Fidelity National Information Services Inc (FIS) 2002 Q3 法說會逐字稿

Please stand by. Your meeting is about to begin. And please be advised that this conference is being recorded.

Good morning, and welcome to the InterCept third quarter earnings conference call on November 4th, 2002.

I’ll now turn the conference over to Carol Collins. Miss Collins, please go ahead.

Thank you, Joanna. Good morning, and welcome.

The purpose of this call is to review the company’s financial and operating results for the third quarter of 2002 and to discuss future guidance. During the course of this call we will attempt to update you on our expectations for the remainder of 2002 and 2003, and will make several forward-looking statements. Anything we say concerning InterCept’s projections, expectations, and beliefs for our future operations, growth, prospects, strategies, business, or financial condition is a forward-looking statement. These forward-looking statements are not guarantees of future performance, and are subject to risks and uncertainties, many of which are outside of InterCept’s control that may cause actual results to differ materially from those expressed or implied by the forward-looking statements.

These risks and uncertainties include whether we can continue to sustain our current internal growth rate or our total growth rate, successfully close and integrate recent acquisitions, and assets, and businesses, and other operations we may acquire. Continue to provide enhanced and new products and services that appeal to our financial institution and merchant customers, continue to have access to the debt and equity capital we need to sustain our growth, and achieve our sales objectives.

Other risks include the possibility that we may be unable to repay our loan, the possibility that credit card companies may fine us for excessive credit card charge-backs, or other issues arising out of our merchant services operation. And the stock price volatility associated with small cap companies.

These and various other factors are discussed in detail in the section in our most recent formal report on Form 10-Q entitled ‘management discussion and analysis of financial conditions, and results of operations, disclosure regarding forward-looking statements.’

Now that we have that out of the way, I’ll turn the call over to John Collins.

Thank you, Carol.

Appreciate you all joining us this morning for the call. We’re proud to announce the earnings and the numbers, and we believe we had an exceptional quarter. We recorded record revenues of $66 million. Scott will discuss all the financials shortly, and we will try to keep our comments to a minimum, as usual. We also recorded profits of 29 cents a share excluding certain one-time items.

We also believe and we’ve stated in our press release, that we remain in a challenging market environment, specifically as it relates to the one-time software and hardware. Although we still feel very confident about our business, and our business is going very well for us.

I’m sorry to interrupt. But I’ve been told that this conference call is not going to the right company. Apparently the InterCept conference call that is being accessed on the Internet is not the one that’s being listened to, and I’m not certain who is getting ours. So, Joanna, if you’re still on, can you please come back on the line?

I am here, sir.

Okay, Joanna, from what I’ve understood, and I just walked into the other room, and people who are accessing the InterCept conference call, they’re getting a different company’s message, via web cast.

I guess it’s possible they may have the wrong telephone number.

Okay, so as far as the information here, we’re sending it out to the correct people via the telephone number. The issue would be the web cast, is that correct?

That’s right.

Okay, then let’s continue.

You’re confident of that?

Yes.

Okay.

Okay.

We’ll go fix the web cast part.

Okay, thank you.

Sorry for the interruption. The only comment that I really want to make, and then I’m going to turn it over to Lynn Boggs, is I really just wanted to talk about our management enhancements, really rather than changes. As we had announced earlier in the third quarter, Boone Knox, who has served on our Board since the inception of our company as a public company, has always been very helpful and beneficial, and we believe that his new position as Vice Chairman will continue to help us in our endeavor.

Also, in the quarter we made Lynn Boggs the COO. He was already, as you know, he was already the President of the company, and has just taken on the additional responsibilities of the COO, and is doing an excellent job as it relates to that.

And I’ll now turn it over to Lynn for a few operational comments and updates prior to Scott’s update on the financials.

Thanks, John. Good morning.

I would like to take a few minutes today before Scott gets into the financial information to go over some of the operational highlights since our last conference call. As we have announced earlier this quarter we have signed a letter of intent with Sovereign Bank to provide item processing and check imaging for their 530 branches located throughout the Northeast. This agreement, which will partner us with a 40 billion financial institution, is a great opportunity for us to continue our focus on check imaging versus traditional item processing.

Further, we announced on September 12 that we have opened a fully image enabled item processing center located in Los Angeles, California. We believe this new center, along with our center opened in Seattle, continues to show our commitment to a nationwide network of data and image processing centers to serve financial institutions throughout the United States.

We now have 38 locations throughout the U.S. with all 28 of our item centers fully image enabled. As part of our Sovereign implementation plan we will be opening four additional item centers, and expanding two centers during the early part of 2003. During the third quarter we also launched our NetImage product, an internet enabled image retrieval service. This product will help financial institutions and their customers to review front and back images of cleared checks, when and where it is most convenient for them. During the first 60 days of this new offering we have had over 60 financial institutions sign-up for the NetImage. This product utilizes our existing infrastructure, and will enhance our item processing offering.

Our continued focus on merchant processing during the last 120 days resulted in several significant achievements. These included our agreement to manage merchant processing for First Source Bank, a $3 billion financial institution with a portfolio in excess of $100 million. We were also pleased to sign a contract to provide services for private label credit card of John Deere Credit. This service will provide data capture, transmission, and switching for authorization and settlement for John Deere Credit’s 6,000 merchant locations.

We continue to see mainstream acceptance of our internet merchant processing with the signing of NHL Dot Com, Time Dot Com, The Houston Chronicle, The Washington Post, among others.

I will now turn the call back over to John.

Forgive us for this brief delay. We apparently have had some technical problems on the web cast, and before Scott gets to the financials and we get to the questions we’re trying to clear this up. Really for full and fair disclosure we want to make sure that it’s available on a web cast at the same time that it occurs live. So, Joanna.

Yes.

We’re going to pause for just a second to see if we can clear this technical issue up. And I apologize for those of you on the line, but if you’ll bear with us for a minute we will try to get this fixed before Scott goes on. So just bear with us for a minute or two.

This is John Collins. I’m just trying to give you an update. If we don’t have this fixed in another couple of minutes then we’ll make some determination at that point. But again, bear with us for just a few minutes. And we’ll expedite once we get this problem fixed.

Okay, just another update here. The web cast company that does these web casts for us has now corrected their problem, and we at least have some test people that have gotten on and are getting our call currently. And the one thing that we’re trying to resolve at this point is do they have to get offline and get back on, reconnect to get that connection live. And we’re getting that answer from the web cast company. So continue to bear with us for, I hope, not more than 60 more seconds, and we’ll get back on-track.

Joanna?

Yes.

I assume that I am still on this call, and everybody on the call just got that message?

Yes. You are live.

Okay. Thank you.

You’re welcome.

Okay. Again, I apologize. I think we’re back online, and I understand that now the web cast is being done. And obviously we were concerned about, again, a full and fair disclosure, to make sure that everybody got to hear this at the same time.

I’m going to have to apologize again for another inconvenience. Because of the – because the people that run the web cast were hearing someone else’s call, that means that they did not get the information that Lynn had given as it related to the operational update. My information was very brief, but I’ll just repeat that very quickly. And that was that we had a record quarter of $66 million with 29 cents per share reported in profit excluding certain one-time items. And then I had talked about the announcement of Boone Knox as a Vice Chairman, and how that enhanced our overall management, and then Lynn Boggs as COO.

And again, I’m sorry to repeat all those things, but I think it’s necessary. And it’s necessary that Lynn go back through his statement, to make sure that everybody has an equal opportunity to hear that statement. Lynn.

John, thanks again. Good morning, again.

I would like to take a few minutes today, before Scott gets into the financial information, to go over some of the operational highlights since our last conference call.

As we have announced earlier this quarter we have signed a letter of intent with Sovereign Bank to provide item processing and check imaging for their 530 branches located throughout the Northeast. This agreement, which will partner us with a $40 billion financial institution, is a great opportunity for us to continue our focus on check imaging versus traditional item processing.

Further, we announced on September 12th, that we have opened a fully image enabled item processing center located in Los Angeles, California. We believe this new center, along with our center opened in Seattle, continues to show our commitment to a nationwide network of data and item processing centers to serve financial institutions throughout the United States. We now have 38 locations throughout the U.S., with all 28 of our item centers fully image enabled. As part of our Sovereign implementation plan we will be opening four additional item centers, and expanding two centers during the early part of 2003.

During the third quarter we also launched our NetImage product, an internet enabled image retrieval service. This product will allow financial institutions and their customers to read front and back images of cleared checks, when and where it is most convenient for them. During the first 60 days of this new offering we have had over 60 financial institutions sign-up for NetImage. This product utilizes our existing infrastructure, and will enhance our item processing offering.

Our continued focus on merchant processing during the last 120 days resulted in several significant achievements. These included our agreement to manage merchant processing for First Source Bank, a $30 billion financial institution with a portfolio in excess of $100 million. We were also pleased to sign a contract to provide services for private label credit card of John Deere Credit. This service will provide data capture, transmission, and switching for authorization and settlement for John Deere Credit’s 6,000 merchant locations.

We continue to see mainstream acceptance of our internet merchant processing with the signing of NHL Dot Com, Time Dot Com, The Houston Chronicle, and The Washington Post, among others.

I will now turn the call back over to Scott.

Thanks, Lynn. I’m happy to report the results for the three months ended September 30, 2002. Excluding the customer reimbursements line item revenue grew to 61.9 million from 34.8 million in the comparable prior year quarter, a growth of 77 percent. Revenue from the financial institutions segment grew to 42.2 million in the third quarter from 34.1 million in the third quarter of 2001, which was a growth of approximately 23.7 percent. Revenue in the merchant processing segment grew to 19.8 million from 750,000 in the third quarter of 2001. This growth was largely attributable to the acquisitions of iBill and EPX that closed during the second quarter, for which we received full benefit during the third quarter of 2002, and strong merchant growth since the date of acquisition.

Net income available to common shareholders, excluding the amounts related to Netzee and the reserve related to non-payment of amounts related to WorldCom increased to 5.7 million or 29 cents per share, from 4.0 million or 24 cents per share in the second quarter, or in the third quarter 2001.

WorldCom reserve is related to our Web 900 service offering in our merchant pricing segment. We offer our merchants’ customers the ability to make charges through their phone bills rather than credit cards, ultimately utilizing WorldCom as the service provider. The monies were collected from the merchants customers but were not remitted to InterCept. We have reserved against the amounts not remitted to us, but are actively engaged in trying to recover these amounts.

In regard to revenues, the increase was fueled by internal growth of approximately eight percent on a consolidated basis. As you may recall, we experienced unusually strong growth on an internal basis in the third quarter of 2001 of approximately 29 percent from significant one-time hardware and one-time software sales in the data processing and check imaging area.

Areas of our company that performed strongly during the third quarter of 2002 included ATM and debt, communications, and merchant processing. Areas of weakness included one-time software and hardware sales, specifically in the core processing, check imaging, and other related ancillaries, mostly on a one-time basis. Another important measure that we often communicate as recurring revenues during this quarter recurring revenues were approximately 92 percent.

Gross margins totaled approximately 56.4 percent in the third quarter of 2002, as compared to 57.3 for the third quarter of 2001. The decrease was primarily due to incremental revenue from printing and rendering business acquired in October 2001 that carries a lower margin, as well as the lengthening of the sales cycle and one-time software that carries a higher gross margin than the company average.

SG&A as a percentage of sales totaled approximately 34.2, which was a slight decrease from the 35 percent recorded in the third quarter, the second quarter of 2002, but an increase of over the 30.4 percent recorded in the third quarter of 2001. The increase over 2000 was primarily due to continued build-out of infrastructure to handle our additional growth.

Net income for the quarter, excluding the 1.6 million charge, net of taxes, related to WorldCom, and the losses related to Netzee totaled 5.7 million, or 29 cents per common share, as compared to 24 cents per common share. Income tax provision was 37.0 percent for the third quarter of 2002 and was in line with expectations. EBITDA excluding the charge totaled 13.7 million for the three months ended as compared to nine million for the prior quarter of 2001.

Lynn had mentioned a little bit about Sovereign. I wanted to expand somewhat on a financial note. We expect revenue to be in excess of 20 million per year, and to grow double digits from price and volume increases over the life of the contract. As part of this agreement, as we’ve previously disclosed, InterCept agreed to grant approximately 375,000 shares of its common stock that will be included in outstanding shares in the fourth quarter. We expect to begin incurring costs in the fourth quarter of 2002 that will accelerate until the conversion of phase one of the contract, and which we anticipate will be June of 2003, and will cease upon the conversion of phase two of the contract, which is expected to finish in November of 2003. We expect the total financial impact from the contract to be neutral during 2003 on a net income basis, with significant profitability expected by fourth quarter when the conversion is completed. We’ve been asked by a number of people relative to the returns we expect this contract to generate. We expect returns on capital in excess of 11 percent over the life of the contract, which includes the value of the shares granted to Sovereign.

As we stated in the press release earlier today, we continue to see strong demand for our outsourced suite of services. Specifically, core processing, check imaging, and ATM debit services. In fact, over the last 120 days we have signed 22 new customers to our core processing solution. However, we have seen a difficult environment related to our sales in the area of one-time software products. Specifically, the core processing, check imagings, and other ancillaries. Due to these factors, and the shares granted, and the costs which we will begin to incur to convert Sovereign, we expect earnings per share to be in a range of $1.11 to $1.15 for financial year 2002, and $1.28 to $1.32 per share in fiscal year 2003.

Excluding the charges we talked about, WorldCom and Netzee, we generated positive EBITDA of 13.7 million in the third quarter, and 34 million for the nine months ended, and have generated cash flow from operations of 27.1 million through the first nine months of this year.

Lastly, on an administrative note, we have talked about the intent to go ahead and do a syndicated facility. We’re working on finalization of our credit facility. We continue to believe that 90 to 130 million is where we’d like to be, and we believe this will give us significant financial flexibility in the future to do any number of things.

With that being said, I’ll turn the call back over to John Collins.

Thank you, Scott. And I won’t delay. We’re already pretty far behind because of the technical difficulties. So Joanna, let’s start with the questions.

Thank you. We will now begin the question-and-answer session. (Caller Instructions.)

Our first question comes from Jeff Baker. Please go ahead.

Hey, guys. Scott, just a couple of things. Number one, can you give us the organic growth by category? You gave us, corporate was eight, but what about financial institution and merchant?

I’ll break it down even a little bit further. The service fee caption, it was approximately seven percent. Datacom was 16 percent. The equipment and products was actually a decrease year-over-year of about 30 percent, due to the significant growth that we had in the third quarter of 2001. And the merchant segment was approximately 18 percent.

Okay. And, all right, good, that’s helpful. And then also, you kind of ran-through some revenue numbers for the financial institution and merchant that didn’t sound like they matched-up with the press release. Can you go over those – I’ve got financial institution at 41.5 million.

Yeah, if you go ahead and take-out the customer reimbursements it’d be 41,500,000, correct.

Okay. And then on the merchant?

The merchant, 20,423,000.

Okay, and those include the reimbursements, or exclude?

Exclude.

Okay.

The reimbursements were 4,360,000 on top of that.

Great. And then, can you talk about the capital structure, as far as the debt obligations you have for current liabilities, and the free cash flow? Give us what the free cash flow number for the quarter was? Thanks.

Sure. As far as the total debt outstanding, we have approximately $49.5 million of debt outstanding today. We have a $50 million line plus a $5 million component above and beyond that which is short-term in nature. We would expect to go and refinance both of those components through a syndicated facility. But we have no issue relative to the compliance of any of our debt covenants or terms at this point in time.

As to the second part of your question, I lost my train of thought, what was it?

Free cash.

Free cash flow, cash flow from ops through the first nine months was approximately 27 million. That was 15.7 million through the six months. We generated approximately 11.4 million cash flow from operations during the third quarter of 2002.

And then after capex, what was the capex for the quarter?

$4.1 million.

4.1 million? Okay. And one more question, and I’ll let somebody else ask – can you talk about the gross margin, you know, what’s going on there as far as the financial institution? As well, as merchant looked like it was down sequentially, where you expect that to trend going forward? Thanks.

Sure. I think the merchant business was actually up over 150 basis points, and the bank group was down approximately 150 basis points, give or take 10 or 20. The bank group down primarily due to the one-time software items that we’ve talked about. As we’ve discussed a number of times, the margins on one-time software are significantly in excess of that of the total company. We came-up short pretty significantly on the one-time software items, which was made-up in part by the strong merchant performance. So what you saw was an increase in gross margins on the merchant group, and a decrease in margins on the bank group.

Okay, and if the in-house doesn’t improve, let’s say it remains dismal, do you look for gross margins to continue to go down? Or is this kind of like a base case down here with the bank group?

I think we still had a good amount of one-time sales, irregardless of the difficult environment and making our number. We weren’t really where we need to be. I guess a lot of it is predicated upon what we expect, or what we see in the marketplace. And I think what we’re telling you is that the market has, in our estimation, has not improved significantly. We expect to see continued weakness in the one-time, so I would say that that would continue to pressure margins up to about another 100 basis points.

Okay, great. Thanks.

Just in the bank group, I might add.

Right. Thanks.

Your next question comes from Stephen Laws. Please go ahead.

Good morning. With the NetImage, could you guys talk about that product a little bit more? I think you said you signed 60 this quarter. Is that a new product, or maybe give us some details on that?

Lynn Boggs (?): Stephen, I think it’s – from our perspective, it’s just an enhancement to the product of the image enabled processing that we do today. We rolled it out in early September to our current customers that we have in a service bureau environment. It’s just an enhancement, where they’re able to go in from a financial institution standpoint and obtain those check images to do research. We think it saves the bank some significant time, and the bank also has the ability to pass that along to its commercial and retail customers, so that they can go in and do the same thing the bank is doing, is look at their images as soon as they’re processed through the center at night. So it’s something we’ve just enhanced to what we’re already doing with our check imaging system we have out there today.

And Stephen, from the financial standpoint what this means for us is really is that there are no significant related costs. The infrastructure that we put in place for check imaging and the archives that we keep allow us to offer this at significant margins to us.

John Collins (?): And it’s offered without regard to their internet banking product. So these – they can offer this to their customers whether they have an internet banking product or they do not.

Great. And then I guess if we could maybe touch on the expenses going forward over the next say 12 months, as we get the four new centers functional, as well as you know, upgrading two additional facilities. Do you expect expenses to be, you know, pretty straight line? Are there any significant, any lumpiness through the next 12 months going forward that we need to factor into our estimates going forward?

Scott Meyerhoff (?): Stephen, the conversion, as we understand it today and I couch it just under the fact that the contract is still being negotiated, and the costs are an estimate, and they may change based on the decisioning of the bank, itself. But the way we understand it today is that the first region will convert in June, and the second region will convert in November, and they’re pretty similar in size. We would have to go ahead and incur costs in the first quarter, and most of the second quarter, without any revenue, with revenues starting in June.

And then, we’d have additional costs relative to the second conversion, which would cease upon the conversion of phase two in November of 2003. What we expect is probably incremental costs of under $100,000 here in the fourth quarter, nearly a half a million dollars in both the first quarter and second quarter even offset partially by the revenue, with most of the profit starting as we talked about in the press release, in the fourth quarter of 2003, of once we have no more training and conversion costs and both phases are live.

So we would expect to go-ahead and see that $1.28 to $1.32 number we have, be somewhat back-end loaded upon the conversion of that bank and the cessation of the one-time costs relative to it.

Great. And I guess, you know, one final question. It’s kind of a combination of two. But as far as the other income line can you talk about maybe what your interest rate is? And additionally, I think the advance you guys have to SLM piece, was that due November 30th? Is that w hat the last Q said? Or could you talk about that? I know it’s secured by shares of InterCept stock, but could you talk about the timing of that event?

Sure. I’ll hit on the other income line. Our interest currently today is at LIBOR based, and it’s based on tiers of debt to EBITDA which range anywhere from LIBOR plus 125 to LIBOR plus 200.

As to the SLM piece, the one thing we did, when we acquired the Division, we were, we had the bank line product, the core processing product we acquired, we had all rights and privileges to it under a billion dollars, and over a billion dollars, SLM had the ability to share and some benefit if we had sold banks over a billion on that core processing product. What we did with them was renegotiated the note where they will go-ahead and pay a higher interest rate, get a nine-month extension secured by all of the stock, and will give-up all rights and privileges relative to any of the bank line or core processing products which are currently outstanding. So that gives us full benefit and full ownership with no revenue share at all for any sized customer in the United States. So that was extended until June 30.

Great, thanks a lot.

Thank you.

The next question comes from Art Bender. Go ahead.

Good morning. A couple of questions. First of all, can you tell us if the item processing is growing faster than the core processing within financial institutions? And if so, is that something that’s weighing on your margins?

Well, I think that – Art, this is Scott – the margins, if you take a look at from the standpoint of a year-over-year comparison. When we acquired the [Holmes & Shaw] on October 1st, that had lower gross margins, but almost in line and the operating margins, and you’ll have a true year-over-year comparison. But when you factor in the Sovereign signing, clearly, a contract of that magnitude will make the item processing, check imaging business grow quicker than that of core processing.

But I think that some of the things that Lynn had talked bout, products such as NetImage, and clearing images outside of the Fed for banks in some of our centers, that those type of things will allow us to increase the margin on our existing customers. So I don’t really believe that that is weighing us down at this point in time on the margin side in the bank business. I think most of the margin degradation is coming through from the lack of the one-time software items in the third quarter.

Okay. And you mentioned that the long-term return on capital for Sovereign, for the Sovereign deal would be about 11 percent. Is that a target for the business as a whole? Or you know, is that lower or higher, relative to your target for the business as a whole?

I think we’d like to see double-digit returns on capital. I think that that’s something that both investors and management here at InterCept are very focused on in getting the best return possible on the deployed capital. And I think we would like to go-ahead, albeit the number that we currently are experiencing is lower than that, we would like to go-ahead and have returns on capital on a double-digit basis.

Okay. And then touching again on SLM, you mentioned that you’ve extended that until June 30th. At that time, assuming that your stock price stays where it is right now, will they have earned enough InterCept shares to fully repay that loan? Or are you counting on some other financial contribution for them to repay that? Thanks.

Well, I think that we have any number, or any measures of recoverability. The first being, of course, the shares outstanding which I believe are somewhere in the neighborhood of between 380 and 425,000. I don’t know the exact number, because there’s still some earn-out components to be cleared-out. So I guess, given that, at the current stock price that’s about six to 6.5 million, but there are other avenues of collection from cash flow and recoverability from the company. We’ve done a review of their financial statements, and based on our extension we believe that they have the means to go-ahead and make payments if the stock is not at a level where the stock itself satisfies it.

Great. Thanks very much. Nice quarter.

Thank you, Art.

The next question comes from Nick [Fiskin]. Please go ahead.

Hi, good morning. Can you walk us through the components of that other income, please?

Well, the other income would be primarily be interest expense on the facilities we have outstanding, plus interest income from notes receivable from SLM and Netzee.

And can you give us the details on that?

Well, the Netzee loan is at prime plus two. The SLM loan is, was at prime, is now prime plus two, as well. And the interest expense that we pay would be a combination of depending on debt-to-EBITDA ratios that I talked about. Lastly, we do have some CD secured notes out there. When we entered into these CDs the interest rates were higher than what the current market is, and were in excess of what we had to pay for our debt. And so, we’ve got interest income and interest expense relative to the CD secured notes, as well.

So in that for this quarter, did you guys get any kind of fees for extending the note for SLM?

Yes, sir. $85,000.

And any – oh, how much were the iBill – how much did you pay on their earn-out for this quarter?

Zero.

You paid-out zero on that?

That is correct.

Does that mean you’re not getting the return that you anticipated?

No, sir, not at all. In fact, if you looked at it, we had expected that we would not pay any earn-out in the first quarter or two, and that was really based on where they believe they could be next year. So I don’t think that implies that at all.

Does that mean the total earn-out goes down by eight million then?

Well, they forego the ability to earn it, and so, you know, they had the ability to earn, you know, an infinite amount. But they did not earn any, so they get zero, and it just moves-on. The eight million I think you’re referring to gave us the ability to buy-out the earn-out at any point in time if they were exceeding by a wide margin kind of our put and call feature that we had in the purchase price.

And in your review of the SLM note, or their financials, I’m wondering why they didn’t pay their amount due? And why the extension?

Well, I think that we extended it and received value from the core processing system and what we got out of that. And additionally, I think that they believed that they didn’t have the cash to pay it out, and believed that there was value in the shares that they wanted to get to realize. They were willing to give-up something to go-ahead to remain and have the ability to get the up side out of the note.

And then, lastly, in the internal growth that you gave us of eight percent, is there anything included in there from HSI, iBill, or EPX?

Well, the merchant side, absolutely. I think they have a strong growth year-over-year, and the HSI piece, I know we’ve been through a number of times. If we sign new customers relative to HSI after we acquired them, that is internal growth. If we converted things from our existing centers over there, that is not internal growth.

And as far as the internal growth components as we talked about, service fee was seven percent, datacom 16, merchant processing approximately 18 in total, and of the service fee the strongest area being EFT which was about 23 percent.

Great, thank you.

Thank you.

The next question comes from Chris Rowen.

Hi, can you give us the components of the $3 million sequential rise in SG&A?

The most significant piece of that would be due to the opening of our call center in Florida relative to merchant processing. As well as continued growth from the facilities that we’ve opened in Los Angeles, as well as other item processing initiatives. The merchant processing, specifically, what we did there is we talked about earlier, we had outsourced that previously, and we thought it was best for us to go-ahead and handle that process entirely rather than outsource it to a third party who was more interested on going ahead and getting the volume of calls through rather than handling the calls, you know, the way we might handle them. We hired nearly 80 people at the beginning of the quarter, and now have that call center fully staffed, and fully operational.

Okay. And what do you anticipate in capex will be for next year?

Capex, right now the requirements that we have are in the $15 to $20 million range. To really touch maybe even more specifically on Sovereign, because I know a lot of people have asked the question, it probably just hasn’t come-up yet. In calculating the returns on capital relative to Sovereign we included the value of the stock first and foremost, and secondly, believe that we’ll have in the neighborhood of $4 to $6 million of capital out-of-pocket expenditures, and then we will also lease equipment in excess of $10 million which is fully included in all the Sovereign calculations and numbers in arriving at that return on capital. It just made more sense for us rather than to buy it, given the low lease rates that we have access to, to go-ahead and lease that, lease those amounts. So if you – in the 15, 20 it includes approximately five million related to Sovereign, and 10 to 15 million outside of Sovereign.

Okay, and the lease equipment is $10 million a year?

No sir. That’s a total lease, which will go-ahead and be expensed over the life of the contract. So in a six-year deal that’s over a 72-month period.

Okay, great. Thanks a lot.

Next question comes from Jim [Overwey]. Please go ahead.

Hi. I’ve got a rather obscure accounting question for you. But under the – and I have only limited knowledge in this, so bear with me. But under the emerging issues task force Abstract 01-9, accounting for consideration given by a vendor to a customer, would your agreement with Sovereign, where you give them 375,000 shares of stock apply to this rule? My understanding of the rule is that in a case where stock is issued under such an agreement that the first, you take the value of those shares at the time of the grant of the shares, and that until an amount in revenue equal to the value of those shares occurs you cannot under GAAP recognize revenue?

No, actually sir, the EITF 1-9 actually was put into practice a number of years ago when Internet companies were trading bandwidth and other things, really where there were no tangible goods or tangible items, transfer in-hands, which is not the case of what we’re doing. But the application is that if you give value for a contract, which we did in this case, we gave 375,000 shares. You have to take the value of that, and that needs to be a reduction to revenue over the life of the contract.

So in our case, what would happen is that that $4 million of stock that we granted in the first week of October would be amortized over a 72-month period. And so, it’d be about 60,000 a month, which would be a reduction of revenue in arriving at our total. So if we, you know, hypothetically out of that $20 million number we talked about, that number would be reduced by about $800,000 per year in the revenue caption to go-ahead and arrive at what GAAP revenues would be. Which we’ve already included in arriving at the guidance we’ve given to the street, in the excess of $20 million per year.

Great. I understand. Thank you very much.

Thank you, sir.

The next question comes from Gary Prestopino. Please go ahead.

I think my question has been answered. But Scott, I just want to go through what you said on Sovereign. Capex of six million, 10 million on leased equipment, and four million on stock, that’s the total capital outlay?

Well, actually it’s $5 million on capex, $4 million on stock, and as far as the leased equipment approximately $10 million. But that’s going to be, we don’t view that as a capital outlay from the standpoint that that’s just going to run-through the P&L statement on a monthly basis over the life of the contract.

So the real capital is about $10 million then?

Yes, sir.

Thanks.

Thank you.

The next question comes from David Trossman. Go ahead.

David, did you make it? David?

Yeah, can you hear me, Scott?

Yes, sir.

Thanks. I’m wondering if you can give us at this time a little bit more color on how different your view of this Sovereign processing operations is relative to the way it’s been done in the past, i.e., if you do on a six cent split across the regions? Is that more or less concentrated? I’m trying to figure-out how big of a change this is for Sovereign and their bank operations?

Sure. David, I’ll start. I’m sure that Lynn and John will chime-in, as well. But the way that the business traditionally has been done was that of a traditional item processing environment, where it wasn’t image, [this card], character recognition, and account recognition wasn’t done, where basically you’d have hundreds of people encoding each and every check that came in. Whereas, now the read rates on the encoding through [Carr & Larr] which is the character and account recognition, will be nearly 70 percent. Which will ultimately cause us to have significantly less in cost.

Secondly, you know, as we talked about relative to the imaging, I think that there’s a great benefit there to image it rather than to have it all in the traditional check environment. I know a number of people have asked relative to the contract, you know, ‘are you going to make money on this? Are you going to have significant returns? And how is this going to work?’

And I assure all of you that are listening that the returns on capital that we’re generating off this contract are significant due to a number of factors, but one, we’re not doing it the same way that has traditionally been done. We’re using newer technology, and we don’t have to go-ahead and reinvent centers or systems, we get to build them out to the detail that we need to in order to do the business that is necessary.

If you’re going to process all this volume through six locations do you know whether it was more than six, or less than six, under the previous contract?

No, sir, I don’t. In regard to what the previous competition has done in this I don’t know how they processed from a number of locations. I know some of our people do know that answer, but I do not.

Got you. And lastly, can you give me an update on the, on the iBill conversion? I think your last decision was to go-ahead and tie that together with EPX. Can you give us the timing of that? And whether there’s any near-term costs associated with it?

David, this is Lynn. From the integration of those two we completed the processing piece in September, where we moved from their prior processor to EPX. That has been completed, and is running smoothly. It is in place. We’ve – I think there were several other things that we’ve looked at doing. But from a human resource standpoint we’ve integrated much of the administration piece. We’ve brought in a Vice President of Finance that actually manages that piece of the business from InterCept’s standpoint. We think that’s been a huge value to put the two companies together with InterCept at the same time, not just EPX and iBill. But the biggest piece was we did finish and complete the processing fees from their prior processor to EPX. And that was finished the very – I think date-wise, about September 1st. From a financial standpoint, I’ll let Scott answer it.

Yeah. Lynn is right-on. It was done in early September. And as we’ve talked about, we see a good bit of benefit relative to utilizing our own infrastructure to process those costs. As we’ve previously talked about, the EPX system is built-out to handle volumes significantly greater than what they currently are handling. And big customer wins such as John Deere and Apple don’t even begin to dent the volume that it can handle, because utilization is still only in the 10 percent realm, putting iBill on is really just a real nice benefit to us.

Thanks.

The next question comes from Charlie Trafton. Please go ahead.

Hi, thanks. Good morning.

Good morning, Charles.

Another flawless conference call. Scott, did I hear you right? You said debt today is 49.5 million? And if that is true does that imply you've paid-down about 19 million in debt since the end of the quarter?

Right. I think some of that, Charles, is related to some of the CDs that came due, that we had back from August of 2001. And when we take those CDs they are self-liquidating against any of the CD secured debt. So clearly, we’ve made payments through cash flow from operations, but we’ve also made payments through that mechanism, as well.

And the 11 percent return on capital, you talk about it, at [FiServe,] I mean Sovereign, how does that compare against a core processing account? I know you don’t have any that are that large. And how would that compare against other item processing contracts that you’ve signed recently?

Yeah, I would say it’s very similar to what we’re doing in the item processing, check imaging world. As to core processing, think it’s a little bit harder to tell, because we don’t have a customer of that magnitude that you know all of the dedicated resources, and a lot of them are in a shared situation. But clearly, I would estimate that the core processing is higher than incremental than check imaging. Although with the number of the initiatives we’ve done, I think what we’re trying to do is increase the returns on capital and the margins from the imaging business, with things like Lynn had talked about on NetImage and clearing of images.

Right. And the last question is the eight percent internal growth and applied services, and fees you talked about, do you have a figure even off the top of your head, or back of the envelope, what that might have been last quarter, and then also this quarter a year ago?

On the service fee piece?

Yeah.

I would say last quarter, and gosh – I would prefer just to get you the exact numbers then go-ahead and kind of pull top of the envelope, which I’ll go-ahead and pull together here. And if I don’t get it now I’ll gladly distribute. But I don’t, I don’t just want to guess on that because I know a number of people tie-into what those numbers are.

Right.

One thing I would like to add as far as 2003, we’ve given guidance on the earnings per share of $1.28 to $1.32. That also assumes revenue of approximately 260 to 270 million excluding customer reimbursement. And believe that internal growth on a full-year basis would be about 10 percent. But, of course, accelerating by the end of the year to 13 to 15 percent upon the conversion of Sovereign which we won’t get almost a full-year benefit, or a full-quarter benefit until the fourth quarter. The first quarter of 2004 will be the first quarter that we receive a full-quarter benefit, which will put us back to about a 15 percent internal growth rate at that time. And what I’m assuming in getting at those numbers is that we really don’t see any change in one-time software systems and items, and should things pick-up there, we would expect the internal growth to pick-up, as well.

Actually, I have two more quick ones, sorry. What about the market for the community bank processing area? New charters are down, because the big banks have stopped merging, what about the health of that business and the demand there? And then, where do you think you’ll end this year on a debt structure basis? Thanks.

On a debt … this is John. I’ll try to address the question of the new charters and the community banking market in general, and then let Scott handle the second part of that.

The new charters are down slightly. Actually, I don’t think that the numbers actually may bear-out that they’re down significantly. But they are down. We’re still seeing a lot of new charters. But understand that, and maybe Lynn can help me with a percentage here. But certainly not all of our new sales are coming from new charters. As a matter of fact, I think community banking in general is very strong, and community banking, and maybe part of that is because of what you said is maybe there’s fewer acquisitions. But I don’t really believe we’ve seen a lot of acquisitions even in the past on really the smaller community banks. They’re the mid-tier banks that get acquired by the big national banks, the big banks, nationwide banks.

So we’re still seeing good, good activity in [Denobo] still only representing maybe 20, 25 percent of our new sales which, in fact, means that we’re taking banks away from other processors. And that’s always been our plan, and that continues to be our plan. So even if there is a weakening in the community banks as far as Denobo’s there’s still thousands, and thousands, and thousands of community banks. So if we continue to take them away from other processors than I think we’re still in pretty good shape. And that is our intent and has been our intent.

I might point-out, and I’ve said it many times publicly that since we’ve got into the data processing business, the service bureau data processing business, we’ve not lost very many customers in the, in that, in the core processing part of our business. We’ve lost some to acquisitions from time to time, but I can only recall one loss to service and, or price. And certainly, since we’re taking a number and you can do the math, we don’t really talk a lot about those numbers, but I just told you that 20, 25 percent of the business is coming from Denobo’s, and that means that there’s a significant number of banks being taken from other processors, and when you look at those numbers, I think that we’re certainly taking substantially more than we’re losing since we’re only lost one in several years that I know of. Hope that answers the question about community banking. And Scott.

Charles, the only thing I’d throw in there is that when you talk about charter slowing, I don’t think we’ve seen the same affect in the Southeastern United States, where we clearly have a stronger presence than other areas in the country. And continue to see good opportunity in our home market.

As far as our capital structure, debt-to-EBITDA is now basically on a ratio of one-to-one which we think is a real strong ratio. We continue to generate significant cash flow from ops, and we use that money as we see best. But the first and foremost thing that we’re doing with it right now is investing for our growth, and paying down debt. We’ll continue to go-ahead and do both things, and continue to go-ahead and structure ourselves so that we have financial flexibility to grow this company the way we think we can grow it.

Great, thanks.

One other quick comment about the Denobo’s, relative to what Scott just said. We get a report from one of our partners here in the Southeast, the Bankers Bank. And they do actually a Denobo report, which may not be every Denobo in their region, but it’s certainly all those that they’re working with. And probably for two years that’s had the same number of banks on it. But it drops-off after it – the bank opens. This is a report of the banks that they’re working with, and the stage that they’re in. And that list continues to be about the same size. We worked with some consultants, I know of one that’s working with 85 banks. And so, it’s still pretty active, even though it may have dropped-off a little bit.

Did you want to make a comment, Lynn?

Charles, the only thing I was going to say and we really didn’t hit on it, that 20 to 25 percent, the great thing about those Denobo banks, even their small and startups, and they obviously will continue to grow some faster than others, where in a typical bank when we go out and sell the core processing we may only sell two and three hundred products at that time to that bank, a Visa bank that’s been around for 10 years, and he has other vendors he may be doing business with. And a Denobo bank one of the great opportunities we have is a typical Denobo bank may take 10 or 12 of our products when they open the door. So we think it’s a real strong market, and we pay a lot of attention to those Denobo customers, and that's why it is still running probably 20, 20,or 25 percent of our customer base on new signs.

Great, thanks.

The next question comes from Lee [Hix.] Go ahead.

Yeah, I got another, a community banking question for you guys. You know, a few months ago they repealed the law in Georgia. The old law was you couldn’t sell a bank until it had been open longer than five years. But now they’ve repealed that law, and you know, have to be, you have to sell it, you know, after any length of time under five years now. Do you think that will affect, I guess, your competitive landscape, or your customer base down there in Georgia?

Lee, it could possibly. Obviously, if you’re going from a five-year opportunity to sell to three years, I think there’ll be some bankers that choose to sell-out, and that’s great with us, too. Because we think every time one of those banks closes down we have an opportunity to open several more banks within that region.

Right.

But we don’t see it as a negative. We actually, I think in most cases, where we see these mid-tier community banks be bought out we see the President, the Chief Financial Officer, the CIO, you know, the Chief Lending Officer, all of them are looking at that point in time to go out and open another bank. They think it’s a great opportunity from that standpoint.

John Collins (?): Yes, one of the things that’s happened in the Southeast recently, the combination of even Wachovia and First Union has created an environment where we may see more new charters in the Southeast than we’ve seen in the past, even though it may have slowed-down nationwide, a lot of those people that Lynn just mentioned, the CEOs are in the case of the combination of a Wachovia or First Union, a regional manager, a regional Vice President that’s running – and I don’t know, I don’t know any of this personally so I don’t know the players, but a regional person that’s running South Georgia for Wachovia, and South Georgia for First Union, it’s very possible that some combination of those won’t still have the same job, or at least maybe they’re over a different region. So a lot of those people may be looking to pull some Directors together and some investors, and start another community bank.

So it’s not, it’s not all bad when banks get – sometimes there’s a slight delay in revenue, but often we get more revenue generated from a start-up bank than we may have gotten from a bank that’s been around 20 years, and had decided that they could do a lot of these things themselves.

Right.

Because they were larger.

And Lee, one other additional comment. I know in previous research that you had put together you had talked about 65 banks in total being signed in a given year. And I think in 120 days we’ve signed 22. And so, I think that you know, a lot of the thesis and commentary on the market itself, well, you go-ahead and when you look at things, think some of the research that you and others have put together on this space has been dead wrong. And I think we’ve showed in the last 120 days that if that were the case and we kept that up that no one else would sell anything in this whole space. And so we remain strong and bullish on the core processing market, and customer signings, and customer takeaways, and I think we’ve demonstrated that over the last four months.

The 22 banks that you guys signed-up this quarter, how many of those were in-house people switching to outsource? I assume the 22 were all outsourced customers?

No, a combination of in-house and outsourcing customers.

Okay. The 65 number is just outsource, and it’s just existing banks? It doesn’t count Denobo banks that start-up this year. Got it. One other question, the – is your guidance still the same for iBill and EPX?

I believe we’ve given consolidated guidance. I didn’t go ahead and give guidance by segment or component. They’ve exceeded, I believe all of the estimates that we put-out there for them, year-to-date, and we remain comfortable that, as well as that business, and the banking business remain good.

What’s – okay, so the numbers that I’ve got. You know, last year I have that you guys made $1.05 after we add-back FAS 142.

Well, I think that’s a little misleading, and we’re not going to go-ahead and get into too many things. But it’s a little misleading because the share count went up 25 percent year-over-year. So you know, you can’t grow amortization like you can revenue and profits with the additional shares outstanding.

Okay. But you guys, now you’re saying – okay, this year your new guidance is $1.11 to $1.15. And so, but if we take the middle, say $1.13, you’re still going to get three cents from iBill and EPX?

Once again, sir, we hadn’t gone ahead and given specific guidance on the different Divisions. What we had originally said was we’d see one to two cents for EPX and iBill.

Right.

And had not gone ahead and given any different guidance at all on that.

Okay. Well, how come, you know, I guess internal revenue growth from the bank business, you know, it’s 14 percent in the first two quarters. And you know, I guess the total was eight percent this quarter. So I guess after you take-out merchant processing it’d be five to seven percent. But it looks like EPS growth from the bank business is going to go from about $1.05 to about $1.09, or $1.10, we’ll say. You know, from, after you back-out all of iBill and EPX. And so what’s the – you know, how come – what’s the difference between the internal growth rate percentage, and the EPS growth rate percentage?

Well, Lee, I think you’re completely off-base with your numbers.

In addition to that, I think that the purpose of this call is not for you to go-through your analysis and how you see the numbers coming together. I believe that Scott’s answered the question.

Okay. Thanks.

(Caller Instructions.)

There are no further questions.

All right. Well, thank you very much. Again, I apologize for the earlier inconvenience and the technical problems. And we’ll work hard on that in trying to make sure that doesn’t occur again. But I thank you very much for joining us for this call. Look forward to talking to you in the future. Good day.

This concludes today’s conference. Please disconnect your lines, and thank you for your participation. 1