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Edited Transcript of TSS earnings conference call or presentation 23-Oct-18 9:00pm GMT

Q3 2018 Total System Services Inc Earnings Call

COLUMBUS Oct 25, 2018 (Thomson StreetEvents) -- Edited Transcript of Total System Services Inc earnings conference call or presentation Tuesday, October 23, 2018 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* M. Troy Woods

Total System Services, Inc. - Chairman, President & CEO

* Paul Michael Todd

Total System Services, Inc. - Senior EVP & CFO

* Shawn Roberts

Total System Services, Inc. - VP of IR

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Conference Call Participants

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* Ashwin Vassant Shirvaikar

Citigroup Inc, Research Division - Director and U.S. Computer and Business Services Analyst

* Blake Anderson

Stephens Inc., Research Division - Research Associate

* Bryan Connell Keane

Deutsche Bank AG, Research Division - Research Analyst

* Dan Dolev

Nomura Securities Co. Ltd., Research Division - Executive Director of Business Services

* Darrin David Peller

Wolfe Research, LLC - MD & Senior Analyst

* Georgios Mihalos

Cowen and Company, LLC, Research Division - MD & Senior Research Analyst

* Glenn Edward Greene

Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst

* James Edward Schneider

Goldman Sachs Group Inc., Research Division - VP

* James Eric Friedman

Susquehanna Financial Group, LLLP, Research Division - Senior Analyst

* John Kimbrough Davis

Raymond James & Associates, Inc., Research Division - Research Analyst

* Thomas Craig McCrohan

Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Analyst

* Wai Ming Kwok

Keefe, Bruyette, & Woods, Inc., Research Division - VP

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Presentation

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Operator [1]

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Good day, and welcome to the TSYS Third Quarter 2018 Earnings Release and Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Shawn Roberts, Vice President of Investor Relations. Please go ahead.

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Shawn Roberts, Total System Services, Inc. - VP of IR [2]

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Thank you, Andrea, and welcome, everyone. We'll begin this evening's call with opening comments by TSYS' Chairman, President and CEO, Troy Woods; followed by TSYS' CFO, Paul Todd, reviewing the third quarter highlights and consolidated financials. Troy and Paul will both be referencing a slide presentation during their prepared remarks. A copy of this presentation as well as our earnings release and supplemental schedules are available on our website at investors.tsys.com. After the prepared remarks, we'll open the call up for Q&A. (Operator Instructions)

I'd now like to call your 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's actual results to differ materially from the forward-looking statements are set forth in TSYS's reports filed with the SEC, including its 2017 annual report on Form 10-K. I will also discuss items that do not conform to GAAP. We reconcile those measures to GAAP measures in the appendix of the slide presentation and in the supplemental schedules to the press release.

At this point, I'll turn the call over to Troy Woods.

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M. Troy Woods, Total System Services, Inc. - Chairman, President & CEO [3]

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Thank you, Shawn. Good afternoon, and welcome to our third quarter earnings call. Our global TSYS team has delivered another quarter of solid results as we continue to execute on our strategic goals and fulfill our vision of being a leading global payment solutions provider. Some of the highlights for the quarter that I would like to call out are: net revenue increased by 13.1%; net income was up 26.7%; adjusted EBITDA increased 12.6%; and adjusted diluted earnings per share increased 32% to $1.16.

During the quarter, we reduced our debt another $175 million, bringing our year-to-date reduction to $355 million. With this reduction, we have achieved our deleveraging commitment after our acquisition of Cayan 1 quarter earlier than anticipated.

The ability to accelerate our deleveraging commitment will allow us to use our strong free cash flow to resume our share repurchase activity in the fourth quarter. These strong results, coupled with a very healthy economy and consumer confidence levels at an all-time high, enables us to again increase our guidance for the third time this year and fuel our momentum as we go into the final quarter of 2018. Paul will go into more details on our guidance increase in his comments.

In recognition of our performance, during the quarter, we received several important honors. In July, Forbes ranked TSYS #116 on its Global 2000 Growth Champions List, which recognizes the top 250 performers based on compounded annual growth rates from 2014 to 2017.

In September, TSYS was ranked #8 on International Data Corporation's Financial Insights' 2018 FinTech Top 100 based on financial services revenue totals. Finally, I am pleased to announce that our own CIO, Patty Watson, was named one of the 20 Women Who Mean Business by the Atlanta Business Chronicle in September. We are very proud of these recognitions and honors and thank all of our team members for their hard work and dedication.

Now I would like to address a few key items across our enterprise then ask Paul to provide additional financial highlights.

It was another very strong quarter for Issuer Solutions. Some highlights include total traditional accounts on file ended at $594.4 million, up 5.8%. Total transactions were up 12%, and net revenue was $434.3 million, an increase of 8.3% on a reported basis and 8.8% on a constant currency basis. All of these were new records for our Issuer Solutions segment.

On the business development front, we signed extensions with Navy Federal Credit Union, Barclays, MB Financial and Regions Bank. As part of the Regions agreement, TSYS will also begin processing Regions commercial credit card portfolio and will support the bank's commercial ePayables offering through our Virtual Payment Precept platform.

In other new business during the quarter, we successfully converted approximately 4.5 million combined Bass Pro and Cabela's accounts for Capital One. We also have the commitment from Capital One to convert 2 additional retail and co-brand portfolios to TSYS in 2019. In addition to the new Regions commercial card business and Capital One's new commitment, we have a very solid new business pipeline, which will add new business over the next 24 months.

On the product development front, as we reported the last few quarters, we have a large pipeline of new products in fraud, data and analytics, digital engagement, customer service, authentication and our communications platform. All in all, we are very pleased with our third quarter results for Issuer Solutions and excited about our momentum moving into the holiday period.

In our Merchant Solutions segment, we also posted solid results for the third quarter. Net revenue was $346.3 million, and we set another record for adjusted segment operating income of $125.2 million. Top line growth was 22.9%, and organic net revenue growth was again double digits.

During the quarter, we successfully converted approximately 50,000 Cayan merchants to the TSYS platform and are on track to convert the bulk of the remaining book of business by year-end. Our other Cayan integration efforts have been completed ahead of schedule, and we still expect to meet our established synergy targets.

Our integrated channel achieved solid results in all key metrics, posting double-digit organic revenue, volume and account growth year-over-year. We also renewed several large ISV partners and signed more than 35 new integrated partners during the quarter. The Genius platform is both a platform on its own and a driver of growth and differentiation in key industry verticals. In the third quarter, the Genius team won 10 new deals and renewed several large partnerships, demonstrating what the capabilities of Cayan combined with the strength of the TSYS brand can bring to market.

One of the significant wins this quarter is one of the largest specialty clothing retailers in the United States with close to 600 locations, over 3,600 lanes and processing more than 45 million transactions annually.

Our health vertical also continues to outperform the market trends as we continue to invest in dedicated sales and technical resources focused on integrating with health care software companies. Our partner channel also continues to add breadth, scale and strength as our ISO relationships are delivering consistent and predictable results.

We renewed 3 long-standing relationships and signed 20 new ISO partners during the quarter. This brings our year-to-date ISO signings to 58. The majority of these wins were competitive takeaways, solid evidence again that we are the partner of choice in the industry.

The indirect channel continues to be a solid performer, posting good results in both revenue and transaction growth on a sequential and year-over-year basis. With our recent iMobile3 acquisition, we've seen strong adoption of our vital POS and marketplace solutions, and we expect this strong adoption to continue going into 2019.

The competitive dynamics of the merchant industry require that we excel at product development and delivery. This quarter, we took another significant step to accelerate innovation, and that has served the needs of our merchants and partners by realigning the entire merchant engineering organization under the leadership of Paul Vienneau, the former Chief Technology Officer of Cayan. While at Cayan, Paul played a key role in building out the Genius platform and cloud-based omni-channel solutions and brings the management and technical expertise required to lead our next phase of merchant innovation.

Merchants are continually driven to meet increasingly demanding consumer expectations for any time, anywhere in any channel payments. Across our Merchant segment, we're capturing high-value growth with our unique differentiation of innovative technology combined with deep industry expertise, service and security.

In our Consumer Solutions segment, net revenue grew 8.8% year-over-year to a total of almost $196 million, and gross dollar volume was over $8 billion for the third consecutive quarter. We continue to see strong momentum in deepening our distribution relationships while continuing to broaden and invest in our underlying technology platform and overall product suite.

During the quarter, we launched the new white label program with Albertsons throughout all of their 2,000 store locations that I mentioned last quarter. This rollout has been progressing well, and customer reaction has been positive to the overall product proposition.

Also this quarter, in partnership with 7-Eleven, we launched the Trans@ct Family card. This enhanced product feature is designed to help families of all types manage and control their day-to-day finances. This family-focused product feature will be available at approximately 8,000 7-Eleven locations where Consumer Solutions products are sold and loaded.

This quarter, we also continued the rollout of our new point-of-sale platform, NetSpend [Connect]. This platform allows us to deliver new sales and reload experiences across many of our more than 120,000 distributing locations and employers as well as adding capability for cardholder servicing, including direct deposit enrollment, SMS alerts enrollment and full customer identity verification capability at the point-of-purchase. Consumer Solutions continues to be on track with regard to the rollout and initial performance of our DDA proposition.

The number of DDA debit active cards increased to more than 470,000 in the quarter, and we are expanding the availability of our DDA proposition to additional distribution channels, partners and end customers. The effective date of the new CFPB rules on prepaid is now just 6 months away, and our preparations for implementation are on schedule. Paul will be providing some additional commentary on our financial expectations regarding the implementation of these new rules in his remarks.

The third quarter was another very positive quarter for our Consumer Solutions segment. Our product expansion and diversification strategy is taking shape, which allows us to increase our revenue and margin expectations for this segment for the year. Excellent results, solid execution, engaged team members and a robust pipeline provide us with confidence and momentum moving into the fourth quarter and 2019.

Now I will turn it over to Paul to provide more detailed financial information for the quarter. Paul?

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Paul Michael Todd, Total System Services, Inc. - Senior EVP & CFO [4]

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Thank you, Troy. And we are again pleased with our results for the third quarter and to be in a position to once again raise our 2018 outlook. I will now cover our consolidated and segment performance starting on Slide 6.

Third quarter GAAP total revenues were $1.02 billion, down 18.6% due to the adoption of ASC 606. And non-GAAP net revenue was $964.6 million, up 13.1% from 3Q last year. We have highlighted the impact of the adoption of ASC 606 on our third quarter results on Page 16 of our press release.

Year-to-date total revenues were down 17.6% related to the adoption of ASC 606, while year-to-date net revenue of $2.86 billion was up 12.9%. GAAP diluted EPS was $0.85 for the quarter, up 28% over 3Q of 2017. And non-GAAP quarterly adjusted diluted EPS was $1.16, up 32% from 3Q last year. Our third quarter results were positively impacted by some discrete tax items that resulted in an effective tax rate for the quarter of 17.8% or approximately $0.05 of benefit. With these benefits, we now expect our effective tax rate for the year to be in the 18% to 20% range, down slightly from our previous 19% to 21% range.

Year-to-date GAAP diluted EPS was $2.40, an increase of 29.3% from this time last year. And non-GAAP adjusted diluted EPS was $3.40, an increase of 33.2%. Our non-GAAP quarterly adjusted EBITDA increased 12.6% to $348.5 million, and our adjusted EBITDA margin of 36.1% was down approximately 16 basis points from the third quarter of last year.

Through 9 months, adjusted EBITDA is up 13.3% to $1.02 billion, and our year-to-date adjusted EBITDA margin of 35.9% is up 11 basis points from this time last year. We still expect consolidated adjusted EBITDA margin expansion in the 25 to 50 basis points range for the year. Free cash flow was $229.6 million for the quarter, bringing our year-to-date free cash flow to $612.5 million, up 11.3%. We continue to expect our free cash flow for the year to be between $770 million to $800 million.

Due to our strong free cash flow, we were able to accelerate our deleveraging for the quarter by paying down $175 million of debt, which brings our year-to-date debt paydown to $355 million, ahead of our plans. At these levels, we will begin to transition away from solely deleveraging and plan to resume some stock repurchase activity in the fourth quarter.

Now I will cover our segment performance, starting with our Issuer Solutions segment on Slide 8. First, on growth. The Issuer Solutions segment grew net revenue 8.3% on a reported basis and 8.8% on a constant currency basis. We saw good growth in both volume and nonvolume constant currency net revenue for the quarter. We had about 170 basis points of nonrecurring revenue in the quarter due to some Output Services-related work among other things. Total output, managed services net revenue grew at 15.1% for the quarter, up from the 8.9% growth we had in the second quarter and the 7.6% growth we had in the first quarter.

Next, on margin. Quarterly reported adjusted segment operating margin of 35.5% is down 136 basis points from 3Q of last year and down 61 basis points year-to-date.

Finally, on outlook. For net revenue, we continue to expect this segment to grow net revenue in the 5% to 7% constant currency range for the year, although we now expect to be closer to the high end of the range. And on margin, I said on our last call that while our goal was still to slightly expand the margin in this segment this year, it would depend on the pacing of the investments we make in the back half of the year. As we are pacing our investments with more focus on a consolidated margin target, we may have some margin contraction for this segment of up to approximately 50 basis points for the year.

We are pleased to be in a position to have strong current organic growth performance this year as well as the pipeline activity that is allowing us to invest in the future. The investments in the third quarter that ramped up include an increase in the 401(k) match for our team members, additive expenses in the build-out of our new data center and additive expenses related to opening a new Managed Services facility to build out capacity for future growth, similar to the added capacity that we brought online for our Output Services facility over the last year in Columbus, Ohio. These are in addition to some other growth-related expenses we are incurring.

We talked for several quarters now on investing in this segment, and the growth we are experiencing and have in the pipeline are enabling us to make these enhancements to our business while still maintaining a margin focus for the segment and achieving our overall corporate margin targets.

Now onto Slide 9 and our Merchant Solutions segment. First, on growth. Q3 was another solid quarter for our Merchant Solutions segment. Net revenue for the segment grew at 22.9% for the third quarter compared to 3Q of last year, right in the middle of the 22% to 24% annual range we talked about on our last call. The story is similar on a year-to-date basis with segment net revenue growth of 23%. This growth is a combination of strong organic growth in our pre-Cayan business, coupled with continued outstanding performance of Cayan.

On margin, our adjusted segment operating margin was up slightly on a sequential quarter basis but down 51 basis points versus Q3 2017 and down 48 basis points on a year-to-date basis. Excluding the impact of our 2 acquisitions, our year-to-date margins would have slightly expanded.

Finally, on outlook. On revenue, we continue to expect net revenue growth in the 22% to 24% range for the year. And on margin, consistent with my commentary last quarter, we expect annual margin expansion for the segment of up to 50 basis points.

In summary, we delivered strong results in the third quarter in the Merchant Solutions segment, demonstrating consistent execution of our strategic plan and investing for growth in our focus areas.

Now onto the Consumer Solutions segment on Slide 10. First, on growth. The key highlight for this segment is the continued strong year-over-year organic net revenue growth of 8.8% on GDV growth of 11.2%. Continuing the trend from the second quarter, third quarter growth was again strong across all 4 of our distribution channels. We exited the third quarter of 2018 with just under 5 million debit active cards, with over half of them, 50.6%, on direct deposit. Direct deposit by cardholders continues to drive higher usage of our Consumer Solutions products as well as higher lifetime value, and gross dollar volume for the quarter exceeded $8 billion for the third quarter in a row.

Next on margin. Q3 2018 adjusted segment operating margin of 25.3% is down 171 basis points from the 27% in Q3 of last year, reflecting pressure related to our large partner renewal last year, which we have highlighted the past few quarters.

And finally, on outlook. We are increasing our expectation of net revenue growth for this segment to the 7% to 9% range, up 100 basis points from the previous range of 6% to 8%. And we are also increasing our margin expectations for this segment to the 23% to 25% range, up 100 basis points from the previous range of 22% to 24%.

As Troy mentioned in his earlier comments, the effective date of the CFPB rules on prepaid is now just 6 months away. Assuming no changes to the CFPB prepaid rules and before considering mitigating effects from our business expansion and product diversification strategies, we currently expect with the April 1, 2019, effective date that our calendar year 2019 net revenue will be negatively impacted by approximately $60 million to $65 million with an estimated negative impact to adjusted diluted EPS of $0.17 to $0.19.

We remain committed to our ongoing business expansion and product diversification strategies, and we expect these initiatives to mitigate 1/3 to 1/2 of the expected negative financial impacts of the prepaid rules, both from a revenue and adjusted diluted EPS perspective.

The success of our strategies depends on a few key factors, including the rate of adoption of our new products, both by consumers and our distribution partners; and the rate of utilization of the various product features by cardholders as well as overall market and regulatory dynamics. While these factors create some uncertainty, we are committed to our strategies in the Consumer Solutions segment. And we plan to elaborate on specific progress against our plans on future calls. In short, another solid quarter and an increasingly positive outlook for Consumer Solutions.

Now I want to comment on our revised full year consolidated guidance on Slide 13. We are adjusting our total revenues range from the previous $3.94 billion to $4.04 billion to a $3.99 billion to $4.04 billion range and net revenue range from $3.74 billion to $3.84 billion to a $3.79 billion to $3.84 billion range, an 11% to 13% growth rate range, up from the previous range of 10% to 13%.

We are also revising our GAAP EPS range upward from the previous $3.02 to $3.12 to a $3.09 to $3.15 range. We are also increasing our adjusted diluted EPS range from the previous $4.30 to $4.40 to a $4.41 to $4.47 range, representing a year-over-year growth rate range of 31% to 33%, up from the previous range of 28% to 31%.

We expect our effective tax rate to be in the 18% to 20% range and expect our annual consolidated adjusted EBITDA margin to expand in the 25 to 50 basis point range and expect weighted average diluted shares outstanding of approximately 184 million.

Finally, I want to wrap up with 3 callouts from today's call. The first callout is on net revenue growth across our company. While we have talked about strong net revenue growth all year, the third quarter was a high watermark for us in this important metric.

Each of our segments continue to outperform our net revenue growth expectations with our Issuer Solutions segment expected to grow at the high end of our 5% to 7% growth range; Merchant Solutions segment expected to grow in the 22% to 24% range, up from the 20% to 22% range we had expected beginning of the year; and our Consumer Solutions segment now expected to grow in the 7% to 9% range, up from the 6% to 8% range we commented on our last call and up from the 5% to 7% range from the previous quarter expectation. We are pleased to be in this position with all 3 segments expected to grow net revenue well above the expectations we had at the beginning of the year.

The second callout is on margins. While we are pleased with our net revenue growth picture, we are equally pleased with the position it puts us in to invest for the longer term for our company while still allowing us to meet our consolidated annual adjusted EBITDA margin expansion target of 25 to 50 basis points. We have commented for several quarters about our desire to ramp up investments to improve our scale and infrastructure, invest in our people, invest to support our growth pipeline and to invest in the rollout of new products. While our investment in these areas will continue, we will always approach these decisions in a margin-conscious fashion with more continued emphasis on consolidated margin targets as we have different pacing levels in our segments.

And the third callout is related to capital. The third quarter was an important one on the capital front as we accelerated our deleveraging during the quarter. This allows us to pivot from an almost solitary deleveraging focus, and we plan to resume share repurchases. We've also been successful in our debt profile with almost 80% of our debt in a fixed rate structure with the remaining roughly 20% floating. We continue to embrace a flexible capital structure while remaining committed to our investment-grade rating.

In all, another great quarter for TSYS. Through 9 months this year, we have had strong organic net revenue growth coupled with an expanded consolidated adjusted EBITDA margin while making additive investments in our people, technology and infrastructure and product and doing so in a way that still allows for cash flow generation to achieve our deleveraging goals while having a favorable debt position in a rising rate environment. We are in a strong position as we complete the remainder of the year and look to the longer term. We again thank all of our team members who made these results happen and are positioning our company for the future.

And with that, we will open it up to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Ashwin Shirvaikar of Citi.

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Ashwin Vassant Shirvaikar, Citigroup Inc, Research Division - Director and U.S. Computer and Business Services Analyst [2]

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So the first question is on you kind of mentioned in the past obviously the large number of letters of intent and looking for an update on these. Is there any change you perceive maybe in the spending environment or dependency to outsource these from your bank clients? It doesn't sound like it, but I want to check. And also in terms of magnitude, I mean, if you signed them all tomorrow, what might that mean for your issuer growth? Could you be at the upper end of your issuer long-term range?

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M. Troy Woods, Total System Services, Inc. - Chairman, President & CEO [3]

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Thanks, Ashwin. I'll address the first part of it, and Paul may want to address the second part. Well, I think it was pretty obvious during this quarter, announcing a couple of new wins. Some of these are the result of the LOIs that we've been talking about now since going all the way back to our Investor Day in New York. I will also add that we still have many LOIs as I indicated. I did not give a number. But in addition to the announcements we made today, we still have many LOIs in the pipeline that will continue to add new business to TSYS and the issuing segment over the next 24 months. As to magnitude, obviously, we're not going to size, but we did give you some sense of the conversions that we performed toward the very end of the third quarter with Bass Pro Shops and Cabela's as far as the number of accounts. Paul, anything you want to add to that on the sizing or magnitude or...

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Paul Michael Todd, Total System Services, Inc. - Senior EVP & CFO [4]

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No. And as it relates to kind of the outyears, as far as the high end of that range, the only thing I would say, Ashwin, is obviously on each year, we'll comment on what the factors are in that particular year. But there wouldn't be anything that we would call out at this stage.

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Ashwin Vassant Shirvaikar, Citigroup Inc, Research Division - Director and U.S. Computer and Business Services Analyst [5]

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Got it. And I just had a clarification question on the consumer business. And thank you for sizing sort of next year's impact, although I kind of feel at this point, most people should have it. But the clarification is absent the CFPB impact, would you expect the consumer business, given sort of the momentum you have in it, to be on par with or perhaps a little bit faster than the pace it's [growing] at?

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Paul Michael Todd, Total System Services, Inc. - Senior EVP & CFO [6]

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Ashwin, it's obviously -- as we talk about '19, we'll cover that in our guidance call when we talk about '19 guidance. I would say that it would be, as we're sitting here today, to kind of look at next year and kind of model it based on what kind of happened this year from a growth standpoint is the right way of thinking about that. And as it relates to this impact, just to make sure we're clear on that, if you were looking at modeling next year, we kind of took these ranges, kind of the net impact, if you're trying to kind of pick a certain number, it would be about taking the growth rate of this year, applying it for next year and then backing out about $35 million roughly of net revenue and about $25 million or so of operating income and on an EPS basis, somewhere between $0.09 and $0.12 on an EPS basis. So just from a sizing impact of the headwind of CFPB, that would be the right way to kind of be thinking about it.

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Operator [7]

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Our next question comes from Dan Dolev of Nomura.

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Dan Dolev, Nomura Securities Co. Ltd., Research Division - Executive Director of Business Services [8]

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I have a question on the Merchant Solutions segment. You mentioned the growth in the ISO business. And can you maybe parse out sort of how much of the growth that you're seeing of that double-digit organic growth is coming from those ISOs that you're signing up?

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Paul Michael Todd, Total System Services, Inc. - Senior EVP & CFO [9]

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Dan, we wouldn't break that out. We don't go down to kind of the customer level or even that kind of break down on the overall growth. I think Troy commented earlier about the great work -- growth we're seeing on the integrated side. But outside of that, we don't give that specific of growth numbers.

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Dan Dolev, Nomura Securities Co. Ltd., Research Division - Executive Director of Business Services [10]

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Got it. And shifting gears to something else, the CapEx spend. What we've noticed here is that your CapEx spend has been really dramatically higher this year. I think 3Q was up 19% on a very tough CapEx comp. Are we nearing another major conversion? Or what is the explanation for this increase in CapEx?

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Paul Michael Todd, Total System Services, Inc. - Senior EVP & CFO [11]

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Yes, Dan. I think there would be a couple of things there. We are spending more. I mean, I talked about, obviously, the [spend] related to building out our infrastructure, and so that has several components to it. Typically, when we have a pipeline, if you go back into our 2015 time frame and look at kind of the CapEx sizing there, even in '14 and '15, that gives you a barometer relative to the size of the company of what we were spending on CapEx back then. And you look at it now, and we're not at those levels. And so we are going to spend more from last year. Last year was a growth from 2016. But there isn't anything unique beyond that, that I would call out.

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Operator [12]

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Our next question comes from Darrin Peller of Wolfe Research.

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Darrin David Peller, Wolfe Research, LLC - MD & Senior Analyst [13]

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Look, on the issuer processing side first, I mean, just to follow-up on that. The growth rate, obviously, at the high end of your range. I mean, as you mentioned, you're still adding a ton of new business on the LOI front. So when we think about 2019 or just going forward, your -- what would be the reason why your AOF growth would not be materially higher than, call it, the 6% range we're seeing now? Or is there anything we're missing about sort of onetime items this year or this quarter? Just to be clear. And then likewise, I mean, on the revenue front, you were at a 5% to 7% range now. I mean, if we were to add a number of these new wins, is there anything coming out that would offset that for being materially higher in '19?

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Paul Michael Todd, Total System Services, Inc. - Senior EVP & CFO [14]

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So as it relates to the quarter, I called out in my prepared remarks, we have 170 basis points of sort of kind of more onetime related items that I specifically pointed to. Also, if you look at the output, managed services just as a grouping of revenue and you kind of took that back to the growth that we saw last quarter, I think that gets you to a much more normalized than the normalized 5% to 7% range as you look at that. As you go into future years, as I said earlier, there is always pluses and minuses in any given year. In this quarter, we had some specific Output Services-related activity that doesn't repeat itself and further will be a tough comp as we look at next year comparing back to it. So there is -- some of this new business plays into being additive for next year, although there is timing elements of that. And so when we get to the '19 call, we'll obviously talk about the specifics of the ins and the outs like we do on any year. But there isn't anything else that I would call out at this stage related to that.

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Darrin David Peller, Wolfe Research, LLC - MD & Senior Analyst [15]

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Okay. All right. And just a quick follow-up then on the merchant side. I mean, overall, while still very strong in your range, 22% to 24%, well, it did decel a little bit. It looks like partly related to the revenue per transaction growth being a little lower, although still up 1%. I mean, what's happening in the business there? Is there anything specific that we should keep in mind in terms of the mix of business? Or -- and then did that have an impact on the margins at all? Or was it purely the investments that you're making now?

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Paul Michael Todd, Total System Services, Inc. - Senior EVP & CFO [16]

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Yes, so there wasn't anything on the margin that I would call out there. As it relates to revenue per transaction, that's more of a seasonality thing. As you did call out, we were up 1% growth. I think this time last year, we were at about 0.2% growth. So we had additive growth there, but we had seasonality that kind of played itself. The Merchant segment performed right in line with our expectations, actually slightly better in a few areas than we had expected. So there isn't anything either on the revenue growth side or on the margin side that played through in 4Q. We had good, strong organic growth on the pre-Cayan business, good strong organic growth on the Cayan business. So it's a good story all the way around there.

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Operator [17]

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Our next question comes from George Mihalos of Cowen.

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Georgios Mihalos, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [18]

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Just wanted to start off on the issuer side again. I think if we look over sort of the last 4 quarters comparing account growth to segment revenue growth, the account growth has historically exceeded the constant currency revenue growth. That wasn't the case this quarter. The revenue growth was stronger than the account-on-file growth. And even if I sort of adjust 170 basis points for output, it's still higher. So is there anything to read into that? Anything different this time around maybe on the value-added services side that contributed to the strength?

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M. Troy Woods, Total System Services, Inc. - Chairman, President & CEO [19]

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George, thank you for your comments on the quarter. Maybe 2 things to call out and maybe take them in reverse order. Yes, value-added certainly was a contributor to the quarter with a strong, I think, 13% growth. It's one of the highest contributions that we've had in value added at 20.2%, so it continues to be a major contributor. I think the biggest thing to call out on the account growth that you mentioned, we had a significant number of accounts that were purged during the quarter on a net basis. It brings that number down. By way of example, that was about double the number of accounts that we had purged in the third quarter of 2017 and about 40% more than we had purged in the last quarter, 2Q '18. So once I think you put those 2 in there, you kind of get back to the normal numbers.

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Georgios Mihalos, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [20]

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Okay, that's helpful. And just quick follow-up. Looking at the strength in the equity and earnings line, anything to call out there with the CUP Data relationship or kind of what drove that strength in the quarter?

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Paul Michael Todd, Total System Services, Inc. - Senior EVP & CFO [21]

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Yes, George. On the CUP and equity and income side, we did have a pickup there. When I talked about this over the last couple of quarters, we had said we expect this to kind of be a more normalized double-digit growth. And if you look at what we had for the quarter on a year-to-date basis now, I think we're up about 14%. And so that's getting us more in line. We've got some timing things in there. We have some private equity kind of pickups there as well. But CUP continues to do well, growing at a good strong double digit and is now glide-pathing to where we expected it to be for the year.

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Operator [22]

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Our next question comes from Brett Huff of Stephens.

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Blake Anderson, Stephens Inc., Research Division - Research Associate [23]

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This is Blake on for Brett. Can you talk about the issuer margins in the fourth quarter? You lowered that guidance a little bit for the year. Can you -- are these more incremental investments, or I think it's more of the pull forward? And if it is the pull forward, do you think we could see a return on that investment sooner in next year than we previously expected?

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Paul Michael Todd, Total System Services, Inc. - Senior EVP & CFO [24]

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Blake, as it relates to the investments, I called out several of them in the prepared remarks kind of on the additive side. We did begin to ramp up those, and we commented on our last quarter call. But we had more ramping in the third quarter, particularly around the data center, the opening of our Managed Services or building out of our Managed Services new center. Also, the 401(k) match I mentioned, and then we had some other investments there. So those are the buckets. And like I said, those kind of started last quarter, but they're now on more of a ramping up basis. As far as the timing of those, we don't really necessarily kind of plot out the exact kind of timing of what those are. But it's like I said earlier, we're doing this in a very margin-conscious fashion. We're doing it in a very intentional sort of way. And we're thrilled to be in a position to both have the organic growth in the current period as well as the pipeline to give us the confidence to make these investments for the long term.

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Blake Anderson, Stephens Inc., Research Division - Research Associate [25]

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Great. And then my follow-up is on -- just on the credit issuing cycle. How would you characterize the demand you're hearing from banks versus recent quarters? Any update there?

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M. Troy Woods, Total System Services, Inc. - Chairman, President & CEO [26]

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Well, part of what I said a minute ago Blake covers that, we have seen just a little bit of slowdown in the newer accounts when you take into consideration we had like 7 quarters of 10 million net accounts. I wouldn't necessarily look at this quarter again as I've said as some significant dropoff when you think about the pretty significant purge of inactive accounts we had during the third quarter. In our -- what we call our quarterly business review meetings with our top customers, we're not really seeing anything of any significance that would cause us to think it's going to be a slowdown. Delinquencies are still running extremely good. We haven't seen a -- we've seen maybe a plateau of direct mailings but certainly not a decline. So all in all, our customers still feel pretty bullish about the card business.

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Operator [27]

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Our next question comes from Steven Kwok of KBW.

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Wai Ming Kwok, Keefe, Bruyette, & Woods, Inc., Research Division - VP [28]

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Just a quick follow-up around the Regions win. Just wondering, is there a way you could help us quantify what the number of accounts on file that will be coming on and timing around when that transition would be?

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M. Troy Woods, Total System Services, Inc. - Chairman, President & CEO [29]

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Well, 2 parts to that, I guess, Steven. One, on the number accounts, no, we're not going to size that. I think you can probably go out to other publications and get some sense of the size of Regions Bank renewal. Really, the same answer for the commercial card portfolio. It is a competitive takeaway. We're very proud to be able to expand that relationship with Regions and bring in their commercial card business. But again, it's not something we're going to size.

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Wai Ming Kwok, Keefe, Bruyette, & Woods, Inc., Research Division - VP [30]

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Got it. And then just following on the Merchant Services segment. The ISO channel, you guys seem to be winning business there. Can you help us think through like what's driving that? We've seen other peers where it seems like they're deemphasizing it. Is that what's happening, where you're taking share away? And then around the margins, just when we look at year-to-date, the margin seems to be down roughly about like 50 basis points. But you guys are guiding to potentially up 50 basis points. How should we think about fourth quarter for the margin? Is there a material step-up to get to there?

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M. Troy Woods, Total System Services, Inc. - Chairman, President & CEO [31]

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Thank you, Steven. I'll take the first part, and Paul will address the second part. As I indicated in my prepared remarks, we're very pleased with the ability to grow our quarter and ISO business. I think I mentioned in the prepared remarks that we've signed up over 50 to 60, I think it was 58 actually year-to-date on the ISO side. I think there are a couple of reasons. I think, as I also indicated in the prepared remarks, that with the TSYS brand and now that we have the TransFirst business and the Cayan business, we're proving in the market that we're beginning to be that partner of choice, the trusted adviser, if you will, to the ISO business. We also have an array of new product offerings, gateway and payment facilitator model that we're bringing to the market. I think our sales support really does a good job of helping our ISOs grow their own business. And as we've had for a long time, we have a good reputation for good customer service delivery. So I think all of those things are helping us in the marketplace to win and sign up new ISOs.

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Paul Michael Todd, Total System Services, Inc. - Senior EVP & CFO [32]

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And just to add on to that on the margin side. I think, Steven, if you look at where we've been over the last 2 quarters from a margin standpoint and you kind of push that same general range out to the fourth quarter, it is going to be a pretty sizable lift on a year-over-year basis that puts us into that range of up to 50 basis points of expansion on a full year basis. I would also remind that our margin is growing on an organic basis. But we have that acquisition impacts of the 2 acquisitions that's pulling this margin down to a negative position on a year-to-date basis. So that would be a way to think about the margin.

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Operator [33]

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Our next question comes from Jim Schneider of Goldman Sachs.

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James Edward Schneider, Goldman Sachs Group Inc., Research Division - VP [34]

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Maybe first on the Issuer Solutions business. Troy, can you maybe kind of clarify for us with respect to the top 20 issuers you talked about at the Analyst Day, have all those been announced at this point? Or are there still more to be announced in terms of the pipeline you mentioned before? And then is the expectation -- with respect to Capital One, you talked about some conversions they are doing. Would you also expect that any future business that Capital One might win would also be subsequently converted to you?

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M. Troy Woods, Total System Services, Inc. - Chairman, President & CEO [35]

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Jim, thank you. Well, on the top 20 that we mentioned, going all the way back to Investor Day in New York, it's really a mixed bag. We have not announced all of those, so still some to come. And as it relates to Cap One, I really can't add anything beyond what I shared with you during our prepared remarks, that Cap One has committed to bring to TSYS in 2019, 2 additional retail and co-brand portfolios that will convert to TSYS in '19.

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James Edward Schneider, Goldman Sachs Group Inc., Research Division - VP [36]

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Okay, that's helpful. And then maybe one for you, Paul. On the margin front, with respect to investments, you've been calling that out for some time now. Do you feel you're now kind of at the full run rate of investment in OpEx? And when would you expect to kind of get back to, like on a run rate basis, year-over-year margin expansion? Is it sometime in the first half of '19 at this point? Or are there headwinds from CFPB that will be mitigating that?

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Paul Michael Todd, Total System Services, Inc. - Senior EVP & CFO [37]

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Well, we are going to continue to make investments. As this new business comes on, some of the characteristics of that will change. As it relates to the margin expansion, we said at Investor Day that it's our goal on our longer-term basis to have 25 to 75 basis points of consolidated margin expansion in a multiyear kind of period. Obviously, for '19, the CFPB does play into the margin in a significant way because of the headwind that I outlined, but I quantified that. And if you kind of look at that and pulled that to the side, then obviously, we would be targeting margin expansion kind of with the exception of that CFPB impact.

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Operator [38]

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Our next question comes from Glenn Greene of Oppenheimer.

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Glenn Edward Greene, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [39]

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I guess drilling down on merchant a little bit. Could you just sort of give us a little bit of color and update on how TransFirst performed in the quarter, and similarly, Cayan on a stand-alone basis, just sort of degrees of growth.

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Paul Michael Todd, Total System Services, Inc. - Senior EVP & CFO [40]

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So Glenn, we don't -- TransFirst, obviously, there is no TransFirst breakout anymore. You know that business, our Merchant Solutions segment, is all integrated from that acquisition. So there isn't a -- you would just look at the total to kind of get the kind of view there. As it relates to Cayan, as I said, we had good double-digit growth in Cayan. It actually was improving from what we saw in the second quarter. And so kind of as I said before, good growth in the pre-Cayan and also Cayan had good growth as well.

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Glenn Edward Greene, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [41]

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Is there a way maybe to bucket in aggregate your integrated business, how that grew? And what percentage of merchant integrated now is?

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Paul Michael Todd, Total System Services, Inc. - Senior EVP & CFO [42]

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Yes. So our integrated business is about 36% roughly of the direct business. So that's kind of the integrated. As far as the percentage growth of that, we've -- it's been in that strong double-digit characterization and that hasn't changed, that didn't change in the third quarter as well.

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Operator [43]

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Our next question comes from Jamie Friedman of Susquehanna.

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James Eric Friedman, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [44]

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I guess I'll ask the 2 together. Troy, in terms of your comments about value-added services, when you talk in terms of pipeline on issuer, is that all account on file? Or is there a pipeline for value-added services? So that's one thing. And then just a housekeeping question. In terms of taxes, Paul, you alluded to some of this, but how should we be -- the tax rate came in lower than we had thought. Maybe it's our fault. But how should we be thinking about taxes going forward? So one on value added, the other on tax.

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M. Troy Woods, Total System Services, Inc. - Chairman, President & CEO [45]

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Yes, Jamie, I'll take the first part. As I think Paul and I both have indicated, when you think about our pipeline, it's both new business. It's takeaway wins in the marketplace. It's launches. It's bringing up people de novo in the business. And clearly, it's product. We talked on several quarters about bringing on some of our artificial intelligence foresight business, data and analytics. We talked about our digital and communications platforms and all the customers that are coming on board. They are in addition to like our new customer service platform. So it's really across the board. I will say, though, when we have talked about LOIs, we're not talking about an LOI for a product. And so those LOIs are for new pieces of business coming to TSYS, be it consumer, commercial, retail, et cetera. Paul, do you want to talk about the tax?

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Paul Michael Todd, Total System Services, Inc. - Senior EVP & CFO [46]

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Yes. So on taxes, 2 things. And obviously, as I called out, we did have the discrete items that pushed us lower for the quarter. I talked about our range for the year being at 18% to 20%. And obviously, if you look at us from a year-to-date basis, the fourth quarter is going to be higher than that to kind of get to that midpoint of that range. So you do have to kind of model a higher tax rate in the fourth quarter to get to the middle of that 18% to 20% range. As it relates to taxes on a longer-term basis, that 21% to 23% range that we talked about at the beginning of the year is the right way to be thinking about the tax rate from a longer-term basis.

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Operator [47]

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Our next question comes from Bryan Keane of Deutsche Bank.

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Bryan Connell Keane, Deutsche Bank AG, Research Division - Research Analyst [48]

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Just a couple of clarifications. I guess, the first on issuer accounts on file, it decelerated a bit to 5.8%. Just curious if anything caused that slowdown. Maybe I was thinking you guys anniversaried some client wins.

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Paul Michael Todd, Total System Services, Inc. - Senior EVP & CFO [49]

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Well, no. I mean, as Troy commented -- and you may want to add something, Troy. We talked purges was the kind of the single biggest thing to kind of play through that with some purge activity. So that's why it didn't have any kind of revenue impact of any significance. So Troy, I mean, you talked about it a little bit earlier.

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M. Troy Woods, Total System Services, Inc. - Chairman, President & CEO [50]

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No. Nothing...

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Paul Michael Todd, Total System Services, Inc. - Senior EVP & CFO [51]

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That's the biggest thing we...

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M. Troy Woods, Total System Services, Inc. - Chairman, President & CEO [52]

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Nothing to add. We do report those -- that growth each quarter, Bryan, on a net basis. So as I indicated, we had a significant number of traditional accounts on file that were purged in the third quarter, inactive accounts, double the number that were purged in 3Q '17. So net-net, you get that kind of number.

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Bryan Connell Keane, Deutsche Bank AG, Research Division - Research Analyst [53]

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Yes. I guess it was just unusual that -- why it happened in the third quarter versus other quarters. But I guess it's just timing. And then...

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M. Troy Woods, Total System Services, Inc. - Chairman, President & CEO [54]

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Well -- go ahead.

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Bryan Connell Keane, Deutsche Bank AG, Research Division - Research Analyst [55]

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No, go ahead. You go ahead.

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M. Troy Woods, Total System Services, Inc. - Chairman, President & CEO [56]

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I was just going to say, if you look over a period of years, some of our customers purge quarterly. Some of our customers purge when they get good and ready. Just some of them run purges to clean up files. There's no rhyme or reason sometimes. So it will spike sometimes. Sometimes, it will go 2 to 3 or 4 quarters to be relatively consistent. But I think the main thing to keep in mind and take away, these are inactive accounts. So they're not doing our customer or us a whole lot of good.

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Bryan Connell Keane, Deutsche Bank AG, Research Division - Research Analyst [57]

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Okay. And then I just wanted to ask Paul just on the investments in issuer. I know we've asked this before, but just curious if there's a way to quantify how much of these is onetime versus some of these investments will be in the permanent run rate going forward.

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Paul Michael Todd, Total System Services, Inc. - Senior EVP & CFO [58]

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Yes. We don't break that out. There are components to both, and so some of the expenses kind of related to some of the conversion activity, has more of an in-and-out flavor to it, and some of the ones that are more infrastructure buildout kind of has more of a permanent nature to it. So we don't parse that out.

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Operator [59]

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Our next question comes from John Davis of Raymond James.

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John Kimbrough Davis, Raymond James & Associates, Inc., Research Division - Research Analyst [60]

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Just want to touch on the Output Services. Paul, I think you called out the 170 basis points. Does that have anything to do around production of tap-and-go cards? And if not, do you see any demand on the horizon from the banks starting to reprint cards as Visa -- some of the issuers push the NFC-enabled credit cards?

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Paul Michael Todd, Total System Services, Inc. - Senior EVP & CFO [61]

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John, I'll take the first part of that, and maybe Troy can answer as it relates to the kind of more the demand equation there. Look, I want to be clear. The 170 basis points I called out did have an Output Services component to it of some specific kind of nonrecurring work in the Output Services. It had a few other things in there that are nonrecurring around some projects and some other things. And so that bucket is both an Output Services as well as some other kind of more nonrecurring items that make up that 170 basis points. In addition, if you look at output and managed services on a combined basis, that was where I was calling out the additive growth that has both the onetime element as well as some other elements that were outsized growth relative to our normal growth rate and particularly on the Managed Services side of the additive growth that we got there. So just to be clear, the 170 basis points kind of stands on one vector, and the output, managed services comparison on a percentage growth relative to what we've seen in the past 2 quarters is kind of on another vector. And Troy, you may want to comment on the demand side of the...

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M. Troy Woods, Total System Services, Inc. - Chairman, President & CEO [62]

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Yes, I'll be glad to. From time to time, John, we do see some of our customers go through a rebranding exercise that might spike up some issuance. We did have one of our international customers go through a relatively good-sized reissue around some rebranding. Most of the EMV work for all practical purposes has been done, so we don't really see that kind of uplift like we were in the last couple of years. And so really, nothing beyond that to call out at all on demand of Output Services.

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John Kimbrough Davis, Raymond James & Associates, Inc., Research Division - Research Analyst [63]

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Okay, helpful. And then just quickly, Paul, on the organic growth in merchant. I guess, double digit was a little bit higher than I was getting to. Anything in Cayan to call out from a seasonality? Or is there an ASC 606 impact that's bigger this quarter than it has been in past quarters? Anything there worth calling out?

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Paul Michael Todd, Total System Services, Inc. - Senior EVP & CFO [64]

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So a couple of things. On Cayan particularly, we've been growing in the double-digit range all 3 quarters there. And so the pickup I commented on there was just relative to 2Q that we saw some growth acceleration if you looked at it on a year-over-year like-for-like basis. We did see some growth acceleration on a sequential quarter basis between 3Q and 2Q. If you look at our overall net revenue growth, the organic growth of that, that's just commensurate with kind of the growth we saw last quarter. We did have a tad bit little more ASC 606 kind of headwind impact, but there isn't anything I would call out significant there. So the growth picture really across the board is very similar in 3Q than what we saw in 2Q, and for that matter, even in the first quarter.

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Operator [65]

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Our next question comes from Tom McCrohan of Mizuho.

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Thomas Craig McCrohan, Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Analyst [66]

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Just a quick clarification. The margins on the output-related services relative to kind of reported margins, are they typically higher or lower than the reported margins for issuer?

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Paul Michael Todd, Total System Services, Inc. - Senior EVP & CFO [67]

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Yes. So they are. Both in Managed Services and in Output Services, the margin of those 2 businesses is lower. And so there is some kind of margin headwind related to the outsized growth that we saw there.

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Operator [68]

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This concludes our question-and-answer session. I would like to turn the conference back over to Shawn Roberts for any closing remarks.

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Shawn Roberts, Total System Services, Inc. - VP of IR [69]

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Thank you, Andrea. Not really any closing remarks. Just want to thank everybody for your interest in our company and tell you that we're here if you need anything and give me call.

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Operator [70]

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The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.