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Total System Services, Inc. (NYSE:TSS)

Q2 2008 Earnings Call

July 30, 2008 5:00 pm ET

Executives

Shawn Roberts - Director Investor Relations

Phil Tomlinson - Chairman and CEO

Jim Lipham – CFO

Analysts

Glenn Fodor – UBS

Bryan Keane – Credit Suisse

James Friedman – Susquehanna

Glenn Greene – Oppenheimer

Julio Quinteros – Goldman Sachs

David Scharf - JMP

Operator

Welcome to the TSYS second quarter earnings call. (Operator Instructions) It is now my pleasure to turn the floor over to your host Shawn Roberts, Director of Investor Relations.

Shawn Roberts

Before we get started I want to call you attention to the fact that we will be making forward looking statements about the future operating results of TSYS. These forward looking statements involve risks and uncertainties. Factors that could cause TSYS’ actual results to differ materially from the forward looking statements are set forth in TSYS’ reports filed with the SEC. At this point I’d like to turn the floor over to our Chairman and CEO, Phil Tomlinson.

Phil Tomlinson

Welcome everybody to the TSYS xecond quarter earnings call. I’d like to thank everyone of you for taking time during this busy season to participate in the call. I wanted to take a few minutes and explain our reasoning for changing this call that was originally scheduled for tomorrow morning. We changed it to this evening last week.

After our first quarter we noticed some confusion regarding the decline in international margins as a result of the nationwide operations center start up cost in London. With today’s announcements and the earnings adjustment that we’re going to talk about we decided that considering the volatility in the market it would be best if we had the earnings call as early as possible after the press release. I apologize for any inconvenience we might have caused for anybody out there but believe this route will give you the latest real time information.

Also, I hope you have had time to notice that we have substantially changed the format of the press release and we’re providing much more detailed information as many of you have asked for. Every time I go the gas pump it certainly feels like a recession to me. We’re continuing to experience growth but we’re now experiencing the back wash of what I would call economic headwinds that our clients have faced all year long.

As outlined in the press release we are reducing our guidance primarily for two reasons. First is the first six months of 2008 were tough on our clients and anyone certainly including us could have ever imagined. The fact that most of our major clients have earnings problems and the anticipated card growth began to slow down in late May and has continued through June. We’re certainly disappointed with the change but our fundamentals are as strong as ever and we’re confident about long term growth prospects.

Now I’d like just hit some highlights on the second quarter. As you’ve seen the consolidated total revenues increased 5% in Q2 and 6.2% for the first six months ending June 30, as compared to 2007, very solid performance under the current conditions. Our operating income on a GAAP basis increased 1.8% in Q2 versus Q2 ’07 and on a non-GAAP basis which excludes the one time Synovus spin related cost, operating income increased 3.1% for the same period.

Our Global Services segment grew total revenues for Q2 at 31.9% over Q2 2007. Sequentially Global Services operating income grew a remarkable 57.7% as we benefited from the investment in the first quarter to start up the processing and managed service clients in the UK, the new ones that we talked about last quarter.

Basic EPS on a GAAP basis came in at $0.32 per share as compared to last year and on a non-GAAP excluding the one time spin expenses we came in at $0.33 per share for the second quarter and $0.64 year to date.

Some highlights, new business we announced that we’ve signed a processing agreement with Global Card for the launch of consumer credit card portfolio in Mexico. We’ll provide account processing services, risk management, portfolio management and reporting to Global Card. As I said, they’re based in Mexico.

We also announced an agreement that we’re very excited about, PartnersFirst Affinity Services, which is a division of Torrey Pines Bank, to process its consumer credit card portfolio. In addition the core processing PartnersFirst will use all of our technology for online credit card services, instant applications, cards, statements, letter production and a full suite of the customer care offerings.

It’s a great partnership between two good companies and we’ll offer a full range of card services for small and mid-size Affinity partner marketing groups. They’ve already experienced good success in this Affinity space and we certainly expect big things from them going forward.

We also announced that we’ve renewed our agreement to exclusively process Canadian Tire. It’s a multi-year contract and it’s for the MasterCard and private label portfolios. We also negotiated several other long term contracts with customers. I do have some negative news, we’ve been notified that one of our retail clients will be de-converting to a competitor in March of next year I believe it is. Price was the issue and while I hate to lose them they represent less than 1% of our revenue.

We’ve also signed a deal in Japan with Sony Bank. We always have a lot of questions about China UnionPay. I’m thrilled to tell you, you may have read pieces of it in the trades here recently. We signed a deal with CUP Data for the Chinese Citi debit business which is very exciting to us. We also, I think this is the kind of things that sometimes go unnoticed at TSYS. This one is so big I just wanted to give you a flavor for it.

I’m not in a position to give you any names today but one of our banks has recently signed a new Affinity group and they have added over a million accounts as a result of that Affinity group in the past 25 days. Those are the things that make a real difference here. Value added products have continued to be a solid contributor. Value added was up 12.2% for the year and 12.4% for the second quarter.

In our Merchant Processing business revenues for the first six months are up 2.1% over the same period in 2007 but TAS contributed significantly to operating income or margins of 29.4% and revenues increased 5% for the first quarter. I talked enough I want to turn it over to Jim Lipham our CFO who is going to give you a lot more details about what is going on at TSYS.

Jim Lipham

I would ask everyone to take a look at the income statement we provided with the press release. As a reminder I’d like to note that several of the comparisons of ’08 to ’07 are impacted by the migration of Chase from a processing solution to an in house licensing model. We’ll anniversary this at the end of July of ’08 and then our comparisons thereafter will be done a quarter basis a more true reflection of the trends of our business.

We’ll start off with electronic payment processing. As you know it mainly includes our core processing and licensing arrangements for both our North American segment as well as our global based clients. As shown in the release our electronic payments processing revenue was down 1% or $2.3 million for the quarter and for the first six months we’re actually up 1.9% or $8.9 million.

The revenues in ’07 include the processing revenues from Chase prior to its migration and this loss of revenue was really picked up by new business that we put on mainly in Europe and the growth of our existing clients here in the US.

We’ve had some good things happen to help offset that loss of revenue. When you exclude the revenues associated with the de-converted class, the impact of the migration also, the electronic payments actually grew 9.3% for the quarter and 12% for the year. Out of this growth 70% of the quarterly growth and approximately 50% growth for the year is also new business added since the second quarter of ’07. This is mainly, as I said in Europe our clients such as Nationwide, CapOne and Rabobank.

The remaining portion of our growth was provided by our consolidated internal growth rate for the year to date is at 7% and we’ve had a little drop in the second quarter which is part of the reason for the change in the guidance we’ve seen the internal growth drop off some and we had price concessions as Phil mentioned we had some re-negotiated contracts that we did through the first half of this year and we had price concessions also affecting our growth from internal customers.

The International revenue segment this includes Global Services as well as Canada and Mexico. That revenue stream increased $20 million or 25% over last year’s second quarter and increased $35.8 million or 18.9% year to date. There again the real increase there is the strong growth in the UK and the international clients that we’ve added.

Also in Europe are the international revenues, mainly in Europe, were affected positively by the currency translation adjustment. In the quarter it was about $650,000 and year to day it’s about $2.2 million. Phil mentioned the value added services so I won’t go into that but obviously a big item there is some of our Triad services, scoring services and with the loss of Chase it’s affected that growth. Sequentially we’re showing some good growth there, about 8.4% in the value added area. It really complements our core services.

Phil Tomlinson

I misspoke a minute ago. Those numbers of 12.2% and 12.4%. What I really meant to say is as a percentage of revenues that growth is.

Jim Lipham

Sequentially I think the big thing there is we are growing in the value added area and it’s up 8.4%. We lost a lot with the loss of Chase. Compare more favorably as we go forward.

During the quarter we were very successful as Phil said in extending the agreements with Target and Canadian Tire. Overall we’ve renewed six clients including four of our top 20. Most of these clients are signed up through at least 2012.

Excluding the de-converted council filed from last year our council file numbers year over year grew 17.8% or 56.7 million accounts to $372.9 million the growth was really the result of 30.1 million new clients and we’ve added a lot of customers with folks like Charming Shops and Green Dot. Then we’ve had internal growth and added another 39.5 million accounts.

Transactions, despite the current economic environment we continue to see cardholders using the accounts. Sequentially our quarterly transactions grew 8% to $1.95 billion and authorizations also increased a little over 8.2% to $1.77 billion. Good growth sequentially in transactions.

Drop to the merchant acquiring services revenue, it increased compared to prior year and also for the quarter. More importantly when you look at it sequentially these revenues are up 6.3% primarily as an increase of both the outgoing transactions and point of sale transactions growing at 7%. TSYS acquiring its revenues before reimbursables are down slightly for the quarter and the other part of the growth here is coming from GPNet. That’s mainly due to their drop still from the de-conversions and price compressions that they’ve had going on which is suppressing their growth.

However, when you look at their operating income for the second quarter it was $18.1 million an 11% increase over the second quarter of ’07. Year to date the operating margin excluding reimbursables increased to 29.4% compared to 24.9% in ’07. This is the result of a concerted effort by all those team members managing those costs and we’ve said that before we tend to do a real good job of managing our expenses in light of our revenues.

TSYS acquiring also had a great quarter from the service standpoint as both it front end and back end maintained over 99.99% availability. Good performance for them.

For the other services revenue you can see there its pretty strong growth in ’08 compared to ’07. The primary reason is Phil mentioned the call center business in Europe and we’ve had huge growth there with Nationwide as we’ve put them on in the first quarter and they really came, the revenues started showing up this quarter. We’ve had also an increase in the US, and it’s mainly coming from Charming Shops.

The reimbursable line item increased for the quarter 15.3% and 16.7% for the year and this is again the result of the treatment of the court costs and our debt management business as reimbursable items instead of our revenue and that’s caused this big jump here in our reimbursable items. Total revenues for the second quarter increased 5% to $23 million excluding de-conversions from the second quarter ’07. These revenues for the second quarter were up 12.2% or $51.9 million. Year to date would have been up 13.4% or $110 million. Revenues would have been strong when you take the de-conversion out.

As we go down the page, looking at the expenses the expense growth in employment was at 1.5% for the quarter $2.1 million and 3.5% or $10 million for the year to date. This is mainly the result of increased salaries, from increased headcount that we’ve had. Basically put on a lot of it in the first quarter and we’ve also had merit increase partially offset by reduction in performance based incentive benefits.

Our growth in employees over ’07 stands around 809 employees and there again it’s the result of the call center build up that we had in Europe mainly. On a sequential quarter basis employment expenses are slightly down so we’re holding the line on them as we go through the rest of this year but it’s slightly down about $651,000.

[Inaudible] and equipment category increased 8% for the quarter and for the year. This increase is again the result of the software licensing agreement signed in December ’07 and the increase associated with the increased capacity is causing the software amortization to grow. In addition to that we’ve had higher maintenance and repairs in our equipment area as well as we’ve had some increased rent and building maintenance in Europe which totaled about $1.5 million so it’s mainly a capacity issue and hopefully this will level out for the rest of this year.

As the result of the spin off from Synovus we did incur expenses associated with advisory services related to the deal. We also had costs that include the incremental fair value associated with converting these Synovus options to TSYS options held by TSYS employees. We do expect to incur additional expenses going forward as we continue to split the shared services we had with Synovus primarily talking about the payroll system. Through all this spin off we have not experienced any significant changes in our own going operating expenses due to the spin.

The other expense category saw a decrease of 4.4% for the quarter and 7.1% for the year. This is largely a part of due to the lower transaction delivery costs of TSYS acquiring. Also the reclassification of court costs expense to pass through items. We’ve had lower TS2 conversion amortization during this period of time and also this was the category that housed the management fee expense that we paid to Synovus in ’07 and it’s now been redistributed as we have obviously brought those expenses in house.

On the operating income line my analysis in talking about that I want to exclude the one time spin costs there. As you see on the P&L its 1.8% growth for the quarter and 1.6% for the year to date but when you back out or exclude the spin cost operating income grew 3.1% for the quarter and 6% for the year. We did improve the quarter and the first six months on our operating profit margin. Without the spin we’re at 26.6% for the quarter compared to 26.3% in ’07. Year to date we’re 26.3% compared to 25.7% year to date.

As included in the ’08 guidance we expect our margins excluding reimbursable items to continue to remain in the rage of 25% to 27%. On our year to date EBITDA it was at $272.3 million on a non-GAAP basis for a 5.5% increase over 2007’s $258.2 million. Our EBITDA margin before reimbursables in ’08 was 37.2% compared to 36.4% prior year and we expect that level to continue as indicated in our guidance.

Other income it decreased $5.4 million for the second quarter and $10.1 million for the year. Interest expense associated with the long term debt arrangements as well as decreased amounts of cash available to invest accounted for all these changes. As you know our debt is that we got is based on LIBOR for the second quarter LIBOR was at 3.25% or 2488 and in July it’s dropped down again to 3.08%. It’s been very favorable for us to have LIBOR based debt.

The effective tax rate was impacted in the quarter as the result of the spin transaction and subsequent utilization of certain state tax credits and discrete items. The discrete items resulted in a tax benefit of $1.6 million for the second quarter and effects of these items resulted in an effective tax rate being 35.1% for the quarter compared to 35.3% last year. Year to date we’re at 35.97% on taxes compared to about 36.5% last year. As we said before we anticipate our effective tax rate pre discrete items to remain in the 36% range.

Net income when you look at pro-forma net income for the quarter it decreased 2.7% to roughly $63.9 million, that’s taking the spin out and that’s down from $65.7 million for the second quarter last year. For the six months it increased 2% to $125.5 million up from $123 million for the second part of last year. Pro-forma earnings per share remained at 33% for the quarter compared to last year and for the year it increased to $0.64 compared to $0.63 last year.

As we mentioned in the press release we did rename our three segments of business to better clarify how we manage our company. I didn’t want to go back over those comments other than have a few words about Global Services because we have seen significant growth as Phil mentioned in revenues and operating income from this segment from the conversions that went on in the first quarter for CapOne and Nationwide.

Last quarter there was a concern going on there regarding our build up of expense in anticipation of these conversions and related drop in our quarterly operating margin. As we expected the operating margin for the second quarter strongly rebounded and we expect operating results to improve significantly as 2008 progresses.

Moving on from the income statement just a few comments I’d like to make on the balance sheet and cash flow statement. If you look at the balance sheet the changes from December ’07 unrestricted cash at $257.8 million that’s an increase of $47.3 million since December. Also during the quarter we purchased 500,000 shares of treasury stock at a cost of $12.2 million. This brought our total for the year to one million shares that we’ve purchased during the first half of the year $23.6 million.

On the cash flow statement you’ll note our significant contribution to cash generated from operating activities at $174 million. It’s good growth for the first six months of this year and we invested roughly $26.3 million in property. This may slow going forward and equipment we bought was mainly in the hardware second of the mainframe disk drives and about $16.9 million was spent on software roughly $8.6 million was purchased and $8.3 million for developed.

We also had an increase in our cash used for contract acquisition costs where the customers were brought on in Europe and some signing incentives. In addition to that payment of dividends was at $27.8 million. With that Phil I’ll turn it back over to you.

Phil Tomlinson

As we all know everybody in the financial services business right now is really treading on unfilled ground and its new territory for everyone that I’ve talked with. The basics and the fundamentals at TSYS are still the same. You’ve heard me say before we’ve got blue chip clients, we’ve got long term contracts, wonderful technology. We are aggressively and successfully expanding internationally. I think the numbers for that are up 15.8% year to date as a percentage of revenues and up to 16.4% for the quarter, showing good strong growth as percentage of revenues.

We’ve got a strong and growing market share in key and emerging markets that you heard from me earlier about. We’ve got a strong recurring revenue model. Also a great play in the consumer and commercial credit business without any credit risk. I think there’s no doubt in anyone’s mind. I know you heard this from Visa and MasterCard that plastic card transactions will continue at a rapid rate replacing checks and cash which means more transactions, which is a good thing for TSYS.

We have this newly acquired M&A capability. We’ve got a strong prospect list and I think you’ll see us continue to win in the marketplace. We’re a company that continues to enjoy a sterling reputation and we’re a company that’s easy to do business with. As I said the fundamentals are all there. We have not lost our way and we are still pushing forward very strongly. With that I’m going to open it up. We’ve got some time for some questions and we’ll try to get them answered for you before we close out.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Glenn Fodor – UBS.

Glenn Fodor – UBS

If you had to characterize what type of backdrop that your guidance forecast incorporates how would you characterize it? Is it more of a down turn and if so how much, or does it assume we hold steady at these levels?

Phil Tomlinson

I think we’re going to hold where we’re at. We actually have some hope that things are going to pick up in the fourth quarter. When you start looking at a list of our customers it’s the same list you’ve been reading on the front page of the Wall Street the last six months. We’re feeling those headwinds right now and so I think the fact that we’re just trying to be transparent here today and I think we’re going to hold our own and I think it will as some point late in the fourth quarter, early next year start picking up. I know people want to grow these businesses, they’re very profitable businesses.

Glenn Fodor – UBS

There’s a lot of moving parts going on here that are affecting the guidance. I want to get a sense of how much of the actual reduction is from pricing versus sales cycles not closing as fast as you thought versus internal card growth not being what you thought it would be.

Jim Lipham

A lot of it has to do with internal card growth has slowed. We’ve got customers that have really slowed down and you know who some of them are WaMu, CompuCredit and some of these others.

Phil Tomlinson

I think it’s in the press release. If you recall last year this organic growth that we have been describing almost as like same store growth to make it easier to understand last year it closed out right at 15% for the year and this year if I’m right its about 7% for the first six months.

Operator

Your next question comes from Bryan Keane – Credit Suisse.

Bryan Keane – Credit Suisse

I want to follow up with the weakness in the financial services industry that we’re seeing and it’s causing you guys to be cautious on the guidance. Is it just in the card growth or it also sounds like you’re seeing it in transactions and authorizations as well that’s making you a little more cautious going forward. Maybe some comments about the amount of value added services they’re willing to spend in this kind of environment it looks like they’re cutting back on that as well.

Jim Lipham

On transaction growth I think sequentially we’re seeing good growth in the 8% range. In the past we may have had some double digit growth and that’s part of the economic environment we’re in may have that 8% growth but I still think that’s good growth in these times. Value added services we’ve had drops there from de-converted customers. We also, as you know these services can come and go and not affect the main processing that we do for customers and we have seen mainly a drop back just from de-converted customers. Outside of that I think it’s pretty normal.

Phil Tomlinson

People have slowed down on projects, obviously we charge for a lot of these new roll outs. I don’t know about you but in the last month I haven’t received very many solicitations in my mail box. That has really slowed down here lately. We get paid for all of that. Our pre-paid business we’ve had some really good success there with a couple of deals that we’ve signed that have grown very rapidly. We are feeling very, very good about what’s going on in Europe and the UK.

We’ve talked a lot about CUP Data and I hope I’ve been clear that that’s a long term payout but we still are continuing to win there as evidenced by what I was saying earlier. We’ve also won several other RFPs in the meantime. As a matter of fact, we had a Board meeting today and the Chairman of CUP Data made a presentation and it was very encouraging. We’re thrilled with that. I think we’re feeling the effects of people just cutting back in general. There are a lot of these banks that are worried about a lot bigger things than credit cards.

Bryan Keane – Credit Suisse

You talked about the environment, it sounded like it got a little bit worse throughout the quarter June being a little worse. How about July, how does it fall through is it still deteriorating?

Phil Tomlinson

I don’t have enough information to speak to July but it really started right at the end of May and really started slowing down through June. As Jimmy said, we still have very positive growth but it’s just a combination of a lot of several things. We did renegotiate several contracts that we did discount to some degree and I don’t have that number in front of me but that’s a contributor. It is not a major cause to this.

Bryan Keane – Credit Suisse

In this kind of environment that discounts more than typical that you’ve had to give bigger price concessions?

Phil Tomlinson

I really don’t think that they are. At least we haven’t seen that. We’ve been renegotiating contracts for 30 years and it’s always the customer wants as much as they can get and we just have to try to balance that as best we can. At the same time we’re certainly trying to make our business faster, better and cheaper and we’re making good progress.

As an example, we charge for inactive accounts. This is a time where a bank might go in; during good times they’ll leave those accounts sitting out there thinking that they might really reactivate those accounts at some point. Some banks are coming in and saying we want to purge these inactive accounts and put them on the tape and hold them for me and I’ll try them later. That’s a good example of a fee that could go away during a time like this.

Bryan Keane – Credit Suisse

Do you have any idea how many of your accounts are inactive?

Phil Tomlinson

No, I really don’t have that handy. We’ve got that information I just don’t have it handy.

Bryan Keane – Credit Suisse

Like 5% or is that too high, too low?

Phil Tomlinson

Too low. When I talk about inactive accounts I’m talking about a guy that’s been inactive for a couple of years. I might go inactive on my primary accounts for a month or two but if I’ve gone inactive for a year or two I quit using that card and somebody’s going to have to do something to prod me to start using that card again.

Bryan Keane – Credit Suisse

The inactive accounts it would be a little higher than 5%.

Phil Tomlinson

Yes, I think it probably would. That’s doesn’t mean that everybody’s doing that. I’m just giving you an example of what people will do in these days to try to reduce expenses.

Operator

Your next question comes from James Friedman – Susquehanna.

James Friedman – Susquehanna

I wanted to ask you about the operating margin because that does seem to be tracking for continued expansions in 2008 despite the guidance and came in pretty good number for the second quarter. I know you had alluded to some of this in your commentary but the data function of the composition of revenue or the cost controls or a combination of both.

Phil Tomlinson

It’s a combination of both. Controls on expenses are and have been for a couple years now real good.

James Friedman – Susquehanna

If we continue to model, looking at the number excluding the reimbursables 100 to 200 basis point improvement in the operating margin year on year is that consistent with what your guidance contemplates?

Phil Tomlinson

The guidance is still in the 25% to 27%. I would say 26% operating margin consolidated.

James Friedman – Susquehanna

That’s up from 24% to 26% last year.

Phil Tomlinson

We do think if you’ll recall last quarter we talked about that to some degree. We really talked about we didn’t think that we could do much with that as long as we were really trying to expand internationally. We think we’ll still be in that range but we’re spending a lot of money trying to expand internationally and we’re having some good success. Those numbers won’t be quite as high as say the core business in North America would be.

James Friedman – Susquehanna

With regard to China UnionPay, on your commentary, can you give us some estimate of what Citibank’s card portfolio is in China?

Phil Tomlinson

I wish I could but even if I knew it right in front of me I couldn’t tell you that. We don’t give any numbers out on specific customers.

James Friedman – Susquehanna

Is this a large incremental customer for China UnionPay?

Phil Tomlinson

It’s a good win for China UnionPay, we’re excited about it. It’s obviously the largest named bank that we’ve signed on a debit card basis. I think that Citi is sort of a debit start up there as I understand it. It’s just a great indicator of where we’re at.

James Friedman – Susquehanna

The equity in income in equity investments, that’s still tracking below where it was in the second half of ’07. How do we reconcile the mechanics of progress in China UnionPay with that line item?

Jim Lipham

The equity line for this year is more in the processing arena. Last year we had a lot of investments in China that were going on that were from the cash that they had and they closed it out. It also, this line item today includes a partnership that we have with B&C an airplane partnership that’s in here that brings that number down, it wasn’t there last year.

China UnionPay going forward will do a little less than they did last year, this year and should improve back to the levels of ’07 and ’09 as it continues to grow. The processing business is picking up over there; the accounts are coming on board. There’s been a shift out the investment market into processing. We’ll get more into the core business of China UnionPay now.

Phil Tomlinson

That line is a little bit muddied up by this. We had this partnership with Synovus on an airplane and we’ve had to break that up and so some of those expenses that take that down are a part of that. If that makes any sense to you.

James Friedman – Susquehanna

Yes, I know there’s a lot of moving parts. Is there any contemplation of monetizing the investment in CUP China UnionPay taking it public? What stage are we in terms of the funding cycle of that entity?

Phil Tomlinson

You’ve heard me say on several occasions that’s a three to five year term and I do think that things, I wish I had some of those stats that I heard this morning about the growth in China particularly about acceptance, the Olympic start next week. I would never say that they wouldn’t go public at some point in time but I don’t think that that’s imminent at this point.

Operator

Your next question comes from Glenn Greene – Oppenheimer.

Glenn Greene – Oppenheimer

The first question is following up on Bryan Keane’s question. If you could give us some color on the transaction trends by month and it fell of at the end of May and it looked like based on your comments and the press release ‘x’ the de-conversion transactions were up 6% for the quarter. Any way you can give us some color on what it looked like April, May and June. What I’m getting at is was this similar to the trends that American Express talked about where it really fell off pretty hard in June?

Phil Tomlinson

We don’t have it in front of us. If you’ll ask us another question if we’ve got it here we’ll dig it out.

Glenn Greene – Oppenheimer

Outside of the slow down of internal account growth and incremental projects, could you give us some color on what your six to nine month pipeline looks like and color around the length of the sales cycle, what’s happening in terms of getting deals closed?

Phil Tomlinson

The sales cycle is pretty long in this business. I would say it averages anywhere from six months to 18 months. We’ve got some good business lined up we have not announced. We do have some very nice letters of intent. If I gave you a number of a pipeline it’d just be an absolute guess but I would say its, I don’t think I want to take a guess at it. It’s not like we’ve got 100 million accounts out there today. As soon as we’re able to release some of these wins that we have going on I think you’ll like what you see.

Glenn Greene – Oppenheimer

That’s kind of what I’m getting at. Is there a lot of stuff going on behind the scenes that we really haven’t seen yet in the environment and maybe slow things down a bit and maybe you’ll get wins some nice deals by the end of the year which are going to help ’09? That’s what I’m trying to get at.

Phil Tomlinson

I think that we will win some nice deals. I wish I could sit here and say that I thought it was imminent that we’re going to sign somebody with 100 million accounts; I don’t think that’s the case. We do have as an example I can think of four LOIs that we got this week that they’re not home runs in the bottom of the ninth of the seventh game of the World Series but they’re very nice wins and they’re names that you will know, names that could be significant over some period of time.

We have some good things going on, let’s start in Mexico. Mexico has really picked up. We’re seeing a lot of activity in Mexico. The US has picked up a little. We got a couple good things going there that we’re pretty excited about. Same way in Canada. I think we’re probably more excited about the UK and Europe right now than anywhere around the globe. We talked a little bit about CUP Data.

I talked about last time we do have the ability to be in the acquisition business. No announcements today but certainly we continue to look hard. There’s a possibility we might have something before year end.

Glenn Greene – Oppenheimer

Is there any way to characterize the pipeline relative to where it was six, nine, 12 months ago?

Phil Tomlinson

I think it’s about the same. There’s no big increase. It’s good or better.

Jim Lipham

On the question you had on transactions what we saw in the first part of the year we’ve actually had an increase in transactions every month through June. We have not seen a drop off from the total transaction basis.

Glenn Greene – Oppenheimer

If you get 6% in the quarter of June was it 8% in April, 7% etc. on down the floor. I’m trying to get a sense for the year over year.

Jim Lipham

Sequentially we grew 8% in transactions that’s for the second quarter. I think you saw about the same thing in the first quarter, 8.5% for the first quarter. I’ve got it by month but I don’t have the percent growth I’ve just got the total transactions.

Operator

Your next question comes from Julio Quinteros – Goldman Sachs.

Julio Quinteros – Goldman Sachs

A quick questions on the M&A front given that the US is slowing and you’re seeing your customers suffering a little more. Would you be willing to accelerate your M&A pipeline and will make more acquisitions on the international front and what would be your regional preference for now.

Phil Tomlinson

That’s one of the key reasons that we were spun from Synovus so we could play in the M&A business. We’ve talked a lot of times about where we would prefer to go. Obviously there are some things here in the US that has come up. As I said earlier we are very excited about the UK, we’re excited about the, when I say the UK I really mean the UK and Europe, we’re very excited about the merchant acquiring business or the merchant processing business.

We’re still very excited about the card processing business, our core business, the business that’s got us primarily to where we are today. There are opportunities, we just hadn’t been able to get one across the finish line yet and we’ll do that. That’s really about as far as I’d rather go today.

Julio Quinteros – Goldman Sachs

On the merchant acquiring side on the top line can you accelerate the top line by maintaining your margins, is it just the softness in the market and are you maintaining your market share on the acquiring side of the business?

Phil Tomlinson

We’re maintaining our market share and I think that Jimmy said that our margins had actually increased.

Jim Lipham

The margins have increased; they’re up to 29% for the quarter. When you look at the acquiring business the volumes are down a little bit in the low single digits but what’s happened to our merchant business is we’re anniversaring some de-conversions and price concessions that have gone on in the later part of ’07. As we anniversary those you’ll see more growth in this revenue as the volumes continue to hold up. They’re not down; they’re all up in the low single digits.

Julio Quinteros – Goldman Sachs

In which quarter are you anniversaring the de-conversions for the acquiring business?

Jim Lipham

It’s spread out during the year. I would say by the end of the third quarter we should be pretty much over.

Phil Tomlinson

Thank goodness the end of July we’ll anniversary the date that Chase licensed our software and moved in house and took the license agreement.

Julio Quinteros – Goldman Sachs

The last question I have is on the first quarter these de-conversions were there as well but the growth on the top line was much strong. It’s overall a more weakness in the market on the acquiring side which is slowing down your top line would that be correct?

Phil Tomlinson

Price and pressure yes was on the merchant.

Operator

Your last question comes from David Scharf – JMP.

David Scharf - JMP

Curious about Europe, it’s certainly the regional bright spot. I think in a lot of past down turns we see a slow down start on our shores and move their way across the Atlantic and also ultimately make their way to Asia. It’s been a couple months now since late May when you started to see some material changes in the US issuers. Are there any early warning signs or anything you’re on the look out with some of your European issuers? We’re just wondering if that’s the next leg.

Phil Tomlinson

I don’t know if it’s the next leg but we’ve got a couple of examples where transaction growth has slowed down in Europe. We’re talking about credit card transactions; the predominant card in Europe obviously is the Debit Card. We don’t process Debit Cards in Europe. We have seen some decline at this point.

David Scharf - JMP

Inherent in the back half of the year’s guidance are you assuming any further fall off in your European growth?

Phil Tomlinson

No, we’re not. We feel comfortable with where we’re at.

David Scharf - JMP

I wonder if you can also give a couple more examples, these were very helpful when you gave some specific examples of how issuers cut back in this kind of environment. You used the example of how you get paid for card solicitation, mailings, maintaining inactive accounts. These are actually helpful examples to give us some benchmarks to keep an eye on. Are there any other top five types of discretionary spending other than obviously just card issuance that we should keep an eye on?

Phil Tomlinson

I think there is. One of the great things about TS2 is we had this massive ability to retain data. We can retain it for a month or we can retain it for 10 years. Some people will go in and adjust that. Retention cuts and things like that. It’s a very complex process that we have and some of those are core services and people have to use them.

We have this system called Total Access which is a relational database reporting system. Some people use it very heavily and others not so much. You have the ability to use it as much as you want but you do get charged for it. You might cut down some of that. It’s really across the board.

On the other side things like our fraud systems card guard, FICO, Experian, those services tend to increase during times like this, credit scoring capabilities, follow up with people who have authorization habits who have changed, you’ve seen those ads on television where somebody’s charging something on his card and you’ve seen it. We do all sorts of things like that. Those services more than likely will increase.

Our plan is to hold our own and we think we can do that.

David Scharf - JMP

One last question, just circling back to the guidance and this is more putting some context around what’s behind the guidance. I’m actually trying to reconcile what looks like some very, very slight, slight trimming of the second half guidance. It looks like your EBITDA guidance for the second half is being trimmed by 1% to 1.5% at most. In some ways that out of sync with the dire language in the press release concerning the state of your clients.

I want to get some additional color on whether a 1.5% trimming of operating cash flow fully captures what you’re seeing in your clients right now.

Phil Tomlinson

Let me go through a litany of our clients right now and I’ll give you an example. When you start thinking about WaMu and Wachovia and Fifth Third and CompuCredit, you name them and we probably do business with them at some point. The expectations are that we had very high expectations on the front end. If you recall back in January we actually raised our revenue guidance.

To be perfectly frank and honest, we’re probably flying a little high, maybe too aggressive with it. We really thought we could get there and I don’t think anybody in January or at least I certainly didn’t think that we would be dealing with the issues in the FI business that we’re dealing with today.

David Scharf - JMP

My question focuses on the second half outlook. In light of those issues you’re facing today is a 1.5% reduction in second half EBITDA guidance did you feel that gives you much wiggle room or is that?

Phil Tomlinson

We’re not used to having a lot of wiggle room with you guys. We tried to keep it as tight as we could. We hated to go down at all honestly, it just makes us sick to do that but it is what it is and we’re very optimistic about our long term prospects and we’re optimistic about the rest of this year. It’s pretty apparent what’s going on in this business and what’s going on with a lot of our customers who had planned on having pretty strong growth.

We looked at it very, very hard and we believe that we’ll be able to get there and while it may be a small adjustment. I’m glad to hear you say that you think it’s rather small. We’ve tried to have a history with all street being upfront and being very transparent.

Operator

That was our last question. Do you have any closing comments?

Phil Tomlinson

In our Board meeting today, you folks might think this is corny but I told our Board, we’re sort of like a toll bridge. There are not a lot of toll bridges out there and you just pay the trip. Our toll bridge is really in good shape. It seems that we’ve got a couple pot holes out there that we’ve got to get fixed. We think that it’s going to take a little time. The bridge is in great shape and we’ll continue collecting these tolls which basically are transactions to us. We’re still excited about out business. We think it’s good. We think we’ll continue to win in the marketplace.

Think of us as like that and I hope that we’ve been able to answer all of your questions today. We thank you for your attention and your support and interest and look forward to hearing from you in the future. If you have any questions don’t hesitate to call or email Shawn Roberts in our Investor Relations department. With that we’re going to close out this call and wish you a good day.

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Source: Total System Services, Inc. Q2 2008 Earnings Call Transcript
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