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Total System Services Inc. (TSS - Free Report) reported second-quarter operating earnings of 28 cents per share came in a penny higher than the Zacks Consensus Estimate of 27 cents and climbed from 25 cents per share in the year-ago quarter.

Excluding termination fees in 2010, earnings per share surged 25.4%, while net income increased 10.8% to $53.7 million from $49.7 million in the prior-year period.

Results reflect increased same client transactions, lower taxes and slight increase in overall transaction volume. However, continued weakness in North America services along with a dip in merchant acquiring services revenue, higher-than-expected cost of services and selling, general and administrative (SG&A) expenses led to the decline in operating income earnings.

Total revenue for the reported quarter was $447.6 million, up 3.9% year over year and exceeded the Zacks Consensus Estimate of $438.0 million. Excluding termination fees in 2010, total revenues witnessed a 6.2% year-over-year growth.

On a constant currency basis, total revenue was $438.8 million, reflecting a 1.8% increase from the year-ago quarter. Reimbursable items totaled $67.3 million, down 1.2% year over year.

As per segments, quarterly revenues from North America declined 1.2% year over year to $233.9 million, while revenues from international services witnessed a 25.2% year-over-year growth to $97.7 million based on new business and organic growth. Besides, intersegment revenues improved 9.1% year over year to a negative of $7.1 million.

However, revenue from merchant acquiring services inched down 0.7% year over year to $123.1 million. Meanwhile, organic growth in the reported quarter stood at 3.9%. 

Total System reported a 3.3% year over year rise in SG&A expenses, which came in at $57.0 million. Alongside, cost of services increased 5.5% year over year to $312.1 million. As a result, operating income plummeted 1.6% year over year to $78.5 million in the reported quarter.

Total number of accounts on file as of June 30, 2011 was 376.0 million, up 13.0% from 332.8 million at the end of the prior-year quarter. This was primarily driven by new client growth and internal growth of existing clients. Additionally, same-client cardholder transaction volumes increased 5.7% over the prior-year quarter.

Financial Update

As of June 30, 2011, cash flow from operating activities was $199.3 million, compared with $195.7 million in the year-ago quarter. Cash and equivalents plummeted to $263.3 million versus $394.8 million at the end of 2010. While total assets were $1.83 billion at the end of the reported quarter, total shareholders’ equity was recorded at $1.32 billion.

Additionally, Total System deployed approximately $252 million of capital for share repurchases and acquisitions in the first half of 2011. However, the company did not repurchase any shares during the reported quarter, while 2.0 million shares were bought back in the prior-quarter.

On May 3, 2011, Total System approved and authorized the extension of its stock repurchase program to 15.0 million shares from 10.0 million shares. The company has also extended the expiry of the total share repurchase program to April 30, 2013. Including the existing program, 9.9 million shares currently remain available for repurchase.

Business Update

On June 28, 2011, Total System announced an agreement to provide core processing services to Elavon Financial Services Limited, which is a wholly-owned subsidiary of U.S. Bank parent company U.S. Bancorp (USB - Free Report) . The company is expected to begin issuing corporate cards in Europe this summer.

In March 2011, U.S. Bank had announced that it would begin issuing corporate cards to European-based employees of its North American multinational customers through Elavon Financial Services Limited.

On May 10, 2011, Total System announced a strategic alliance with Caledon Card Services, a Canada-based payments technology provider that processes in the rapidly growing eCommerce, tokenization and card-not-present arenas.

The partnership is expected to help boost Total System’s market presence and its long-term growth strategy that also includes business diversification. However, terms of the deal remain concealed.

On May 2, 2011, Total System announced the acquisition of Atlanta-based merchant acquirer, TermNet Merchant Services, which is the 52nd largest merchant acquirer in the U.S. by dollar volume, according to The Nilson Report. The company will be re-branded as Total System and fully integrated into TMS.

With an operating history of 25 years, TermNet will help Total System to expand its merchant acquiring services to more than 327,000 merchant locations around the U.S. However, the pricing of the deal remains undisclosed.

On April 26, 2011, Total System announced that it has renewed its agreement with Advanzia Bank S.A. to process its more than 1.5 million consumer credit card portfolio. Advanzia Bank S.A is the largest issuer of credit cards in Luxembourg.

Dividend Update

On July 1, 2011, Total System paid a regular quarterly dividend of 7 cents per share to the shareholders of record as on June 16, 2011.

Our Take

Overall, Total System signals a sluggish improvement in the near term, given the inefficient cost-cutting efforts, inadequate diversified growth, and interest and currency risk. Moreover, the company is also vulnerable to increased competition from dominant players such as Global Payments Inc. (GPN - Free Report) and Alliance Data Systems Corp. (ADS - Free Report) .

Although the complete acquisition of FNMS coupled with TermNet and expansion into merchant acquiring services is expected to drive growth, sole dependence on it could be risky in the long run. In addition, we do not foresee any other substantial development strategy to drive earnings in the near future. However, a healthy impact of the regulations can help recover client accounts and long-term contracts.

We expect Total System to benefit from the improving economy and generate healthy cash flow to achieve the guidance for 2011.

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