TNS, Inc. Q3 2008 (Qtr End 09/30/08) Earnings Call Transcript

| About: TNS, Inc. (TNS)
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TNS, Inc. (NYSE:TNS) Q3 2008 Earnings Call November 3, 2008 5:00 PM ET


Mike McCarthy – Assistant Corporate Secretary

Henry Graham - Chief Executive Officer

Dennis Randolph – Executive Vice President and Chief Financial Officer

Ray Low – President


Wayne Johnson III - Raymond James & Associates

Gary Prestopino - Barrington Research Associates, Inc.

Franco Turrinelli - William Blair & Company


Welcome to the third quarter 2008 TNS Inc. earnings conference call. (Operator Instructions)

I would now like to turn the presentation over to your host for today's conference, Mr. Mike McCarthy, TNS Assistant Corporate Secretary.

Mike McCarthy

Good evening. Thank you for joining us to review TNS’ third quarter 2008 financial results. I am Mike McCarthy, TNS’ Assistant Corporate Secretary. This conference call and web cast are accompanied by a brief slide presentation that we invite you to access on TNS' website at Leading today's call from TNS are Henry Graham, CEO and Dennis Randolph, Executive Vice President and CFO.

Before turning the call over to Henry, I will read the Safe Harbor Statement. The matters that we will be discussing today, other than historical information, consist of forward-looking statements. These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to differ materially from those expressed or implied by these forward-looking statements.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We caution you not to place undue reliance on forward-looking statements which reflect our analysis only and speak only as of today's date. We undertake no obligation to publicly update the forward-looking statements to reflect subsequent events or circumstances.

Finally, we refer you to our form 10K filed with the Securities and Exchange Commission on March 17, 2008, which is available on our website, for additional information concerning factors that could cause actual results to materially duffer from the forward-looking statements.

With that, I turn the call over to Henry Graham, CEO.

Henry Graham

Thank you Mike and thanks everyone for joining us to discuss TNS’ third quarter 2008 results. I will begin today’s call with an overview of the quarter’s results and accomplishments and give you an update for our plan for the remainder of 2008 and our initial thinking about next year. Then Dennis Randolph, our CFO, will take you through the results and our financial outlook. After Dennis’ remarks, he and I will be available to answer your questions in the time remaining.

As we go through the discussion we invite you to follow along the slides we will be presenting on our website. TNS’ third quarter performance on a fundamental basis was strong and overall as we expected on a constant currency basis. Solid growth in our ISD and FSD divisions achieved over 300 basis point expansion in gross margin and our high operating leverage generated substantial cash flow generation during the quarter enabling us to again pre-pay debt while investing in growth.

Our reported results do reflect an unanticipated impact of $1 million from foreign currency exchange as the dollar strengthened suddenly against our local currencies in the second half of September. This was coincident with a slight weakening in transaction trends in certain markets.

Revenue in the fourth quarter grew 4.8% to $88.6 million, slightly below the lower end of our outlook range and adjusted earnings excluding non-recurring items grew 24.5% to $11.2 million at the high end of our outlook range. We continue to execute very well operationally and generated a substantial amount of cash enabling us again to pre-pay our debt.

So let’s talk about the quarter in more detail starting with web cast slide number two. I will walk you through our divisional performance.

International services division, TNS’ largest division, reported year-over-year sales growth of 10% in the third quarter and accounted for 47.1% of total revenue. Excluding $800,000 in lower pass through revenue as was disclosed last year our ISD grew 12.2% and ISD margins continue to be quite strong in the third quarter.

As I mentioned earlier, we saw a slight drop off in the pace of transactions in certain markets as we entered the second half of the quarter which I will highlight as we go along.

Looking at ISD by geography, in Europe demand for our international POS continued to drive growth in transaction volumes and increased sales of IP services albeit at a slightly slower than anticipated rate and we gained additional share of these growing markets. Constant currency revenue in the region grew 9.6%.

In the United Kingdom, third quarter growth in constant currency was approximately 10.4%. As we mentioned in our second quarter call we had begun working with ScotMid, a mid-sized Scottish retailer serving the U.K. to upgrade its payment processing and data accessibility and provide managed DSL service to 260 outlets which are now on TNS’ network.

In the third quarter we also signed a new contract with Bank Machine to provide ATM services with a higher volume commitment going forward. As we have discussed in the past, our broadband products are being well received internationally and this past quarter we announced an agreement with a co-op group in the United Kingdom which is a separate entity from the co-op group in the U.S. provide IP connectivity for credit card transaction processing of the co-op’s headquarters to its 1,800 food stores.

In France, revenue growth and constant currency was approximately 9%. This market is one of those in which we did see some weakening in transaction volumes in September. Our traffic migration of one final bank associated with the JPG acquisition is now underway and is expected to be completed in the first quarter of 2009. Our volume ramp of JPG associated traffic is building and is contributing to ISD growth.

In Italy and Spain transaction volumes remain quite strong in the third quarter. Revenue growth combined in constant currency was approximately 18%. We have seen good sales penetration into the retail market in Italy and signed with our first retailer, Ferragamo, to provide IP services as well as with Diners Club Italia and [Roxom] Bank.

In Australia, revenue growth in constant currency was approximately 23%. I’ll give you an update on Dialect product development in a moment. Our core business in Australia is performing well with good transaction volume trends. We are now focusing on expanding into the retail sector in Australia and New Zealand. Despite the uncertain global financial markets our international FSD business growth was solid in the third quarter and we continue to win new pieces of business.

TNS’ secure trading internet established links with the Australian Security Exchange and with Kotak Securities, the stock brokerage arm of India’s Kotak Mahindra group. We also began providing Tora, the leading electronic trading platform and liquidity platform in Asia with fully managed, low latency trading connectivity for its brokers and clients. Also we signed with IDC’s Interactive Data Real Time Services to provide fully managed connectivity to carry market data feeds and other data services to its clients.

To support international FSD growth in the Asia Pacific region, we opened an office in Hong Kong. This office will focus on growth in a region which continues to open global trade doors and where demand for security data communications is growing rapidly.

Moving into FSD, revenue in our domestic financial services division increased 13% year-over-year and was 13.2% of total third quarter revenue. FSD growth in the third quarter resulted primarily from large bandwidth installation supporting market data feeds as well as increasing connections with existing customers. During the quarter we re-signed our largest FSD customer, IPG, which was an important accomplishment and will in addition bring over 100 incremental end points to our network over the next 18 months.

We also imitated a new suite of low latency services featuring a range of new connectivity and hosting packages that will leverage our Secure Trading Extranet. We ended Q3 with 1,407 global physical end points of which 986 are domestic and 10,904 domestic logical virtual connections.

Moving to TSD, revenue in our telecommunications services division increased 6.6% from last year and was 18.6% of total third quarter revenue. Third quarter growth was mixed as we continue to migrate cable customer traffic onto our network adding higher margin revenue as we add their subscribers. We also experienced a consolidation of traditional wire line traffic that was disclosed previously and the unexpected loss of a CM customer. We continue to pursue expansion into the cable vertical where a large opportunity for growth remains not only for our TSD division but for POS as well as cable providers are beginning to focus on providing broadband connectivity to retailers.

Overall, however, we are experiencing a positive mix shift in this division’s revenue towards higher margin revenue as we grow into cable and nontraditional telephony verticals.

Moving to our POS division, revenue in our domestic POS division decreased 9.9% year-over-year in the third quarter and accounted for 21.1% of total third quarter revenue. Total POS dialup transaction counts were down 11.8% year-over-year through the combination of a large customer moving traffic off of our network in the fourth quarter last year, the consolidation of Alliance Data Systems Network Services business into Heartland Payments and as we have stated a slight weakening in overall traffic patterns in September.

The migration of co-op financial services ATM’s is proceeding well. This represented our largest quarterly installation in our history with approximately 2,000 end points installed to date and we are expecting orders for approximately 1,500 more by year-end. Given the magnitude of this accomplishment I want to take the opportunity to personally thank our Lansing, Michigan division staff and our operations team in Reston for this extraordinary effort.

The remainder of the year we are focusing on continuing to convert our broadband pipeline. By the end of this year we expect to have approximately 4,000 end points installed which compares to 1,200 installed end points at the end of 2007.

Over the past 18 months TNS has been investing in the future of its payments business. Our focus has been to provide best of breed network products to acquiring processes and banks around the world. As new technologies are developed we have continued to be an innovator in integrating these into our product line and bringing a number of new initiatives to the market on a global basis. Following our acquisition of Dialect last July TNS is now one of the key providers of card not present and Internet payment gateway services in the Asia Pacific region. In addition to delivering services with card associations such as American Express and Master Card, we are also supplying products to the travel and entertainment industry and to car parking and general Internet merchants.

Second, we launched FusionPoint Lite product during the last quarter. This low cost service is focused directly at the small mom and pop merchant who wants to maintain existing dial POS and ATM equipment but run it over DSL or cable circuit.

Third, TNS was founded on its ability to take a POS message from a POS device in one format and convert it into another format that the acquires host can understand in real time. We have recently seen new opportunities for these properties relating to cross boarder acquiring and consolidation by banks and processors of processing platforms. A product enables our customers to accept a POS transaction in any format and from any country and deliver this transaction to an acquiring host in a format acceptable to them.

Finally, the POS industry around the world is naturally increasingly concerned with issues surrounding fraud and security. We have developed new secure IP services along with those of the acquiring processors banks and merchants which enables our customer to deliver a superior level of security not previously available for POS transactions in the past. Denny will talk more about potential exposure to the economy and foreign currency fluctuations in our budgeting process going into next year.

At this point I would like to make a comment on our 2009 outlook. To those who have listened to me on this call over the last two years you have heard me discuss our target of 8-10% constant currency revenue growth with operating leverage driving earnings 15+%. Given the weakness in the economies is which we operate today we think it is prudent to adjust our revenue growth rate in 2009 to the mid single digits in constant currency based on recent trends affecting transaction volume growth and uncertainty in the financial services market. We will update you further on any revisions to our adjusted earnings growth outlook when we report our fourth quarter 2008 results in early 2009.

Remember, our business model is characterized by high operating leverage as our [deferral] adjustments we can make to preserve adjusted earnings growth during this period of potential slower top line growth. Also, as Denny will outline, on a reported currency basis we anticipate the foreign exchange impact in the fourth quarter 2008 to be $6 million in revenue. Should foreign exchange rates stay where they are for the next year that impact as it relates to year-over-year revenue growth could be $18 million in revenues in aggregate for 2009?

I want to make it clear that our pipeline of opportunities has not changed. In essence, the swings in currency in one month have taken the dollar to a level we have not seen in over three years. While these currency swings are effectively setting us back a year, the opportunities in front of us are as strong as they have ever been given the investments we have made in people and product during the two years this management team has been in place.

Now I’ll turn the call over to Denny for a review of the financials.

Dennis Randolph

Thanks and good evening everyone. We will start the financial review with income statement highlights beginning with web cast slide three.

Total revenue in the third quarter increased 4.8% to $88.6 million from $84.5 million in the third quarter of 2007. While we had expected some impact on revenue from foreign exchange in the third quarter the move in the dollar in the last half of September was a surprise. Overall, currency affected our revenues by $1 million versus our internal projection of affected EBITDA of $400,000 and earnings per share of $0.03. I’ll discuss later my comments on our exposure to [inaudible] currencies we operate in and how currency affects or P&L.

As Henry already detailed the divisional components of revenue, I will move to the gross margin line. Gross margin in the third quarter increased 320 basis points to 53.4% from 50.2% in the third quarter of 2007. The improvement in gross margin is the result of increased contributions from ISD and FSD, the company’s highest gross margin divisions, and to a lesser extent from the improvement of gross margin in TSD as the mix of services we are providing continues to evolve as we bring more of the cable company traffic onto our network.

Engineering and development costs during the quarter were $7.3 million compared to $6.9 million in the third quarter 2007 and were flat at 8.2% of revenue. The increase in E&D spend results primarily from investments made by the company to enhance both our IPSSD and POS service offerings.

SG&A expenses were $21 million or 23.7% of third quarter 2008 revenue compared to $20.1 million or 23.8% of revenue in the third quarter of 2007. SG&A increased as planned as we continue to make investments in top line growth specifically in our business development group that is focused on driving revenue growth from our global customers.

Going forward we plan to control costs carefully and make selective necessary investments to drive long-term growth and maintain our competitive position given the overall economic environment.

Depreciation expense in the third quarter increased 3% to $6.1 million and was 6.9% of revenues versus $6 million or 7.1% of revenues last year. Amortization of intangibles decreased 6.6% to $5.9 million in the third quarter of 2008 versus $6.3 million last year as certain tangibles from prior acquisitions became fully amortized earlier this fiscal year.

Interest expense in the quarter was $2.4 million versus $4.3 million last year as we have substantially reduced our debt levels and are benefiting from a lower effective interest rate. As a reminder, our long-term debt is currently 200 basis points over Libor and we also have the option to borrow at 100 basis points over the prime rate.

Other income and expense was an expense of $900,000 during the quarter versus income of $1.2 million in the third quarter of 2007. The decrease primarily relates to losses from the revaluation of foreign currencies predominately the Euro and pound Sterling against a gain on those currencies last year. The total impact to adjusted earnings year-over-year is approximately $0.07 per share related to these items.

Because of the high amount of amortization of acquired intangibles that we record and the fluctuations in our effective GAAP tax rate we use two non-GAAP measures to evaluate operating performance. EBITDA before stock compensation expense and adjusted earnings, both of which are illustrated in today’s press release in the accompanying slide presentation.

Let’s take a look at slide number four.

EBITDA before stock compensation expense is calculated by taking income from operations and adding back interest, tax, depreciation and amortization and stock compensation expense. EBITDA before stock compensation expense for the third quarter of 2008 was $22.4 million amounting to 25.3% of revenues compared to $19.2 million or 22.7% of revenues for the third quarter 2007. This is an increase of 17%.

Included in third quarter results of 2008 and 2007 are pre-tax charges associated with severance of $700,000 and $1.1 million respectively. Excluding these charges from both quarters, EBITDA before stock compensation expense increased 13.9% which represents a 200 basis point increase in operating leverage.

Moving to slide five, adjusted earnings are calculated by taking pre-tax earnings or loss from continuing operations before equity and net loss of affiliates and adding back certain non-cash items including amortization of retainable assets and stock compensation expense. The results of which have historically been tax effected at a 38% rate. As previously announced, we are now taxing adjusted earnings at 20% and my comments will compare last year’s comparisons to the new rate.

Adjusted earnings for the third quarter 2008 increased 26.8% and $10.6 million or $0.42 per share from third quarter 2007 adjusted earnings of $8.4 million or $0.34 per share. Excluding the previously mentioned pre-tax coverage charges from both periods adjusted earnings for the third quarter 2008 increased 20.5% to $11.2 million or $0.44 per share from $9.3 million or $0.38 per share for the third quarter 2007. Again, these results reflect our efforts to increase our operating leverage.

Now let’s review the balance sheet highlights on slide six.

Our current ratio is 1.45 times, slightly above the 1.43 times at the end of last year and up from 1.31 times at the end of the third quarter last year. Long-term debt at quarter end was $105 million for a total debt to capitalization ratio of 62.1% versus 68.9% at the end of last year and 70.3% at the end of the third quarter last year.

In the third quarter we made voluntary pre-payments on our term D loan of $7 million for a total of $44.5 million pre-paid since the March 2007 recapitalization. Year-to-date we have prepaid $25 million. Cash at quarter end was $23 million, up $500,000 from last quarter and up $5.2 million from last year.

During the third quarter we generated $18.7 million from operations, 2.3 times the level generated in the third quarter of last year. Capital expenditures in Q3 were $11.6 million compared to $5 million in q3 2007. In the third quarter we have made incremental investments in our network backbone to expand our IP capabilities as well as in certain back office initiatives to improve our internal network monitoring systems and reporting capabilities. We do expect capital expenditures to moderate in the fourth quarter and going into next fiscal year.

Now let’s move to slide seven.

For 2008 we have decreased our outlook for revenue to reflect the continued strengthening of the dollar against the other denominations we do business in and our assumption the dollar will remain strong throughout the fourth quarter against these currencies for a longer period of time than it did in the third quarter. As Henry mentioned, we are also making a prudent adjustment to our outlook for volumes in our transaction-based businesses. Our outlook is based upon information available as of today.

Let’s take a moment to talk about foreign currency effects. In the markets in which we operate we recognize revenue and incur expenses in each market’s local currency. We then translate these local currency results and report in the U.S. dollar using the average exchange rate for each currency in effect for that period. Forty-seven percent of our total company revenues are transacted in currencies outside the U.S. in our international services division which carries EBITDA margins of approximately 38%. These primarily currencies are the pound Sterling, the Euro and the Australian dollar.

To give you an idea of the currency exposures in our business model, the currency composition of our third quarter results was as follows: ISD revenues accounted for 47% of total revenues of which the pound Sterling represents 45%, the Euro represents 32%, the Australian dollar represents 18% and other currencies make up the balance of 5%. In terms of expenses, the international services division expenses were 39% of total operating expenses of which the pound Sterling represents 49%, the Euro represents 29%, the Australian dollar represents 17% and other currencies make up the balance of 5%.

Based on the current outlook for our major currencies we anticipate an approximate $6 million impact from our prior outlook for the fourth quarter 2008 and an impact to adjusted earnings of $1.8 million or $0.07 per share.

Our current forecast contemplates the following exchange rates for the major currencies. Pound Sterling exchange rate of 1 to $1.65. The Euro exchange rate of 1 to $1.32. The Australian dollar exchange rate of 1 to $0.68. These exchange rate assumptions are based on actual average exchange rates through the month of October as well as estimates based on a composite of financial institution’s forecasts for the remainder of the quarter. To the extent that weighted average exchange rates differ from our estimates our actual reported results will be affected.

In addition to the effect currency has on trades in our local currency results to the U.S. dollar, we carry certain assets and liabilities that are denominated in currencies other than the local currency for which we recognize on a periodic basis unrealized and realized gains and losses as those assets and liabilities are settled or revalued. Our expectations for unrealized foreign currency revaluation losses based on the exchange rates I just mentioned is $1 million for the fourth quarter 2008 which will be reflected in the other income expense line of the P&L.

Now let’s move to slide eight to review our revised outlook.

The press release we issued today shows our 2008 financial outlook at the 20% rate and the comparison from last year as tax for both the former 38% and the new 20% tax rate. The slides we are showing today reflect a 20% rate we have adopted for this year as compared to last year’s results taxed at the 38% rate.

For the fourth quarter 2008 our outlook for total revenue is $82-84 million versus fourth quarter 2007 revenue of $89 million. Included in this outlook is approximately $6 million of foreign currency impact, approximately $1 million related to our revised outlook for transaction volumes and $500,000 related to the reduction of taxes and regulatory charges in our telecommunication services division.

Our outlook for adjusted earnings is $8.7-9.7 million or $0.34 to $0.38 per share versus $10.5 million again based on the new 20% tax rate or $0.43 per share for fourth quarter 2007. Included in this outlook is approximately $2.5 million or $0.10 per share of foreign currency impact from our previous outlook. Again, please note these numbers do not include any non-recurring items.

Our revised 2008 outlook is as follows: Total revenue growth of 6-7% to $345-347 million versus 2007 revenue of $325.6 million. This assumes constant dollar revenue growth of 6.5-7.5%. Our outlook for 2008 adjusted earnings is now $38.3-39.3 million or $1.51 to $1.55 per share versus $32.5 million or $1.33 per share for 2007 on the 20% tax rate for total EPS growth of 14-17%.

This outlook assumes an increase in our fully diluted share count of approximately 4%. Please note these numbers do not include any non-recurring items.

Finally, as it relates to Q4 2008 outlook and Henry’s comments for our outlook on 2009, it is important to note we have a high degree of control over our operating capital plan and are prepared to prudently adjust them further for changes that may arise in the environment while still making selective, necessary investments in our business to drive long-term growth.

At the current time we are working to finalize our 2009 budget and we will update you further on the next call.

With that I will now turn it back to Henry.

Henry Graham

Thank you Denny. Operator this concludes our prepared remarks. We are ready to open the call to questions.

Question-and-Answer Session


(Operator Instructions) The first question comes from Wayne Johnson III - Raymond James & Associates.

Wayne Johnson III - Raymond James & Associates

Let me just get a couple of updates here. On the POS side can you give us a sense of the co-op network? Where are they in that ramp? You said you are expecting 1,500 more for ATMs. Is that part of the contract? Can you just refresh our memory? How long is the contract, what is the dollar value and what are the milestones we should be tracking for that particular contract with this POS?

Henry Graham

Effectively the contract was a 3-year contract. The first year minimum was $1 million. The second year minimum was $3 million. The third year minimum was $5 million. If things proceed according to what we understand now we have about 2/3 of them installed. We have 1,500 ordered. That would leave about 2000 more that we don’t have an order for as yet. We estimate roughly 55,000 aggregate sites when this is fully ramped.

Wayne Johnson III - Raymond James & Associates

On the FSD side, looking into next year I appreciate you guys giving us some color and some guidance on that in the aggregate, but on a divisional level how should we think about FSD? Has it been impacted by the global financial meltdown and if it has to what extent?

Henry Graham

Effectively it still grew 13% year-over-year.

Wayne Johnson III - Raymond James & Associates

In the third quarter right?

Henry Graham

In the third quarter. We continue to see cautiously double-digit growth in that division. We would expect in the second half of 2008 it will probably by the end of this fiscal year will have been impacted somewhere between $400,000 to $500,000 mainly as the result of some disconnects but also of a slower uptake on additional installs that some of the people on Wall Street are sort of holding off on to see how things go. We are being very cautious in our outlook on that because there is a lot of balls still up in the air and a lot of things we don’t understand yet and can’t forecast. So this year it was about $400,000 to $500,000. We do expect it to continue double-digit growth going into next year but again, we are going through our 2009 finalizing of the budget process right now. Certainly the re-signing of [IPP] and the incremental 100 end points they will bring over the next 18 months will certainly help continue to drive growth there.

Wayne Johnson III - Raymond James & Associates

So I’m thinking things like Lehman Brothers, Merrill being absorbed by B of A, Bear Stearns going away, lower overall business and employment levels at the targeted audience, but I’m not getting the sense from your response that is having an impact on the service. I just want to make sure I’m understanding that correctly.

Henry Graham

It has not had an impact thus far other than maybe $400,000 to $500,000 we anticipate this year. Lehman was taken over by Barclays Capital and I am happy to say they have rolled over the contract we had with Lehman with them at least domestically. Obviously we had a foreign piece associated with that too that I don’t have as much clarity yet as to exactly what is going to transpire there. We are anticipating there will be some impact although we are not seeing a significant amount of impact as of yet. That is one of the reasons why we are lowering the estimate if you will to the mid single digits for fiscal year 2009 at the current time.

Dennis Randolph

Our expectations for FSD would still be for double-digit growth.

Wayne Johnson III - Raymond James & Associates

On a constant currency?

Dennis Randolph

FSD as we report are all denominated in U.S. dollars.

Wayne Johnson III - Raymond James & Associates

All domestic and I understand that I guess overseas for ISD what percentage is FSD?

Dennis Randolph

About 10% of international services division revenues are FSD. On a constant currency basis we see in local currency the growth of our FSD service is particularly in the Asia Pacific region is growing at a higher rate than the overall ISD business. Our FSD international business grows around 25% on a constant currency basis. Now obviously that is [inaudible] but we are still seeing good growth in the international FSD markets.

Wayne Johnson III - Raymond James & Associates

So just on the domestic business environment for POS, looking out on a constant basis it was a pretty big down quarter on volume, not really too far out of out expectations. Is it possible that next year we start seeing some type of stabilization in that division?

Henry Graham

Yes, we would fully expect that. Obviously the combination of the movement in the fourth quarter of last year we were not fully wrapped that deal with a large customer of ours, certainly we could not have predicted the ADS/Heartland deal if you will. We would expect the beginnings certainly the year-over-year decrease should slow dramatically in the fourth quarter and given the fact we are putting more of these monthly recurring type charges in we would expect today to tell you there will be growth year-over-year in 2009 in domestic POS.

Wayne Johnson III - Raymond James & Associates

On TSD, what percentage of TSD’s revenues would you say is now part of that higher margin, cable, triple play related mix?

Dennis Randolph

Between 25-30%.


The next question comes from Gary Prestopino - Barrington Research Associates, Inc.

Gary Prestopino - Barrington Research Associates, Inc.

Could you give me those exchange rates?

Dennis Randolph

The exchange rates we used for the outlook? On a weighted average basis for the Pound Sterling it is $1.65 for the Pound, $1.32 for the Euro and $0.68 for the Australian Dollar. Now again, those reflect the actual exchange rates or the actual average exchange rates through the month of October. Then what we do is we go out and we get a hold of other financial institutions and take a composite of what the forecasts are for the balance of the quarter. To the extent the actual exchange rates differ from those estimates our results will be impacted accordingly.

Gary Prestopino - Barrington Research Associates, Inc.

In terms of this revaluation of balance sheet items, this is something that could continue to be ongoing if the dollar continues to appreciate against these other currencies, correct?

Dennis Randolph

Yes, but I don’t believe that you will see it to a magnitude. What we did anticipate in the third quarter that we would have some strengthening of the U.S. dollar but not to the extent that it was. Obviously in October it strengthened even more dramatically. That’s why we are saying we think the impact is roughly $1 million in the fourth quarter. To the extent exchange rates begin to normalize we don’t see these wild fluctuations, those amounts and revaluations that come through in the other income and expense line through the P&L should begin to see those moderate. It is only in periods of high volatility that you are going to see a significant impact come through that line.

Gary Prestopino - Barrington Research Associates, Inc.

In terms of the ISD countries you said like France was seeing a little bit a slowing in transaction growth, did you also say the U.K. was as well?

Henry Graham

Yes. We have seen some weakness mainly in the second half of September.

Dennis Randolph

It is important to note too we are still seeing transaction volume growth in those markets. Particularly in the month of September we did see a noticeable decline in those growth patterns in the U.K. and in France.

Gary Prestopino - Barrington Research Associates, Inc.

Has that continued through October?

Dennis Randolph

We have seen it rebound slightly in October. But still below kind of what our expectation levels were when we talked to you guys back in August.

Gary Prestopino - Barrington Research Associates, Inc.

In terms of your expenses, you obviously have ratcheted down your top line growth here. What can you do in terms of reducing the growth of expenses you may have planned for before all this happened?

Henry Graham

Effectively what we do is we evaluate before we make any expenditure or increase expenses it always has to be tied to either a potential sale, a deal being signed or something of that nature. There are a number of things we can do dependent upon which division is signing deals and which division is not signing deals. So there are a number of things we can do that we have yet to do but quite frankly the business lends itself very well to timing expenses to corresponding sales like the decision to open up Hong Kong. That was a very good decision. We made that decision. There were other decisions similar to that which we make those given the economy and the macro economy as it stands today.


The next question comes from Franco Turrinelli - William Blair & Company.

Franco Turrinelli - William Blair & Company

There seem to be some encouraging announcements on FusionPoint. Can you bring us fully up to date on what is going on there?

Henry Graham

Yes, as a matter of fact Ray is sitting right here and I’ll let him do that.

Ray Low

Finally we are starting to see some growth in the FusionPoint particularly here in the U.S. We are seeing good take up in the fuel sector. We recently launched our FusionPoint lite product which Henry talked about earlier which is a product that allows us to convert legacy dial terminals to an IP circuit. Again, a lot of interest from both merchants and from banks around the world. In that particular case we are focusing on three markets, the U.S. here, the U.K. and Australia. In all three of those markets we are seeing a lot of interest from both merchants and from banks. Generally we are seeing finally a take up in all three of the product lines that we call collectively FusionPoint. We are seeing good movement in the fuel sector which is good because obviously it takes away the variances in transaction volumes. When they are just on dial we just get a fixed fee for providing that service and we are also seeing continuing interest in the larger upscale merchants around the world.

Franco Turrinelli - William Blair & Company

When you said you were expecting domestic POS to be up slightly in 2009 does that include any great assumptions about FusionPoint or is it pretty insignificant still in those numbers?

Dennis Randolph

We need to be careful about how we talk about Fusion but a lot of it is the combination of the broadband products. So if you look at what’s happening right now with the co-op and a couple of the other fuel based FusionPoint customers we have we are actually in the process right now in the fourth quarter of doing a large number of installations. We should have a pretty good run rate going into next fiscal year that should show slight growth in POS.

Franco Turrinelli - William Blair & Company

Sticking to POS for a second, have we basically seen all the reduction we should expect to see from the Heartland alliance combination or is there still some more to come there?

Dennis Randolph

No, there is actually some more to come. Where we should see that really is in the first quarter of 2009. Right now they are leaving a portion of their 800 traffic on our network until the first quarter of 2009.

Franco Turrinelli - William Blair & Company

That is again factored into your thinking on POS obviously?

Dennis Randolph

That is factored into our thinking on POS next year. That is correct.

Franco Turrinelli - William Blair & Company

Do all of these exchange rate gyrations have any impact on your tax rate and in particular your ability to keep the tax rate down to this low level of 20%?

Dennis Randolph

Effectively right now due to the NOL situation we have in the U.S. we are only tax payers internationally so to the extent that the dollar actually strengthened the actual amount of CapEx that we will report on a U.S. dollar basis will actually come down as a result.

Franco Turrinelli - William Blair & Company

But we should continue to use this 20% for our 2009 thinking as well?

Dennis Randolph

Twenty percent is a conservative tax rate for us to use moving forward.

Franco Turrinelli - William Blair & Company

Obviously this is a horrible environment and you guys are doing a good job navigating through it. Anything positive at all coming out of this environment in terms of banks looking harder at outsourcing or maybe costs coming down for you?

Ray Low

I think generally yes. I think the banks are looking at where they spend their money or how they spend their money. A lot of our customers now are partly owned by governments and their decisions are being changed as a consequence of that. So I think there are opportunities for us to sell services to them that perhaps they wouldn’t have been so interested in the past. The one thing I would say though is that as a consequence of the changes our sales cycles have probably lengthened a little bit. Decisions are taking longer to be made. They are going up the command chain perhaps a bit further than they did before. As a consequence it is going to take us longer to close those deals. But I think there are opportunities that are still out there.

Henry Graham

Obviously Ray touched on longer sales time. Banks are all very concerned about their balance sheet, cash and things of that nature. We don’t know the full extent of this. Logic would dictate that if we can save them money they would jump at the chance but then again you have to temper that against that cash position at any certain time.


At this time there are no further questions. I will turn the conference back over to Mr. Graham.

Henry Graham

Thanks again everyone for participating today. We look forward to speaking with you again after the fourth quarter. Have a good evening.


Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect.

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