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Total System Services (NYSE:TSS)

Q4 2005 Earnings Conference Call

January 18th 2006, 8:30 AM.

Executives:

Philip W. Tomlinson, Chief Executive Officer

James Lipham, Chief Financial Officer

Analysts:

Alex Brown, Lehman Brothers

Craig Ellis, Citigroup

Paul Bartolai Credit Suisse

Gregory Smith, Merrill Lynch

Roger Smith, Fox-Pitt Kelton

Larry Berlin, First Analysis

David Scharf, JMP Securities

Operator

Welcome to TSYS Fourth Quarter and Year-to-Date Earnings Conference Call. At this time all participants have been placed on a listen-only mode, and we will open this floor for your questions and comments following the presentation. It is now pleasure to turn the floor over to your host Phil Tomlinson. Sir the floor is yours.

Philip Tomlinson, Chief Executive Officer

Thank you, Michelle. Before I get started, I wanted to go ahead and cover the safe harbor statement. I want to call your attention to the fact that we will be making forward-looking statements about the future operating results of TSYS. They involve -- that may involve risks and uncertainties. Some of these factors could cause TSYS’s actual results to differ materially from the forward-looking statements that are set forth in the TSYS reports filed with the SEC.

As all of you know and we appreciate you joining this morning, 2005 was somewhat of roller-coaster year, full of great achievements in new markets and certainly some well-publicized disappointments. We had really exceptional financial performance that is exceeded our expectations we had great expense control by our people. We had historic market share gains. We entered into some of the very fast growing markets including China, and certainly the Vital acquisition had to be a real half point. We had very strong growth in our fundamental business, and the last few months as far as e-business have been some of the best in the Company’s history. And I believe we are very close to announcing some other good news this time as we move forward into 2006.

As you know recently we have announced the Capital One agreement we’ve announced Toronto-Dominion up in Tronoto, and one is really exciting to ask is the CUP Data deal in Shanghai, China. There is no doubt, we’ve been terribly disappointed by the Bank of America’s decision to take that consumer portfolio in-house. There is still a really large client of ours and frankly we are hopeful that we will do even more business with them in the future. I don’t think that decision in anyway diminishes our reputation for providing the highest level of service and the gold standard in technology in this industry. This is not the exactly new ground for us, losing our largest customer. If you recall back in 1998 AT&T was sold to City and we lost that business in the year 2000.

I firmly believe that we have the most experienced management team in the industry, and I am totally confident that we are going to manage our way through this given the up coming challenges. We will discuss more of the impact of this later in our presentation. Right now I want to turn it over to Jim Lipham, our Chief Financial Officer who is going to go through the financial details with you. Jimmy?

James Lipham, Chief Financial Officer

Thank you, Phil. And we are pleased announce this morning as Phil said that we finished ‘05 slightly ahead of our upper-end of our, target range of 28% as net income came in with the growth of 29% that’s the earnings per share of $0.99 versus the consensus out there $0.98. As Phil mentioned we had a lot of good things happen in our core business, as well as the acquisition of Vital back in March that contributed to this great year. And as we go through the P&L this included in the press release, I’ll bring a few of those things to life.

First of all in the electronic payment processing revenue line if you look at the quarter we were up 12.8% to 224 million in year-to-date up 14.5 to 870 million, some great growth there in both quarter and year. BoA and Chase obviously continued to be the leader -- real drivers behind the quarter as well as year-to-date. For the quarter BoA had the course of positive effects from the fleet conversion that came about in the first part of ’05. And they also had another 100% billing, which is about the third one that they’ve had this year. They had that in October, which contributed greatly to our increase. Chase continued to add other services and growth ahead of forecast during the fourth quarter and continue for the year.

If you look at the increase for the year of 110 million, Chase accounted for about 27 % of this increase, and Bank of America accounted for about 18% of that increase. Europe had good growth representing about 11%, and is mainly attributable to middle Bank of Ireland was converted in the second quarter of ‘04 as well as ABN AMRO came home in March of ’05. Our process services area has been a pleasant surprise all year, the revenues there represented about 13% of our increase. TSYS Prepaid as you know, we acquired August of ’04 and they accounted for about 12% of our revenue increase since they were here for full 12 months of ‘05.

The other services area which have value-added accounted for the remaining 18% growth and also note that during the year I cancelled 5, they grew at 22% and finished the year at 438 million. When we look at our authorization that builds, they grew 15.7% for the quarter and 16% for the year. As a total, authorizations were 4.7 billion for the year, which is outstanding growth. Transactions deal they grew at 16% for the quarter as well as 16.7 for the year. The transaction numbers for the year are 5.2 billion. When we look at our revenue make up of growth of 15%, we can’t break it down into internal growth of around 12%, new clients added another 9%, and then to bring that 21% total down to the 15, it was a combination of things with lost services and clients as well as pricing concessions associated with contract extensions.

We will drop down to the merchant service line, obviously this is a growth process and related to Vital as well as the majority owned subsidiary in Japan GPNet. When we look at merchant services for the quarter was 67 million compared to 6 million for the same period last year. For the year merchant services at 237 million compared to 26 million. This increase in both quarter and year-to-date is mainly attributable to Vital's results. Vital is experiencing continued volume growth of over around 46% in their VirtualNet products. As well as continued good expense control. Vital’s operating profit margin before reimbursables for ‘05 was 21.6, which is continued to show a raise over the last few years. We look for margin improvement in ‘06 of another 1% to 2% as we go forward. Sequentially merchant revenue is down from the third quarter and it is due to a one time termination fee around 2 million in the third quarter, as well as a re-class of around 2 million of contract revenues that we recorded as expense reduction, instead of -- as a revenue reduction during the third quarter.

We drive down the other services line, you will see flat revenues for the quarter and on a sequential basis the other revenues they increase 1.8 million as a result of bankruptcy services growth at TDM as well as loyalty services at ESC. For the year ESC had revenue of 27.1 million, which was up 26% from ‘04 and accounted for 6 million of our increase in other service line. Reimbursable items again they include money that we’ve received from my clients for out of pocket expenses, and obviously the largest reimbursement item here is for postage which represents 50% of our year-to-date reimbursables and the card association fees represent another 22%. The increase in reimbursable items year-over-year is the impact of the acquisition of Vital and TSYS Prepaid, $39 million is attributable to those two for the year-to-date increase.

When you look at on revenues for the four quarter up 37%, or 114 million for the year 35%, or 416 million, excluding reimbursables we experienced fundamental growth in revenues of 34.5 for the quarter, and 34.8 for the year. The increase in revenues for ‘05 includes the decrease of approximately 2.9 million for the quarter. And a decrease of 1.2 million year-to-date related to the effects of the currency translation of our foreign based subsidiaries. But all-in-all we had a very strong very solid quarter in year-to-date in revenue growth.

When we look at the operating expenses, our employment expense for the quarter grew 39.2% to $128 million and for the year at 27.8% to 462 million. Vital contributed 48% of the increase for the quarter and 55% increase for the year-to-date. And the remainder of increases came from of core salaries and benefits when compared to ’04. We had around 6700 employees at year-end compared to 5700 last year. Vital added 800 employees of the increase and during the fourth quarter we saw over 176 new employees at TDM, which is our subsidiary line that we've added in the call center business.

If you go down to occupancy and equipment expense grew 26.2%, or 71 -- up to 71 million in the fourth quarter and 18% up to 284 million for the year-to-date. We continue to add least equivalent and software expense necessary to add capacity for the new conversations prior to Cap One in the line, also the results of the 2005 include a full-year expenses associated with our new data center in Europe which began live production in August of ‘04.

Other expenses they grew 51% for the fourth quarter and 68% for the year. Vital was a predominant reason for the 22 million quarterly and year-to-date increase. Vital as you know had a lot of their fees in other expense which have to do with their telecommunications and all their infrastructure accounts. During the fourth quarter we also had an additional one time charge of a 2.2 million, which was a charge-off of professional fees and other cost associated with our decision to abandon our plans for western data center at this time.

If you go down to our income tax for the quarter it increased slightly as a result of increased foreign earnings, effective tax rate for the quarter was 33.8 versus 33.7 for the year, our last year, excuse me. For the year, our effective rate was up and almost a full point at 34.9 compared to 34.1 last year. The equity income line, joint venture is down for both quarter and year-to-date as a result to consolidate the results of Vital obviously in March of ‘05. This kind of, this will continue to be down in until the anniversary of the acquisition of Vital in ‘06. I’ll note, Phil mentioned during the quarter we did acquire a 34% equity interest in CUP Data for around 37 million. We did have a positive pick up there in their earnings and look forward to a good contribution from them in ‘06.

Net income for the quarter has increased 15.7% or $6.7 million, our basic earnings per share includes $0.25 compared to $0.22 last year. For the year net income up 29% or 44 million, and as I mentioned before our earnings per share was $0.99 compared to $0.76 per share last year. In conclusion, for the financials we are extremely pleased with our performance for ‘05 and are looking forward to a good ’06. As uplift to the segments phases there are few comments there, as they are three categories and again during the domestic based support services international and merchant.

When you look at the domestic based, it includes the results of the entities based in the U.S. that have to support the core process and business. Revenues for our domestic based services increased to 11.8% for the quarter and for the year-to-date. Excluding the reimbursable items revenues grew 9.7%, and 11.5% for the year-to-date. Depreciation and amortization increased as we mentioned before as a result of the mainframe operating systems and the growth that we have experienced in MIPS and software expense. And the segment expenses represent various transactions between all segments including management -- certain management fees. The management fees between the segments are cost at the international based support services and merchant processing segments, rely on the domestic based support services to combine and this portion of the base tend to fluctuate between periods as our requirements change.

Domestic based support services operating income increased on a sequentially basis and this is mainly due to more management fees during the segments. International base support services include the financial results of our foreign based introducing branches. Total segment revenues increased 18.9% for the quarter compared to the same period last year of 27.8% increase for the year. Also impacts in these revenues of the international base segment are the impacts associated with the effects of the currency transaction adjustments and were negative that I mentioned earlier. During the fourth quarter TSYS Europe reimbursable item increased and this was a result of the third party call center service provided to our new client and excluding the reimbursable item segment revenues for the quarter increased 5% and 14% for year-to-date, mainly the result of the increased process in volumes of the TSYS Europe Company

Segment operating income decreased sequentially as a result of the inter company management charges previously discussed. In the merchant processing segment includes the financial results of Vital, sequentially total revenues are down 6.7 million as a result of a termination fee received in the third quarter and also less revenue from the terminal business at BTMS, segment operating income decrease sequentially as result of the decrease in revenues.

If you look at the balance sheet next sheet over the acquisition of Vital has greatly affected the comparison of’05 to ’04. We had cash at the end of ’05 at 238 million, it was an increase of 5.8 million in ‘04 most significant, it is really more significant when you consider that cash outlays of Vital at 95.8 million CUP data 37 million. We had an outstanding year in growing our cash balance. And as you could see going down the balance sheet we continue to make investments in the Computer Software and Property and Equipment.

On the cash flow in the next page, you will note cash provided operating activities of 239 million for the year compared to 333 (ph) for last year, an affected 41 million in property and equipment, this is mainly the acquisition of computer equipment and another 36 million was invested in software, 13 million had been purchased and 23 were developed. But the majority of the developed software related to Vital’s work on some of their software Vital Express, MS2 and then ESC and Atlanta developed a new system which they call TOP in their business.

Our CapEx of ’06 is expected to be between 75 to 100 million and with the Banc of America announcement of taking that consumer processing in-house, we have decided to indefinitely halt the construction on our Western datacenter as I mentioned before. Our free cash flow for ’05 was 144.6 million and continues to show good strength. With that Phil I’ll turn back over to you.

Philip Tomlinson, Chief Executive Officer

Thank you Jim and I appreciate it. On, I don’t know the business I want to make sure I had some questions last night, you saw in the press release where the board appointed me as a new Chairman and Rick Ussery stepping down. I did retain the CEO title, I am happy to tell you this morning, so I did have some people to question that last night, now I just want to make sure you are clear of that. Rick’s have had a wonderful career and I know he is looking forward to his retirement. He is going to remain our Director and he is not going very far. He lives right down the street to me.

As Jimmy said we started off the year with projections between 19% and 22% and we wound up reporting growth at 29.2%. In April if you recall we raised our forecast from 20% to 25%, then in July we raise the forecast to 25% to 28%. The drivers of those changes including, included, certainly included the conversion of Chase, strong performance of Vital, value added services that we talk about a lot in here and the fact that our customers using our systems and services more and more as jimmy talked about our product systems that have become very, very popular. We also installed a project management system that has allowed us to track projects and get fully reimbursed dry up its there. If you also we doubled our cash dividend back in April when we talk about cash flow.

Our core businesses really continued to perform exceptional well is evidence by 12% growth in organic revenue growth. Some times I get the feeling that our core business gets a little under appreciated and I think it is important to say that in 2005 we added over 40 million accounts organically, none of that customers based added that. And then you add all that to conversion work that we did. I think we’ve had historic market share gains and really about the only journal or trade that we can refer to is the Nelson report and, in, in 2003 we were felt like, we were processing about 20% of the branded Visa and Master Card market. We will reach a peak this year of 49% which is about as close to half as we can get. During 2005 we converted the Fifth Third Bancorp in Cincinnati, ABN AMRO in Amsterdam, FleetBoston and Chase. Those were the big ones.

We also renewed contracts with a number of customers that represented over a, over a half of billion dollars over the life of that relationship and that’s Navy Federal out of Washington which is the largest Credit Union in the world, AmSouth out of Birmingham, Vancouver City Savings, Credit Union out of Vancouver, Canada, Trustmark Bank out of Jackson, Mississippi, Juniper Bank which as you know has been acquired by Barclays out of Juniper’s in Wilmington, Allied Irish Bans in Dublin, CNS Podesto (ph) in Mexico and Metavante in upper Wisconsin, Metavante has been a customer of ours, since 1978 and I think that if my memory serves me right, Trustmark is about the same age they both are very, very old customers and we are proud to have them.

I think one of most exciting thing that we have going on is we have a convergent pipeline it is the largest in the history of TSYS. We have over 75 million accounts lined up in that convergent pipeline. It is stand as; it’s in the process of being converted over to TSYS. We will, we of course Toronto-Dominion that will be coming on July, CUP Data will be coming on in three stages August, October and February, and I think all of those are progressing very nicely. We also think, an interesting has happened with the, as a result of the Banc of America and MBNA Merger or acquisition where we had some pretty good enquiries from aged banks of MBNA that that frankly are just kind of exploring as to whether they have, whether they want to get back in the business or not. So that’s a little bit encouraging and so we will keep you at plugged in on how that’s going as time goes back.

I want to take just a second and talk about international expansion. We still have less than 10% of the global market. Our international revenues make up about 19% of our total revenues and I firmly believe that over the next 5 years international should be in the 30%, 35% range as far as revenues. There is a tremendous amount of geographic and product expansion through Europe. We see good opportunity there over the next 18 to 24 months, particularly in the UK as a lot of issuers will be forced to make system conversions to other platforms. There is also another in house issue that are waiting there a bit, our key strategy is in options. We are having conversations with, I think some, one of the really neat things that we did was the Bank of Ireland Post Office Deal. I don’t know how familiar are you with the post office in UK, but it’s, they are huge merchant and they, Bank of Ireland has launched a new credit card that allows customers to treat some transactions like installment loans and some of the same credit card. That relationship for the UK post office will wined up offering a really board range of services that may attract a tremendous amount of traffic.

ABN-AMRO is a big win for us 2005. And it’s really like getting the good house keeping seal of approval in Europe. We are continuing to see success in the Dutch market and we believe that certainly there is going to be much more opportunities there as result of the ABN AMRO deal. Toronto-Dominion is, we loved doing business in Canada. They have approximate about 5 million accounts according to Nelson with the conversion of Toronto-Dominion we will have 3 of top 5 banks in Canada, plus several large retailers including Canadian Entire which is the largest retailer. We believe that our market share today, well after Toronto-Dominion deal is done will be in 43% range.

We think there is still lots and lots of opportunities in Canada with other banks and retailers and I can assure we are working hard on. We will convert as I said earlier Toronto-Dominion in mid ‘06. CUP Data, we made the announcement in the CUP Data in December, I believe its, I believe long term its going to be the most significant international announcement we have made. The biggest we have ever made was Royal Bank of Scotland, as you know we purchased a 34% equity stake in China UnionPay. And we will increase that ownership up to 45% here in the near future. I am confident we'll have it done no later than in end of the first quarter. We’ve been working with CUP Data over the past several years to get this deal put together and CUP is sanctioned by the China Union Pay sanctioned by Peoples Bank of China, which is there equivalent to the Federal Reserve of China Central Bank. And it has quickly one of the world’s largest and fastest growing payment networks. The PBOC, the People’s Bank of China has mandated that all banks must adapt the CUP brand for domestic transactions. That’s good for CUP Data. CUP today has a 166 member banks and they are responsible for operating the only national bank card network that accepts bank cards in China. So you can imagine the feeling that we have, as best we can tell according to our G2 there are about 875 million general purposes cards that carry the CUP brand today in China.

Only 35 million of those cards are credit cards. Our best estimates are that about 2008 that 35 million will go up to about 200 million. You have heard a lot about bank card penetration in U.S, it’s the 2.9 cards per person in the U.S. It’s about a half a card in China. The nationwide retail consumption on bank cards is only about 5% in China. We have had people ask us why we didn’t, why we partnered up with some one and you heard me say for the last couple years, when we go to China we feel like we have to go with a right partner. It’s a, we found that the business is very relationship driven. The government has strong influence in this very complex process. And we feel, I say we will be very happy that a notable cause going in. I don’t think there is any doubt that they are clearly the best partner in the market place. They could currently provide transaction processing, the last recovery for other banks and bank card issues in China including debit processing. To-date in 18 months they have signed, they have miscued contracts with 23 banks in 18 months of operation. We have about 5 more lined up. We believe it’s a great strategic fit that we would certainly have some long term impact on TSYS and absolutely I think it could be the next Vital or really even bigger Vital over the next 3 to 5 years. I described with our people everybody that is in this business try to do this deal with CUP Data and a lot of people that were not in this business and I think its like hitting a home run in the bottom of the seventh to win the world series, I mean it is a, it is a big, big deal and we are thrilled about it.

Switching over to the prepaid market, 2005 was a year of trying to build some momentum in the prepaid market on a global basis. We have received strong traction with our prepaid services and this segment is important to TSYS because it positions us to capture a broader retail finance market. And it serves as a wonderful bridge to new geographic markets and product segments. The prepaid cards are getting probably as much a more attention in Europe than they are in the U.S and I believe this is going to be a great platform to help us expand in the European market. For a lot of the international customers this is, prepaid is really the first step in outsourcing and we are absolutely one of the first movers in the industry and we have established ourselves as a market leader. By the end of 2006 we would be processing 13 million prepaid cards in 14 different countries with numerous issuing partners. Some of the deals that we announced in 2005 with a Zoomcard and the Answers Etc. card through KeyBank and this is primarily for the un-banked market, the un-banked population in the US. We announced a deal with Royal Bank of Scotland with HMV, which is the largest seller of music, and CDs and all of that in the UK. We did a deal direct with Sonae Distribuicão, a large Portuguese retail chain and then we did a deal straight, direct with Hunkemoller, which is a leading Dutch specialty store. We also, I think showed some great leadership, we took the initiative to create a Branded Prepaid Card Trade Association, and the purpose of that association was to establish industry standards, and create greater awareness in this -- in this business. We also see prepaid as an access to a broad range of other payment applications at the point of sale and we are confident that the healthcare industry will be an early adopter of this technology. I think that the healthcare industry has a problem desperately looking for solution and frankly we thought that we would have a good announcement by this call, but we believe we’re very close to, closing some business in this area. Our products offer unique multiple plus capabilities that allow a provider to integrate HSAs, FSAs eligibility add debit cards, and on separate loan of credit, all on the same cards. So, we think that’s a strong area for future growth. I couldn’t let the day go by without talking a little bit about Vital. They just have performed magnificently. They have renewed contracts this year with 3 of their top 10 clients, including a long-term contract with Banc of America. They had strong organic growth, coupled with the pipelines that continue to add new products and services. And, I think that I am confident that Vital will be a consistent growth engine for TSYS.

We are in the process of introducing two new products, a gift card solution for a smaller to medium merchant segments, that has some enhanced reporting capabilities. We have brought Orlando Vital express, which is a single point of entry, for when you go out and you sign a merchants, and do maintenance on merchants, and its had successful data launch, and we’ve already signed up two more customers after the data for Vital express, which we do charge forth.

Another interesting area, we start to look around and saw that we had 4 or 5 different call centers, and everybody was sort of doing their own thing, and what we’ve done is developed a new division called Managed Services. And we’ve restructured our call centers to create a strategic business here with more than 1,250 agents in 7 contact centers around, across three countries. It will have a more efficient operating structure and a dedicated sales and support team. We think that we are positioned to deliver customized half quality support in these centers, for things like receivables, management merchant technical support, provide a risk management in just general services. -- Over the next couple of years, our leadership team believes that they can generate over $50 million of new revenues from this group. Certainly, there is no doubt that we had some setbacks, and we were certainly disappointed with the Banc of America decision, I will tell it was a terrible way to end the year. And I will say this, if you would ask me the list of the top 100 problems that we had on January 1, of 2005 Banc of America wouldn’t been on that list. There are a happy customers, they, we got a great relationship with them and as you know we converted the fleet business in March of ’05 and renewed the Banc of America contract out to 2014. As we talked about when they de-convert the significant termination fee that would certainly impact our financials and basically it’s a moving target which is based on a number of months remaining in the contract and they have said that they going to leave in October and so that’s what we are planning on. It’s our, in expectation that we will use this cash to invest in the business. We may use it for some acquisitions. We are looking several right now. But certainly we can put to good use. This cash we have, frankly was we, we would never get that pay out. We do have a plan to manage our expenses. As you know it’s sort of a cliff issue when you talk about expenses with credit cards. We have to service these accounts until the very last day that they are here and they are gone and the next day we have to start getting, start reducing those expenses that we have.

For 2006, we have a zero growth rate in our team member base, so we don’t go and add any net people in 2006. We have about 90 team members working solely on the Banc of America business. We loose about 30, 35 professionals every month and a total of about 80 team members through just normal attrition. In over the course of the year we are going to redeploy those team members to fill other jobs and certainly we have a need for that through out the company. We are also going to have to lean heavily on our hardware and software vendors to restructure our capacity. If you look at TSYS in 2005, the people and equipment are 57% of our expense base. We also have some new clients coming on that will observe some of the capacity. I think it’s a tragedy that all of the accomplishments and momentum that we build in 2005 seemed to be getting over shadowed by the BoA decision. I hope that you realize that from my comments that there is no one silver bullet that can replace the Banc of America’s consumer business. It was a huge piece of business for, for us. They were an anchor client. They have been here for 25 years and they are going to be hard to replace, but we do have a lot of different pillars of growth if you will and we are encouraged by a long-term prospects. Our fundamental business is, is still very strong. We continue to have 8% to 10% organic growth and that’s what we think we will have in 2006. Our value added products as you know the industry continues to get more sophisticated, we will continue to roll out new products every year. Value added is about 14% of our revenue.

The loyalty business is, is one that I am really excited about. I believe that the acquisition of ESC loyalty is going to be one of those great events in our history of long term. As, as Jimmy said we built this new product TOP and its really becoming a must have in this business and I think you are going to be surprised long-term with the results that we post on ESC. We are very, very encouraged by that. When you, when you talk about Europe, the European banks are getting more comfortable with outsourcing before we get there, I don’t think that they have really thought much about that. There is, there is going to be more consolidation in banking and it’s going to leave a lot of European processors with multiple technology providers. The other thing is there are over 80 processors in Europe, mostly owned by banks, very similar to what we had in US 25 years ago. And of course any time we have regulatory and compliance changes. It causes insurers to reconsider their in-house solutions and may be somebody else can do it better.

In China, we absolutely are convinced that CUP Data is the right entry into the Chinese market and I think it would do; see some right things out there. Vital gives us good growth and diversification. We have a very aggressive anti-strategy and expense control plan put together, but certainly when you loose a customer like BoA it forces you to look at every efficiency and so we are evaluating everything. We want to move in to new technologies that can reduce our costs structure. I want to take just a few minutes and talk about our forecast for 2006. There is no question, 2006 will be a good year, given the challenges that we face. Certainly, the timing and the decision on the Banc of America conversion will have an impact. We had not expected them to pick the October date. But provided that Banc of America leaves in October, we believe that our total revenue growth will increase in the 5% to 7% range. Our revenue before reimbursables growth will be in the 9% to 11% range. And -- and that includes the termination fee, and the fact that as a result of them leaving, that we will have to accelerate $7 million in contract acquisition cost that we had been advertising over the, after the 2014. Our earnings per share will be in the 21% to 23% range. We fully expect to close out the year at 395 million to 405 million accounts on file. And, as a part of our assumptions for 2006, we are deferring the revenue and cost associated with the Cap One contract. That contract has got some multiple components, and there are some outstanding questions around the timing of the revenue and expense recognition. So, when you extract the BoA termination fee, and try to normalize the numbers, both revenue before reimbursables, and EPS would be a 4.6%. I think it’s right incredible when you think about losing 131 million accounts. I think it’s pretty impressive that we could have any grows. So, with that Michelle I will open the floor up for questions, and we will go from there.

Questions and Answers

Operator

Thank you. Ladies and gentlemen, the floor is open for questions. If you have any questions or comments please press the number 1 followed by * in your touch tone phone at this time. Pressing one for a second time when we remove you from the queue after question may please pick your handset listening on speaker phone for optimum sound quality. Please, hold yourself for questions.

Your first question is coming from Roger Freeman. Please announce your affiliation, then post your question.

Q - Alex Brown

Yes, hi Lehman Brothers and this is actually Alex Brown for Roger. How are you? All right, all right. First question on the BoA, you talked about the de-conversion not affecting the commercial and small business card programs and can you remind us little bit how big those programs are and what do you think the risks are about loosing that perhaps as well?

A - Philip Tomlinson

Well, we will give a specific numbers on clients, but I can tell you they are absolutely in our top 5 customers. I don’t think that there is high risk of loosing that business. We, it’s a very specialized business in the U.S. We tend to dominate that business. We have got close to a 90% market share. We also process in MBNA commercial and small business accounts and I would say probably at sometime they will merge those two businesses together. I don’t have any details on that, but that’s a business decision for them. But we have been advising that business in good shape and we feel good about our long-term prospects there.

Q - Alex Brown

Okay thank you, it’s helpful. And then on Vital, it looks after you pack up these one time items I think that’s $4 million that was in it, it looks like there was a 5% sequential decline in revenues and is that what we can expect going forward in terms of seasonality, do you think that it was basically that’s the seasonality that we can see next year?

A - Philip Tomlinson

No, that’s not seasonal; I mean that was more inline with the one time things that happened in the third quarter. We also had some accounting entries and dealing with Banc of America contract that was finalized. So you will see the third quarter was little abnormal. And the third quarter and that’s the reason we are down from the fuller in the fourth quarter.

Q - Alex Brown

Okay.

A - Philip Tomlinson

We will go normal. Now because it’s several one time hits a ….

Q - Alex Brown

Great and then lastly I guess I don’t know if I missed that but did you give tax rate guidance for next year?

A - James Lipham

Yes, we did. We should been in the same neighborhood of 34% to 35%. I think we have some audit years that will be closed now then; we could have a little favorable impact there. So we might be able to bring it back down to 34 ranges.

Q - Alex Brown

Alright, thank you very much.

A - James Lipham

Thank you, Alex.

Operator

Your next question is coming from Tony Wible. Sir please announce your affiliation and post your question.

Q - Craig Ellis

Hi guys this is actually Craig Ellis calling for Tony Wible. I just hope you can go over couple of quick things, one is translate your comments regarding, your desire to cut back on expenses subsequent to the BoA de-conversion that you guys actually are looking actually to keep some of those expenses on, in anticipation of some further wins. Can you just give me a little bit more flavor for that?

A - Philip Tomlinson

I will try, I mean, obviously we have a plan for those expenses. The key thing probably is we are not going to add new people. We are going to redeploy. As I mentioned earlier, we lose about 80 people a month for various reasons. We estimate that 30 or 35 of those would be the professionals, IE programmers. So, we have the BoA and secret business fallen off, and we have dedicated people, very strong people dedicated to those two accounts. And, as these new businesses come on, Toronto-Dominion and Cap One and others, we hope to be able, where we will hope we will be able to move those people around and assign them to strong slots. What we are trying to avoid frankly is a layoff. And we, we prefer not do that. We have got a lot of good business coming on, as I said we have got a 75 million account Q; that is very strong, it is the largest Q we have ever had in our history. -- There, we think we have planned as best we can to be able to get these, these myths out the door. As I’ve said earlier, almost 60% of our expenses, our people and equipment. We have, we have delayed the building of the western data center until all these settles down. Now, I said delayed, we still believe that we need a western data center, but, you know when you go back to, to what I’ve said earlier, if we would have had, if you ask me to list a 100 worst problems we have loose BoA would not have been on the list. And so, we are working our way through that. We think we have a good plan. We think we are going to do well, but the problem is with these expenses you just can’t cut them off the same time that the customer leaves. You have leases to deal with, and you have people issues, but I think we are going to be pretty efficient with that.

Q - Craig Ellis

And just, maybe just talk about from an absolute dollar point, dollar value standpoint, as you guys are exiting maybe out of ’06, do you expect that the absolute dollar amounts as compared to 4Q of this year, for both dollars and personal, and that occupancy in equipment will be lower than that are exiting this year?

A - Philip Tomlinson

I don’t, I don’t think there will be low but I would expect them to be in the same range now, in our forecast we are optimistic and I am somewhat optimistic that is going to be better than what we put out there in the news release, but our folks are here temper me a bit but I, deep down in my heart I have this feeling that we will be better than that. It’s a, in this forecast we do have, we do have full benefits in there we, we, we believe that we can pay those benefits. That would be the one big thing that might reduce the’05 expenses versus the’06 because that can be a big number based on the year that we have, but I think the key is we have stop hiring, we are not hiring anybody. We are replacing some people. And that’s going to be the, that’s going to be our aim until further notice, now we, do we have some business on the horizon I think so, I think you can always depend on us to have some good business on horizon. We got a lot a lot of unique and niche opportunities out there that I think next quarter we will be talking about and you are going to be impressed with.

Q - Craig Ellis

All right and just make sure I got this straight on the one time fee net of the amortization, big flourish in amortization, that’s being taken into account within the guidance correct?

A - Philip Tomlinson

That’s right.

Q - Craig Ellis

Okay, so make sure on that, thank you.

A - Philip Tomlinson

And by the way just said you known this that termination fee we will not pay that will be a one time event, we will not pay any bonuses or profit share based on collecting that fee. We think collecting that fee is a negative.

Q - Craig Ellis

All right, thank you very much.

Operator

Your next question is coming from Paul Bartolai. Please announce your affiliation, then post your question.

Q - Paul Bartolai

Good morning it’s Paul Bartolai, Credit Suisse. First just a follow up on that question is the one time fee going to be in revenues?

A - Philip Tomlinson

Well yeah, we think we have to take it in the revenues.

Q - Paul Bartolai

Okay, I am, and then just back on Vital, I was just trying to understand what is going on here I mean, so you have $4 million in one time type of stuff in 3Q?

A - James Lipham

That’s correct.

Q - Paul Bartolai

So then is that a normal seasonality that it would have been down 5% in the 4Q is that the normal seasonality or may be if you could give us what the kind of the pro forma year-to-year revenue growth would have been in Vital if you can give a sense of what was going on in that business?

A - Philip Tomlinson

I think, if you look at the third quarter too, we had a, we closed the San Diego office a Vital merchant services with sales organization. That was probably around the $1 million worth of revenue in the fourth quarter that disappeared. And I think that will something going forward as we will continue to see a little less revenues coming from. I think year-over-year Vital is going to continue to grow in the higher single digit in their revenue growth and as Phil mentioned they continue to have a pipeline that continues to help our opportunities from…

Q - Paul Bartolai

Give your view on your processing volumes for Vital?

A - Philip Tomlinson

Well the main process and volume as your VirtualNet products and I mentioned in there that they were up 46% and as you know the dial is, dial goes down and VirtualNet goes up, VirtualNet is the most profitable piece they have and that’s good growth form. I think year-over-year they were in the 16% to 17% growth range total. The problem with that maybe to give you, my simple answer is going forward you should expect the fourth quarter in Vital would be higher than the third quarter.

Q - Paul Bartolai

Okay that’s helpful, and then just on the guidance, can you give us any indication of the, what you expect by revenue line item in the Vital segments.

A - Philip Tomlinson

Well we haven’t really ever disclose that and how the Vital Merchant pieces is new to us this year. I think we still want to stick with our consolidated number this time.

Q - Paul Bartolai

Okay thank you.

Operator

Your next question is coming from Greg Smith, please announce your affiliation and post your question.

Q - Gregory Smith

Hi, Merrill Lynch. Just on the revenue on the, you guys mentioned the revenue guidance before reimbursed bills, I want to verify that you said 9% to 11% growth and that does include the termination fee is that correct?

A - Philip Tomlinson

Yes that is correct.

Q - Gregory Smith

Okay, so it’s like 5% without the termination fee.

A - James Lipham

Yes

Q - Gregory Smith

Okay. And then just…

A - James Lipham

I would say 5 to 7.

Q - Gregory Smith

Okay and then the, just the timing on the DFAD conversion I spent some prior skepticism about this October deadline I mean is that still operationally realistic at this point?

A - James Lipham

Well, Greg they believe it is, so I think we have to go with what they believe, they are having to do all of the heavy lifting and I think that certainly between Banc of America and MBNA they are large enough and have enough resources to where they can do about anything they want to do. So I think we are on count on October.

Q - Gregory Smith

Okay, there’s nothing…

A - James Lipham

I think they are going to, they going to have a difficult time, is a hard conversion but, but they get it done.

Q - Gregory Smith

Okay, so there is no big dating items on your hand preventing you from meeting that goal in anyway share performed?

A - James Lipham

No that’s easy for us.

Q - Gregory Smith

Okay, okay, thanks a lot appreciate it.

A - James Lipham

Thank you.

Operator

Your next question is coming from Larry Berlin. Please announce your affiliation and post your question.

Q - Larry Berlin

Hi guys First Analysis. Actually the last two analysts did such a good job against my questions thank you.

Operator

Your next question is coming from Roger Smith. Please announce your affiliation and post your question.

Q - Roger Smith

Hi, Fox-Pitt Kelton and I just want to go for this Vital again, as I want to reconcile back between your 225 to 235 annual revenue before the investments and then is that really against the merchant services on the consolidated income statement rather than the merchant processing services on the segment reporting and just how should we think about that, those two, the difference between those two numbers?

A - James Lipham

You know I think that when you look at Vital as far the merchant services and we floated in 235 and that’s pretty much where they ended the year. So if you look at it going forward you can count on the, few more months next year but though they started a little late bit but they would be up, get 10 months at 235, so you can count the figure where it be.

Q - Roger Smith

Okay, and that you, then but when we look back at the segment numbers it looks like that numbers closer to 220 there, does Vital has some revenue in the other segment lines as well then?

A - James Lipham

No they don’t.

Q - Roger Smith

Okay, I should -- that, I could follow-up with you on that, that’s fine.

A - James Lipham

Okay.

Q - Roger Smith

And then the other thing on the China Union Pay data that is in the guidance right now?

A - James Lipham

Yes.

Q - Roger Smith

Okay and then…

A - James Lipham

Now, you know we have said on several occasions we are not expecting any, any big numbers for, several years.

Q - Roger Smith

Okay.

A - James Lipham

But it is profitable.

Q - Roger Smith

Okay and then we, I mean I guess you gave us the $37 million as the investment number? Should be…

A - James Lipham

Yeah, that’s right.

A - James Lipham

So far.

A - Philip Tomlinson

So far.

Q - Roger Smith

Great so far. And then we should we think about return on investment as some kind of contribution in the near term?

A - Philip Tomlinson

I don’t think I would initially are with -- I would initially, if you can -- there was -- this is a, -- we planted the seeds for the future here, and I just think it is going to be a while longer before we would be thinking about a lot of that I think at some in point you ought to be thinking that.

Q - Roger Smith

Okay, great thanks very much.

Philip Tomlinson, Chief Executive Officer

Thank you. Michelle the time is getting late the market is before my watch is opening so we will take just take one more question.

Operator

Okay. Your last question is coming from David Scharf. Please announce your affiliation and then post your question.

Q - David Scharf

Hi, JMP Securities thank you. Two things, one can you give us a little more color, really as we looking over the next may be 3, 4 years with the domestic versus international mix, it sounds like card account is going to look like and then now that you, one, Capital One and two JP Morgan Chase, Bank One, and BoA in-house. There don’t appear to be any real big 800 pound realism in the domestic front. If we had to forecast three years from now and where the growth is coming from and what the mix is going to look like what do you think international revenues as a percentage of the total might look like in few years?

A - James Lipham

Well, I said over the next 3 to 5 years I think I said over the next 3 years be in the 35% range.

Q - David Scharf

Okay, and is the pricing in Europe still in a material premium to what we are seeing in the US?

A - James Lipham

No, no not really. All the years consultants have moved to Europe and they -- we have our own set of rules that we play with and so they, they’ve succeeded in reducing that premium down. I think what happens is, we talked about earlier we have this, this huge capability and as people move on to, to Total Systems they, they tend to buy more and more product and we talked about the value-added products in the differ margins on those products and, and so as we get into a deal several years it really becomes more sweeter for us. So, there would be good growth in Europe, as far Europe, internationally there would be good growth. We are excited about that, you know, I keep saying 3 to 5 years in China because that’s really new ground for us. We -- I would like to think it could -- it could be faster than that. We have the Olympics coming to China in 2008. The government has mandated that the last majority of merchants must accept credit cards. But there is a corporal issue there, were they are used to debit cards and a part of that is, is happening, same thing is happening in Japan. And some to degree in Europe, I mean, there is much more debit cards, and many more debit cards in Europe than there are credit cards. So we are, we think they are great opportunities, you add on top of that some of these new businesses we've added, I mean, we still think we will be very successful in prepaid business. We know we are going to be very successful in the loyalty business. And so we are very bullish over our long-term capabilities, now that we have some other things that we are working on, absolutely. I think that you will see some good things out of us in 2006. So from is, all of this as a pretty long-term sales cycle that we are bullish on it. And we are encouraged as we believe the card industry is very dynamic and particularly when you at look the transaction growth, and the product evaluation at the point of sale, so we are very excited about it, but international has got to be part of our long-term growth plan.

Q - David Scharf

Got you, and lastly, you obviously will have more of an imposing the cash balance in Wall Chest (ph) after the termination fee. As you look the acquisitions I know you have put a lot of different processing in merchant oriented platforms. But your value-added products have grown considerably, and I trusted a lot of those are products that you host for other vendors. For example fair highway products and so forth. Would you be interested in acquiring a lot of those types of technologies for yourself instead of relying on vendors and perhaps, you know, capturing more of the economics of that or would be focused on acquiring still more process and oriented business?

A - Philip Tomlinson

Well, I wouldn’t want to limit anything, but absolutely we are looking at several key areas right now. I mean the one area that we talked a lot about over the year -- past several years has been debit processing. Frankly we may have missed the window there and there is a huge price war going on that business anyway data analytics we talked about before. We’ve got some issues that we want to got to deal with in the, in the merchant in you know in with vital in the merchant business we think there is some, some gateway if you saw we would like to go deal with the some new products so we have got pretty to deal with to try and go deal with and I think, we are building up a good – just and but the fact the matter is its got a fit we are, as you know we are, we are not the kind of folks who just buy just to buy --. And some, some, some people would think that may be we are little too particular but as you can is evidence matter financial we are conservative and now see that change in any time soon, so I don’t mean to ramble with you Roger but we are, we are really looking at a lot of different segments that they might make some sense for us we a got a, a full time team doing that.

Q - David Scharf

Okay, thank you very much.

A - Philip Tomlinson

I more I more try to close it out I don’t know if Steve Stout is out there with UBS but I would like to say to him he is a Texas Longhorn– congratulate him on university Texas winning the national championship, things like that are always important. We believe that, that the card industry is still very dynamic, we believe that we have the goal standard we have a varied client centric service model we have proven capabilities and we think so more advantages in the market place I am convinced that we will continue to win and with lot of the gossip in the industry news going around in this business today I think it, its very helpful to us we are clearly committed and focused on this business and, and we feel its going to continue to grow. As always a I really want to thank you for your support over the past year and, and hopefully in the 2006 and thank you for your encouragement and friendship ph and we will be talking to you thank you a lot bye, bye.

Operator

Thank you, ladies and gentlemen this thus concludes today’s conference call you may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.

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Source: Total System Services Q4 2005 Earnings Conference Call Transcript (TSS)
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