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Total System Services (NYSE:TSS)

Q1 2006 Earnings Conference Call

April 19th 2006, 8:30 AM.

Executives:

Philip W. Tomlinson, Chief Executive Officer

James Lipham, Chief Financial Officer

Analysts:

David Scharf, JMP Securities

Gregory Smith, Merrill Lynch

Paul Bartolai, Credit Suisse First Boston

Tony Wible, Citigroup

Cannon Carr, CIBC World Markets

Robert Dodd, Morgan Keegan & Company, Inc.

Operator

Welcome to TSYS First Quarter 2006 Earnings Conference Call. At this time all participants have been placed on a listen-only mode, and we will open the floor for your questions and comments following the presentation. It is now my pleasure to turn the floor over to your host Phil Tomlinson. Sir, the floor is yours.

Philip Tomlinson, Chief Executive Officer

Thank you. We want to welcome you to the call and we appreciate your interest and also I wanted to personally apologize for the press release being so late getting out last night. We had some issues which I won’t bore you with, but they were more technical issues than anything. As usual, before I get started, I want to call your attention to the fact that Jim and I 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’s actual results to differ materially from the forward-looking statements are set forth in our reports that we filed with the SEC. So, now let’s get onto business.

We have really felt like we had a good quarter and we think it’s a great start towards another record year of earnings. We continue to maintain our focus on what we do best and we fully expect to achieve our 2006 goals despite of the consolidation issues that we are wrestling with now.

Moving onto the numbers, our revenues before reimbursables were up 17.5%, we had a 9.3 increase in net income. To give you an idea what we feel like the growth drivers were certainly our core business in Vital, which by the way I hope you saw our rebranding yesterday to TSYS Acquiring Solutions. And we are certainly getting the benefit from the additions of the Fifth Third, ABN AMRO and Chase conversions last year. Total accounts on file grew by 18.8%.

We did have some good things that happened during the quarter as far as new business and one that I wanted to focus on was that we finally did enter the healthcare payments market by signing Exante Bank which is wholly-owned sub of United HealthCare, and I am sure you all know who United HealthCare is, one of the largest medical care providers in this country. We are going to provide our broad range of payment processing and other related services to them and we will give you more details on this later.

We continue to realize the enormity of the CUP Data partnership and the breadth of the long-term growth potential in China. We continue to add people to our offices in Shanghai, we have been really – frankly we have been overwhelmed by the reception that we have had in China since that announcement. And of course, we recently renewed our agreement with CompuCredit in Atlanta, for they are large 6 million account portfolio. With that, I am going to turn it over to our CFO, Jim Lipham who is going to give you the details on the numbers. Jimmy?

James Lipham, Chief Financial Officer

Thank you, Phil. And I will draw attention to our P&L within the press release. And Phil has mentioned a lot of the things that happened for the quarter, if you look electronic payment process and revenues up 8%. He talked about the new customers that came on board since last being obviously the Chase conversion, the fleet accounts that came over at BoA at the end of the first quarter and then, he mentioned CompuCredit, where we are seeing some good growth in CompuCredit year-over-year.

The revenue or the accounts on file, they did grow at 18.8%, finished around 440 million accounts, and a good growth there. On the international revenue front, revenues increased $2.4 million or 4%, and it was negatively impacted by CTA adjustments of about 4% also, so, had we not had the negative currency effect, we would have had 8% growth in the international revenues.

The highlight in the international area are as far as Mexico goes we have now anniversaried our deconversions that we had there and we’ve added new customer who is Xperio and the revenues down there growing at about 48% quarter-over-quarter which is very good for us.

The value-added service area, we have growth of about $6 million or 13% from ’05 quarter. We also saw our acquisitions grow at a good strong pace of 17.7% for the quarter. Transactions likewise were up 18.5%, and both of these were a little over 1.2 billion to 1.3 billion range of transactions and authorizations for the quarter. So good growth there in our core business.

We got down to the merchant services line, and obviously there – Phil mentioned TSYS Acquiring Solutions, we have two more months this year than we had last year in that comparison.

Sequentially, revenues for the last two quarters have been down and this past quarter, they were in the process of closing the San Diego sales office for BTMS, which is the merchant terminal provider for Vital, in that we had a loss of revenue quarter-over-quarter for that. But this is that they are closing there had very small margins to zero, really it was not very beneficial. Vital has also continued to experience a reduction in the VAT revenues which is mandate about these made by the move from vast to in bank installations and Bank of America has started visit in the fourth quarter and finished it up here in the first quarter given, moving from that and taking some revenue away from Vital.

But going forward for Vital, we feel like the front-end transactions in the first quarter were up 17%, so that’s good growth, and that continued during the year, they did complete the conversion of 203,000 merchant backend customers for Merit Bank, and the seasonality of the business as it goes through the growth in the second, third, fourth quarters will shell some increases for Vital. They do have some price compression going on from the new kind of tracts that they’ve renewed over the last two quarters.

But we do expect sequentially as we see Vital move out that they will continue to grow in revenue sequentially but it will be the fourth quarter probably before we see a year-over-year growth in their revenues. But we are pleased with where they are, and where they are headed and we continue to expect great things from them.

As we move down to P&L and other services, you’ll see that they are down 8.2%, which is mainly calls have decreased in call center volume, we lost several customers since last year, just we have Fleet, AT&T calling card, Vance Salto (phonetic), calls decreases there, we’ve also had some of our specialty training services with Chase that has been suspended. But also in ‘05 if you remember we had a non-recurring revenue item in that first quarter of about $1.5 million that was related to a discontinued servicing arrangement, backup servicing arrangement with one of our customers. So that created this negative 8.2% there.

The total revenues Phil mentioned up 17.5% and very strong, and then the total negative impact of CTA on this revenue number was $3.1 million.

Coming down the page to our expenses we’re up 24% in employment, this was largely due to Vital being in here for two more months and what we had last year. Included also in this first quarter we had the effects of adopting SFAS 123(NYSE:R) which requires expensing as the fair value of stock options, and as we stated in the press release, this resulted in an additional 1.8 million expense for the quarter or about $0.01 of share.

Sequentially employment, the quarter is lower than the fourth quarter, mainly due to the amount of performance-based incentives, which we recognized between the two quarters with more gain in the fourth quarter of last year. We also made great strides during this quarter in controlling our head counts through attrition as we lowered our number of employees by 115. This is mainly in our debt collection area. We are continuing our efforts so to make efficient use of our resources in making every effort we can to redeploy existing folks and resources from projects that are nearing completion and to new start-up projects.

Our occupancy and equipment as we go down there. We see a strong 14% to 75.4 million in the first quarter. Since last year, we have added a lot of equipment during the year to bring on the Cap One conversion and it compares unfavorably to the first quarter of last year. Also during this first quarter as you recall some of our software licenses for our mainframe software on the process and capacity mix agreements that require us to use units of production amortization basis. And as a result of the deconversions scheduled later this year, our total future MIPS are expected to decline and this resulted in us having to increase the amount of software amortization for the periods prior to these conversion days. So that caused a little higher amortization for software.

Drop downs and other expense category were up 22%, the main reason strictly Vital being in there for two more months, we will see this category go flat on this over the next three quarters for the year as we compare back to Vital being here for approval, being here for those quarters last year. Excluding reimbursables, our operating profit margins it dropped 21.8 from 23.6 for the last year, and that’s all created the cost in increased equipment costs and software amortization, and the additional item of expense of stock options. We do expect our margins this year to remain in the 21% to 22% range. We will have a spike in the fourth quarter with the termination fee from -- expected termination fee from BoA.

I want to mention on the income tax line during the quarter, we did settle items in regard to multi-year federal tax review with the government authorities and recognized a net benefit for the quarter. We still anticipate our effective tax rate for the year to be approximately 35% this quarter, it was up about 33.4 from those favorable adjustments.

Phil mentioned net income growth for the quarter was 9% or 4.3 million earnings per share, $0.26 per share, up 9% over the last year. As we elected to expense stock options in ’05, our pro forma net income growth ‘06 would have been around 13%.

The other information that’s included is the balance sheet cash flow. I want to mention I wanted to make of those two is that we continue to have strong cash accumulation, we have 242.9 million, and it’s grown slightly over where it was in December but we did have the payments this first quarter for benefits and we feel pretty good about where our cash flow is.

Two final statements I’d like to make. One is that most of the analysts are looking at the BoA termination fee and the amortization of the accelerated conversion costs and adjusting our earnings per share for the year about $0.20 a share which we concur with and think is appropriate.

Also, one final thought is when we look at our home-grown business, after excluding Bank of America, the penalty from Bank of America and into the Sears business, when you exclude those from ’05 and ’06 numbers, the year-over-year earnings per share growth is a very solid 25%. We clearly think our another clients will continue to produce strong results that provides just a rock solid foundation for future growth. With that Phil, I will turn it back over to you.

Philip Tomlinson, Chief Executive Officer

Thanks Jimmy. Obviously, you know, some of these developments that we received late last year have made things well difficult around here but I can assure you that we are more passionate than ever about our business. And I want to try to tell you why. First, we have the largest new account pipeline with well over 75 million accounts scheduled to convert between now and year-end. That’s the largest pipeline in the history of this company. And that includes certainly Capital One and Toronto-Dominion and a very large national retailers included in that also that we cannot, we won’t be allowed to do a press release.

Our core prospect list is as strong as ever, our international prospect list is stronger than ever, and we were hoping to have several more good announcements around this time that contracts are sometimes more difficult to get signed than you would like. We do expect some good announcements in the very near future.

We believe that we are finally getting traction in the prepaid business and expect some great successes in 2006 and some big announcements. We have had to go in and basically reengineer that prepaid operations, TSYS prepaid, and now we believe that we are ready for prime time. We also seem to be gaining more traction in Japan and expect to have some news there soon. We believe that if we can sign one significant customer in Japan, that will be equivalent to the good housekeeping seal of approval and we will move forward. Our loyalty company, TSYS Loyalty is enjoying strong growth with the new TOP loyalty system, I believe is the talk of the industry, we are actually signing clients to bill process with TSYS, which I think is pretty significant, when they are processing either in-house or processing with one of our competitors.

You can see from the press release, we finally have moved forward with the healthcare business, and we believe that its exciting what we are doing with Exante Bank and UnitedHealthcare group. Some of the capabilities of that program are we will be able to do HCAC: Health Care Account Card which combines the health plan membership and eligibility functions, we’ll be able to do FSA: Flexible Spending Account cards, we’ll do HSA: Health Savings Account cards, it’s a multi-purpose card that incorporates membership eligibility, HSA, FSA and the line of credit functions that could be used for higher deductibility visits to the doctor of a hospital.

It also includes customer service and support functions including dispute resolution into our management. We believe that we can make a real vent in the healthcare space and we think this is the first of a lot of action is coming in this healthcare business. Moving on, I strongly believe that our technology and our people and our service are all world-class, you’ve heard me talk about this many times about having the goal standards in each segment of our industry, and I strongly believe that in the vast majority of cases TSYS is there. One thing that I wanted to talk about was the Sears and BoA announcements and tell you that we have a great plan, its working well on Sears, as far as dealing with expenses, we certainly hate to lose them but we think we are going to be fine there. They have been a great customer over the years and but we have had enough time to be able to deal with that.

And I got to tell you, its another story on Bank of America, I’ve told our people here, if you would ask me last, you will add I’ll name them. 100 biggest problems that TSYS faces going into the future losing the Bank of America certainly would not have been one of those, they are a long-term anchor tenant, but we are moving forward, dealing with it, we do believe they will leave and they are working hard to move in October. Here today we have identified over $35 million annually that will go away starting in ’07 where we have got the entire company really working hard on continuing to define more savings.

The biggest problem that we have got right now is we need a full staff, full technical support, all the computers, everything until the very last day that they are here, which is mid-October. And then as I say they are finally leaving in October. I think that all of our team members here realize the gravity of these losses, and we are committed to doing whatever it takes as soon as business will allow us to get on with cutting these expenses and doing whatever it takes to continue our long-term success. I have had some people in the last six months ask me, do I think that’s a trend with Bank of America’s decision to go in-house? I absolutely don’t think it’s a trend, and frankly we consider Banc of America slash MBNA to be one of our best prospects over the next two to three years.

Remember both Sears and Bank of America MBNA will continue to be significant customers of TSYS with commercial card and merchant acquiring. So we will continue those relationships and we will continue to do everything within our power to try to expand those relationships. It really is a time of transition and a test of our will to succeed. It is not that we hate these consolidation events, our fundamental business as Jimmy alluded to is as strong as ever. Our industry is going to continue to consolidate to some degree and hopefully in the future we’ll win more of these and we lose, that’s been our history. But as you know much of that is certainly out of our hands. I did mentioned earlier that we re-branded Vital as TSYS Acquiring Solutions, as Vital has been a great name, and they build a lot of goodwill and brand equity over the past 10 years. We believe the new brand better describes what we hope to make of the merchant business in the future, and we have, I think we have the best team in place at Vital that we have ever had, as a matter of fact I was there last week, and I was just really impressed with what they have got going on there.

They will continue to diversify through new product offerings and acquisitions. As Jimmy said, over the last two quarters they have re-signed four of their top ten customers to long-term contracts, they continue to invest in product development particularly in few areas, Gift card and contactless terminals. As a matter of fact, they recently launched a program of contactless point of sale terminal of using RFID readers during the past quarter. We will continue to look at diversifying TSYS in the areas that we find interesting, of course would be anything related to the issue or processing business, anything related to the merchant processing business, data analytics, we think with the amount of data that we have on file here that would be a - we could really beef up our analytics capability, and we have started an in-house consulting group that is very profitable within the first year, and will continue to expand that.

We are totally committed to this business and we are totally committing to be in the best in this business. But as I said earlier, its not exactly a business as usual today. We have felt a little head battered over the last six months but we have gotten our balance back and we are ready to go, we are excited and we are passionate. Next year so represents a real-time of transition but our fundamental business continues to set a strong face, we have got an awful lot of irons in the fire, and we feel strongly about our prospects. With that I wanted to reaffirm that will be in the high end range of our earnings guidance for 2006, and that range is in the 21% to 23% range. And with that, we appreciate your time, the interest, and we are going to open it up for questions.

Question-and-Answer Session

Operator

Operator Instructions Your first question is coming from David Scharf. Please announce your affiliation then pose your question.

Q - David Scharf

Hi, good mooring, David Scharf with JMP. Couple of things, curious, you had mentioned that if you back out Sears and BoA from ’05 and ’06, your guidance for this year would be a very material 25% earnings growth, and I would assume that some of that is related to the additions of Cap One and Chase Bank One. As we then anniversary the addition of those two, as we look beyond this year, a more normalized growth going forward. Can you talk a little bit about how the revenue model might change a little bit with those two companies, with ones being ultimately for any, they are processing in-house once they license from you, do you get as much growth for additional account filed, and once Bank One and Cap One license in-house as they do when considering the housing change?

A - Philip Tomlinson

Well, David, let me try to answer that and Jimmy can add on to it. One is, we don’t expect Cap One to ever take it in-house, we have over the years licensed the software to folks who have just felt like they needed that option, but that is not they are planning to do that. With Chase it is the plan to do that, and we expect them unless something were to happen between now and next July to do that. If in fact Chase does go forward, we would certainly lose revenues but at the same time I think our bottomline numbers would increase. We certainly don’t give away TS2 and it is a long-term license agreement and I think we have said before that if they would continue to pay us for the next six years after they left and the numbers are substantial. And so it would be a great addition, in some ways it would be more profitable, I mean literally it would be more profitable but certainly we don’t want that to happen and I can assure you that everyday we are talking to them, trying to convince them that taking in-house is not the best decision but certainly they ultimately will make that decision and they have made a very clear that that’s what they want to do. I want to be clear about Capital One, they don’t plan on doing that. I think the only way they would ever do that is if we had a train record of TSYS, if we fell into financial difficulty or god knows what, I can’t say of a lot of things that could happen but that would be the reason for Cap One to consider that, they would have that option if we fell upon real problems.

Q - David Scharf

Okay, got it. Secondly, I think you had mentioned regarding the head count reductions so far in the first quarter, they were primarily all related to the collections business, it actually was the deal total debt management of the business you may be exiting?

A - Philip W. Tomlinson

Well, I think that we certainly have not been -- be very frank with you. We have not been happy with the financial results of the total debt management and I think we have made a decision that this is going to have to do better or we’re going or we will exit that business, it has not lived up to expectations, we certainly have not made any decisions today but we are looking at it really hard, I’ll be frank about that, and so our team out there is trying to come up with the plan to make some sense, they can make a real difference or we will exit that business.

Q - David Scharf

Got you, and lastly Phil I know this was something you would like to always publicly speculate on but, I am just curious, it seems to be one last domestic guidance the M&A is still in-house on the issuing side really, any sense for whether reading that they may ultimately pull the trigger and decide its time to probably outsource these functions?

A - Philip W. Tomlinson

Well, I mean your guess on that is as good as mine. We think that they are just like I said Bank of America has become one more of our biggest prospects again. Citi may not know it but they are one of our biggest prospects and we will continue to work on that those guys, we do believe we have a solution that works for them, but there are a lot of other folks out there that besides Citi, now Citi is obviously the giant of all that and we believe we can certainly be of help but when you look at some of the customers or clients with our competitors, some that are in-house, there is a lot of players that are still in-house of significant size. And when you start looking at - again is the large players that are competitors, the large players in-house, other card schemes in particularly as we go forward throughout Europe and the Asia-Pacific region. I just cannot tell you how excited I have become over China, I was somewhat skeptical about what is going to happen long-term in China, but I thought there will be great growth, I think I have been just bowled over with the response that we have got in China as a result of our announcement. I mean we can’t – we don’t have the people there to talk to all the folks that want to sit down and have real discussions with us in CUP Data, so we are incredibly excited about what’s going on there and we think that, I believe that in 2008, we will see significant benefit coming out of our deal in China, now we still have the other 10% to go in China as you know we got the 35%, excuse me, Paul in here is about to kill me, but we are working on finalizing the other 10% so we get ourselves up to about 45% equity position. But there is a lot of business out there that is available. This been our long-term sales cycles anywhere from a year to two years, and we have got multiple deals in the queue that we will be announcing here in the future. Like I say, it’s sometimes things don’t work out to the – to what we would hope be the best timing for particularly a call like this but rest assured, we are not sitting back, just hoping things will get better. I hope that answered your question.

Q - David Scharf

Yeah absolutely.

Operator

Our next question is coming from Gregory Smith. Please announce your affiliation then pose your question.

Q - Gregory Smith

Yes, hi, Gregory Smith of Merrill Lynch. Just on the guidance, it looks like last quarter you did not include Cap One but this quarter you are including Cap One but the guidance isn’t changing, I understand you just have Cap One in their for one quarter but can you may be quantify the impact of Cap One for at least this quarter?

A – Philip Tomlinson

Greg, what we have in Cap One, they are coming in mid-October so we will have some revenues hitting in November and December, but since the original guidance we have also been informed by Chase of some of their services that as their services that have gone down, so you have to pick-up in revenues and that from Cap One and then allows some of our other services and you know we had our range there, which was taken into account some of Cap One but it just pushed us to the top end of the range as Phil mentioned.

Q - Gregory Smith

Okay, and then I was hoping you could just you know hear a lot about the healthcare side and the CUP data deal, but is there anyway just a kind of translate this into potential revenue and earnings over the next couple of years?

A – Philip Tomlinson

Greg, I don’t think there is a way to do that right now but I will assure you that we would do that as soon as possible. I read your report this morning, and it was disappointing that you thought our guidance was a little bit exceeding, we try to be very upfront with that about particularly the termination fee.

Q - Gregory Smith

My thought was next year you would probably exclude it for the compare so I just thought it…

A – Philip Tomlinson

We absolutely will. We were absolutely excluded from next year and rest assured we are excluding it from – from any sort of incentive payments around here too.

Q - Gregory Smith

Okay, and then the last question, if Chase is more profitable, if they move back in-house, why wouldn’t you want to have, why wouldn’t you want that to happen, why would you give away sort of the processing for free then?

A – Philip Tomlinson

Well one, we would like to continue to process them forever. When I say forever, certainly for a long term, when I say is more profitable, and that may not be entirely accurate but it would be certainly the margins would be absolutely very strong and it would be very, very profitable but I think you have to understand that we really don’t consider our sales to be in the software sales business, we are in the card processing business and that’s what we think our, what we are good at and what we are passionate about, and what we would like to do is be able to convince anybody to stay with us long-term under the recovering revenue model.

Q - Gregory Smith

Okay and then just one last one. There is a lot of speculation that you may have won a large retail client out there, is there any comments you can make on that front?

A – Philip Tomlinson

Well we have won a large retail, I said that in my opening comments as far as the 75 million accounts but really is more than 75 million accounts. We are not -- they do not want to announce that and we certainly have to honor that.

Q - Gregory Smith

Okay, fair enough.

A – Philip Tomlinson

It is a large retailer that you can probably take a pretty good guess, it would be right.

Q – Gregory Smith

Okay, thanks a lot.

Operator

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

Q - Paul Bartolai

Thanks, good morning, this is Paul Bartolai from Credit Suisse. First question just on the revenues, with the bank card revenues up 8% and the account on file up almost 19%, if you could help us reconcile what’s going on there?

A - James Lipham

Yes, Paul, the revenues on 8%, if you take a look at our internal growth, which is in the 8 to 9% range and then you add the new customers that we had, it would be up revenues around 15%, but what brings that number down as you know is price compressions and deconversions, and we mentioned we had some loss customers from last year also, but the 18% is, you know a lot of those custom - accounts got paid.

Q - Paul Bartolai

Okay, and then Jim you mentioned international revenues were up 4% but in the press release it looks like it was flat, what has been included there that was not in your comments?

A - James Lipham

In the international side of the segment information, that’s just accounts and revenues from processing outside the United States. We do have some other international revenues from Canada, Mexico that are processed in the US.

Q - Paul Bartolai

Okay.

A - James Lipham

And you know, we mentioned Europe we had the CTA negative effect, that’s why that was flat.

Q - Paul Bartolai

Okay, and then on the profitability side, there looks like there was a dip in the operating profits in the international segment. What was the effect on that?

A - James Lipham

Really as the infrastructure built-up, we have opened offices in Spain, Netherlands, we have increased some expands in China, Brazil is being opened, so we had little infrastructure built-up there that’s caused that.

Q - Paul Bartolai

Okay, and then I guess it’s the last question, on the merchant side it looks like, you did have some pretty good profitability there, improvement, what we try for that in light of your comment on the pricing pressure has been Vital?

A - James Lipham

Well, only the volume growth that they have experienced this first quarter and putting Mericone (phonetic) has brought in some net increase demand. They have claimed up by shutting down that BPMS San Diego office which was as I mentioned very low to zero margin business so. And then again this three months when you compare to prior year versus one month.

Q - Paul Bartolai

Okay, great thanks.

Operator

Our next question is coming from Tony Wible. Please state your affiliation, then pose your question.

Q - Tony Wible

I am from Citigroup, I actually was hoping you could provide a little bit more color on some of your M&A prospects and thoughts, you would kind of highlighted some areas that you think to potentially look into, what are your restrictions on kind of the size of the deals that you could potentially look to execute on considering all those relationship?

A – Philip Tomlinson

Tony, that’s a really hard question. I would think that we are probably a billion dollars or below, billion dollars or less. We are looking at two or three right now, we are looking at one really hard, and I think that would be an international acquisition and I think that will either happen in the next 30 days or its not going to happen and then we are starting some conversations here this week with a US prospect and which would be pretty sizable for us, but I really would be reluctant to tell you what space that would be in, its not a real loss.

Q - Tony Wible

Yeah I think its pretty easy to guess. I know you guys have been asked this question a couple of different ways, I am just going to give it a try, on China Union Pay I am afraid It doesn't come, we were going to get DP sales just yet, but it’s only a way of kind of framing that market, how we should be looking at it, what the growth rate is, the market that you are trying to initially sell into within China?

A – Philip Tomlinson

Well, I think that as I recall is eight or 900 million debit card accounts in China today, there is only 35 million credit card accounts. We think in the next five years there would be a minimum 200 million credit card accounts. I think the thing we are trying at Union Bay that you have to remember is that they are the equivalent of MasterCard and Visa combined in China, and then if you are Chinese national or a Chinese citizen, that’s the kind of card that you are going to have to have, it don’t necessarily have to be processed at CUP Data but it will be a inkling brand CUP hard, and then you if you need a card to skirt her outside of mainland China, you’ll have to apply for some sort of exertion basis. So, we don’t think we own the market, I think we found ourselves in what we believe is a very neat, neat position. I certainly would have liked to have been in this position in the U.S. 30 years ago, because we would absolutely own the marketplace, and we think we got a good chance in China to really be a large player there, and you start looking at how that market works.

Q - Tony Wible

What would be the scope of services that you look to offer in China, I mean considering that this is an open-ended relationship, would ATM driving beyond the table in addition merchant I presume?

A - Philip Tomlinson

Well, we are not in the merchant business today but we are certainly in the debit business, we are in the card processing business, disaster recovery business.

Q - Tony Wible

Do you feel that the current infrastructure that you have today could be leveraged into the front end and further away from the back office where you typically operate at the back end?

A - Philip Tomlinson

Absolutely.

Q - Tony Wible

Okay. One last question here relating to just the expenses in the quarter. I guess the occupancy expense you had indicated I funnily note that it had gone up because of some incremental amortization expense. How should we expect that to paying up for the rest of the year? Should we start to see that trend down or should that just be offset by salary reduction?

A - James Lipham

Tony, it will continue until those big conversions yet which will let biggest one I guess is in October, then it’ll level out, it’s probably an additional total this year but certainly in those of expand.

Q - Tony Wible

Okay, great, thanks a lot guys.

A - Philip Tomlinson

Thank you.

Operator

Your next question coming from Cannon Carr. Please state your affiliation then pose your question.

Q – Cannon Carr

Hi Phil and Jim, Cannon from CIBC World Markets. Just a question on margins. Looking forward and then also just looking back a little bit, but closer 22% operating margins, I know you said 21 to 22% target for the year, what really when we get to the fourth quarter, what is the impact look like after BoA catch us through and Cap One helps offset that a little bit?

A - James Lipham

We are possibly looking at 35, 36% margin in the fourth quarter.

Q – Cannon Carr

Well, they’d been excluding the reimbursable, excluding the termination fee.

A - James Lipham

Well, if you, excluding the termination fee, it will probably still be in the 20, you got about 100, it would be close to where we are, probably 20%, 21%.

Q – Cannon Carr

Okay, and then another thing that changed a lot last summer I remember I think last summer, last fall, you kind of targeted year-end about 22% maybe a little bit more than that. And is it lacking a little bit even now with, you know, what I am seeing the impact of deconversions yet, is that lagging kind of where you wanted to be last summer?

A - Philip Tomlinson

It is lagging a little bit because we have had to accelerate some of our expenses in anticipation of these deconversions.

Q – Cannon Carr

Okay, and then last question, looks like depreciation actually did jump up higher than historically as well, I just wondered if there is anything on the amortization front or something as well?

A - Philip Tomlinson

Only the software for as far as amortization, depreciation and obviously in this first quarter, you get two months is more Vital in there, which you had last year.

Q – Cannon Carr

Okay, great.

A - Philip Tomlinson

Thank you.

Operator

Your next question is coming from Robert Dodd. Please announce your affiliation then pose your question.

Q – Robert Dodd

Hi guys, yes, Morgan Keegan. Two questions. Really on Europe first of all, I realize that’s the currency translation effect and that distort to comparison, but even if we back that out, it looks like revenue growth in Europe slowed pretty substantially from the late that we saw last year. Is that just a function of price compression or is there anything else going on over there?

A – Philip Tomlinson

It is a function of some price compression, it is also a function of how new contracts continue to fall.

Q – Robert Dodd

Okay, and then secondly, you made reference when Bank of America switches off, you got to maintain that the tech headcount until the last date. What the transition effect of the fact that you’ve got Capital One coming on at about the same time which obviously needs a ramp-up in headcount? I mean, does that create an opportunity to just shift people around or it’s just, can you give us any idea about what the real possibilities of it?

A - James Lipham

Well, certainly Sears and Bank of America, it does give us an opportunity to shift people around when you got 75 million accounts coming on. The problem is like with on MIPS and ASD, we are having to build-up right now to do all the testing and the conversion processes that we go through with all of these new accounts. And the last part of the new accounts is coming on about the time that the Bank of America will be leaving and then we are going to have to have a process to try as best we can to get rid of that equipment, I mean we obviously have leases that we have to deal with some of our vendors, not only on just MIPS but storage ASD as well. We will certainly shift people around as best we can, and we have already started that process, and are pretty far along in that process as it relates to Sears. The Bank of America transaction is a little harder to do and that’s why I’ve said earlier, we have identified already on that particular transaction about 35 million that will go away on an annual basis and we’ll continue to increase that as time goes by. It’s really like a driven off a clip though, I mean, you know, in mid-October, when they leave, we are sitting here with a cadre of people, who have been great employees, have done a good job on Bank of America for years and we are also sitting here with this mass of equipment and all the things associated with that that we will have to get out the door as quick as we can. We have made a commitment on the people side to find our work our way through this attrition as I said last time, we averaged about 83 people a month leaving what we are doing is we basically really slowdown the hiring TSYS and you will see our numbers continue to get smaller as the time of departure for Bank of America comes closer. So it’s a very fine juggling act and we are walking in a raise of thin wire here to, one probably the right thing with our people and two, make sure that we do the right thing with our shareholders and investors.

Q – Robert Dodd

Okay, and one final question on Vital or TSYS Acquiring internationally. You said, you’ve opened offices in Spain, Netherlands, China, Brazil etc., I mean, to what degree TSYS Acquiring Services being marketed over there or do you expect to make an entry into that, one of those markets or another international market through a JV or partnership with the bank or an acquisition, I mean what’s your best guess is, the best entry into international there?

A - Philip Tomlinson

I would think that certainly all of those are options but if I have to make a bid, I would bid on some sort of JV.

Q – Robert Dodd

Okay, thank you.

A - Philip Tomlinson

Thank you.

Operator

At this time, there are no further questions in the queue. Do you have any closing comments today to finish with?

Philip Tomlinson, Chief Executive Officer

I do, one I would like to say thank you for being with us this morning. We believe this is going obviously as I said twice earlier, time of transition for TSYS, we have some challenges, I think we are up for the challenges, we have an awful lot of really good things going on here, we have a team of people that are committed to making -- to continue to make this company great. We are going to continue to win in the marketplace, we have got great technology, we have got a great stable world-class customers, when you – as Jimmy said, when you pro forma and take out these two customers for 2005, 2006, the fundamental business is growing at a rate of 25% and we will continue to diversify, I would ask you to stay tuned for that and we will continue as I said to win, we have some good announcements coming and we look forward to a great year, and look forward to chatting with you about this in more detail. So, thank you and we will see you next quarter.

Operator

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

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Source: Total System Services Q1 2006 Earnings Conference Call Transcript (TSS)
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