISOs continued to growvery strong and as they growstrong the margin isimpacted by that growth. Thenon-ISO aspect of thebusiness is actually improved over levels that we had seen in’07. We are getting amodest amount of growth from those channels and I hope to seecontinued growth, but there hasbeen no negative trend on thenon-ISO side.

Themargin hasn’t moved that much interms of our guidance, but to theextent that there hasbeen some movement, itis largely for thefactors that I have described, which is ISO channel, investments ininternational, thecheck guarantee and some higher expenses relating to theintegration of that facility.

Operator

Your next question comes from David Koning - Robert W.Baird.

David Koning - RobertW. Baird

A couplemore questions on AsiaPacific. Over the lastcouple of quarters I think you did 20% sequential growth last quarter and about15% sequential growth this quarter. I know you mentioned some non-recurringitems, etc., but that would suggest very strong year-over-year growth if thatsort of pace would continue. I amwondering if there is any seasonality to maybe theQ1 or Q2 timeframe and that maybe they arejust weaker quarters inthe back half of theyear.

Joe Hyde

You aretalking in Asia?I don’t think there is ahuge amount of seasonality differences. I think there area lot of moving partsand as we areinvesting in thebusiness, the revenue hasaccelerated.

I think itwould be difficult totake a look atit on asequential basis. That is not theway that I would look atit, but we just look atit on ayear-over-year and how theresults are trending.I don’t have a clearanswer to your question, I amnot sure that there is apattern there.

David Koning - RobertW. Baird

How many sales reps doyou have now in AsiaPacific?

Jim Kelly

We last reported anumber, but we have increased that. We have actually decreased alittle bit in Indiaas we are tryingdifferent models. We arenotionally in the300 range with upticks insome areas and downticks inothers.

Quite frankly, as I said earlier, you could double or eventriple that sales force. Once we build theproper infrastructure and rollout all of ourproducts and get ourconversions done, I think these markets can justify massive numbers.

We have added significantly inChina, forexample. We have not added – infact, actually took some away inIndia and therest of the markets arepretty stable. Adding alittle bit pretty much inevery other market, but not significantly.

Operator

Your next question comes from Mark Sproule – Thomas Weisel.

Mark Sproule – ThomasWeisel

Last quarter we talked alittle bit about thedirect sales force and theimprovements that you have started to seethere and how that might help out alittle bit. How hasthat progressed over thelast quarter? Are youstill seeing improvement there?

Joe Hyde

I don’t think there is any notable changefrom what we said previously. Itcontinues to be verypositive, new leadership that came inabout 18 months ago hasrevamped the seniormanagement team and avariety of factors have led to growth year over year, as Phil mentioned inhis comments, both through our alliance with Comerica and our coredirect business areseeing good growth in thebase and good growth innew sales across theboard.

Mark Sproule – ThomasWeisel

Is that helping to offset some of theISO pressure that you areseeing on the marginside?

Paul Garcia

Itis.

Joe Hyde

Itis, but when you put them into context, we aredealing with – I don’t know exact count – but somewhere close to 100 ISOs allof which touch hundreds, if not thousands, of independent sales representativesas compared to our U.S.sales force which is substantially smaller. Sowe are ata disadvantage butagain, the ISOs arefocused on a vertical,on a market namely thesmaller merchants where our focus is for mid-market merchants. We try to stayaway from each other relative to competition and complement each other. I thinkwe are going toconsistently seestronger growth out of ISOs just because we have more of them that we aregoing to be able tosupport from a directsales force, at least atthis time.

Mark Sproule – ThomasWeisel

As you sign new ISOs, you said theISOs that you signed to this quarter were on thesmaller side. Are youtaking on an increasedlevel of risk associated with thetransactions that they aredoing, or have you been able to stay away from some of thehigher risk type of activities and maintain alower [tone] there?

Jim Kelly

Thenew business that we’ve added, either through our direct channels or adding newISOs, we have not changedour risk profile. We areever vigilant to stay away from problem areas and any new ISO relationship thatwe engage goes to thesame credit review and they areobligated to follow thesame procedures as everybody else.

Mark Sproule – ThomasWeisel

On thecheck cashing side, maybe I will stay away from thecontinual discussion of atwhat point does it getlarge enough that you separate that out from theother merchant platform businesses. I know you sayit is less than 10%;your money transfer business is roughly 10% anyways. How bigdoes it have to bebefore you start to separate that out and we can focus inon what the corebusiness is?

Jim Kelly

I think thecheck business has gota longway, it is not aseparate business in thecompany. Joe andothers would make that decision, but I don’t seeit inthe near term.

Paul Garcia

It hasgot a longway before it is 10%.

Mark Sproule – ThomasWeisel

On your cash situation, obviously you continue to build up alot of cash. From anacquisition perspective, areyou still looking aggressively inthe internationalarenas? Are you seeinga lot more activityout there? Has thepricing become more normalized and rational versus where we would have beenthis time last year?

Jim Kelly

Interms of the markets,clearly given First Data going private is going to have animpact on international expansion, as I think most people know. I think thereis still expectations of strong pricing internationally; I think that is goingto take some time to reset itself. But we seea very, as Paul hassaid many times, avery strong pipeline and we areoptimistic that we will continue to besuccessful on theinternational acquisition front as we have been inthe past.

Operator

Your next question comes from Greg Smith – Merrill Lynch.

Greg Smith – MerrillLynch

Following along on theacquisition commentary, is there any chance you might belooking at anythinglarger? Obviously we have acouple of public companies facing some issues. Is there any chance you may beshifting and possibly looking ata larger potentialacquisition?

Paul Garcia

Wow, Greg, how doI answer that? We look atlots of stuff, and just because something is large or public wouldn’t discourageus as long as thefundamentals made sense. We like doing smaller deals; we like doing deals that arestrategic markets or potentially open up new markets to us. That is not to saywe wouldn’t consider something. Soyes, we are looking atlots of things.

I would tell you though that most of our focus is indeedinternational, as Jim just alluded to.

Operator

Your next question comes from Robert Dodd – Morgan Keegan.

Robert Dodd – MorganKeegan

On theDiscover portfolio inclusion, I know itis small, but can you give us anidea of what your plans areto market that with your direct sales forces, and also how that is flowingthrough to your ISOs atthis point?

Paul Garcia

Robert, we arejust delighted to have done that deal, and thefirst guy to market with that to theISO community. It isbeing marketed exactly theway a Visa MasterCardtransaction is, and many times, priced exactly thesame way. It istypically bundled to amerchant. So if you area merchant target ofour direct salesforce or ISO, we would offer you anall-inclusive product and you would getreporting that was inclusive and acommon number to call for any customer service enquiry, funding. I mean, itis truly a productthat you could accept and not have to go to any additional amount of work tooffer that to your customer.

We areseeing a nice uptick; itis another revenue opportunity for our ISOs, itis a revenueopportunity for our direct sales force and we were able to acquire some of thatbusiness that Discover had signed where we had thebank card relationship.

Jim Kelly

Interms of your question on ISO relationships, theprogram that we put inplace and we have previously announced, our four major, largest ISOs havealready been converted and areparticipating in theprogram. Inthose cases, we purchased from Discover themerchants that were related to theVisa/MasterCard accounts of those ISOs and then simultaneously turned aroundand sold them to theISOs so that theyenjoyed the fullbenefit of not just new business, as Paul described, to sign up as aone-stop shop for statement and merchant contracts and thelike, but as well they enjoy thefull benefit of pricing for their existing portfolios.

They have been allvery pleased with theprogram and we areanxious to convert therest of our ISOs and hopefully have that done by theend of this summer.

Robert Dodd – MorganKeegan

Financially on that, I amtrying to quantify inmy head and I don’t know if I can figure itout, to be honest,what kind of impact could that have on your margins going forward, as well?Because obviously we aretalking about anon-organic increase inthe ISO revenue whichis lower margin and will have adepressing effect. Is that going to bematerial or are yougoing to give us more indications of that ata later date? Can yougive us any hints now?

Joe Hyde

Itis all positive, bothfor our direct business, thespread increase from what we were earning on acard fee versus now atthe full rate, oreffectively the fullrate, is all positivefor the company, eventaking into account thepurchase price of theportfolio.

As well for theISOs, we charged a feefor switching thetransaction to theISO, we are nowcharging them a fullend-to-end processing fee sothat is also additive. Theoffset to it arereally two factors: one, theISO margin overall would berelatively consistent for aDiscover transaction as aVisa, MasterCard transaction for theISO so that is adrag on it.

Secondly, Discover while ithas got greatopportunity to grow, itis still relatively small inthe marketplace. Soin total, itis not big enough tohave an impact. Itis all positive, but Idon’t think it isgoing to be thatnoticeable. But itwill help margins across theboard.

Robert Dodd – MorganKeegan

Moving on to Dolex, can you give us any hints on, areyou looking at any changeson the pricing modelor the commissionmodel, rather? Because obviously any adjustments to pricing atyour end, as far as I understand, donot affect thecommission payouts sothat is where you get amargin hit.

Have you had any discussions with any of your agents or yourlarger payout agents with regard to achange inpricing at their end?

Joe Hyde

No, theshort answer is no. I don’t believe we have had any direct conversations. Manyof these relationships aremulti-year agreements. I think itis a good point, butthose are based on theopportunities within theagreement and as I said earlier, we areconsidering allopportunities to reduce expenses whether itis at thebranch level, at thecorporate level or at thesettlement level.

Operator

Ladies and gentlemen, this conference will beavailable for replay starting today at7:30 pm and ending atmidnight on January 18, 2008. If you wish to listen to thereplay, please dial 1-800-695-4249. International participants can dial402-220-0322. This concludes our conference for today. Thank you for yourparticipation. You may now disconnect.

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