First Data Corporation Q2 2006 Earnings Conference Call Transcript (FDC)

First Data Corporation (FDC)
Q2 2006 Earnings Conference Call
July 21, 2006, 8:00 am ET

Executives

Ric Duques – Chairman and CEO
Kimberly S. Patmore - CFO
Gary Kohn - Vice President, Investor Relations.

Analysts

Adam Frisch - UBS
James Kissane - Bear Stearns
Liz Grausam - Goldman Sachs
Greg Smith - Merrill Lynch
Bryan Keane – Prudential
Charlie Murphy - Morgan Stanley
Pat Burton - Citigroup
Kartik Mehta - FTN Midwest
Tim Willi - A.G. Edwards
Paul Bartolai - Credit Suisse

Presentation

Operator

Welcome and thank you for standing by. (Operator Instructions) Now I will turn the meeting over to Mr. Gary Kohn, Vice President, Investor Relations.

Gary Kohn

Good morning. Thank you for joining us today. With me today are Ric Duques, Chairman and Chief Executive Officer; and Kim Patmore, Chief Financial Officer. Today’s call is being recorded.

Our comments include forward-looking statements and I ask that you refer to the cautionary language in the earnings release for additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements.

During the call we will discuss items that do not conform to generally accepted accounting principles and we have reconciled those measures to GAAP measures on our website in the Invest section under the Financial heading.

All statements made by First Data officers on today's call are the property of First Data and subject to copyright protection. Other than the replay, First Data does not authorize and disclaims responsibility for any recording, replay or distribution of any transcription of this call.

As always, we will have time for your questions following our prepared comments. With that I'll turn it over to Ric.

Ric Duques

Thanks Gary, and good morning. I am Ric Duques. When we spoke in April, we guided you to $0.52 to $0.55 of earning per share in the second quarter and we are pleased that our reported earnings per share was $0.56. Revenue for the quarter grew a solid 10% to $2.9 billion. By the way, for those of you interested in records, that’s the largest quarterly revenue in our 14 year history, and we are really pleased with that. We're also pleased that revenue growth excluding acquisitions and divestitures, which we call organic growth, was 6.6%.

The performance of our four major segments continue to fuel our growth. Segment revenue and operating profit growth grew 11%. We are very pleased with both our revenue and earnings per share growth this quarter, especially considering that Western Union's U.S. business performance was impacted by consumer reaction to immigration reform activities in the United States. I'll cover immigration issues in more detail when we review the Western Union segment.

So now let's take a look at each segment and since we're on it, we'll go right to Western Union. For the quarter, Western Union segment generated 15% reported and euro-adjusted revenue growth. Vigo, our acquisition last year, contributed $37 million in revenue equal to 4% of the revenue growth.

Western Union segment operating profit increased 9% and operating profit margin for the quarter was 31.2% versus 32.4% excluding the Vigo acquisition. I think all of you know that Vigo is a drag on our profits right now. We're working on that.

The worldwide strength of the brand and the geographic diversity of Western Union continue to drive the strong performance of our global consumer-to-consumer business. Consumer-to-consumer transactions increased 27% in the second quarter and 18% excluding Vigo acquisition. Consumer-to-consumer revenue increased 17% in the quarter or 13% excluding Vigo. The Western Union same-store US sales growth was 12% this quarter.

Now let's discuss Mexico and the impact of immigration on the Western Union segment in more detail. Significant controversy surrounds U.S. immigration policy, legislation, demonstration and other events that are creating a great sense of uncertainty amongst the entire migrant population in the United States. Although these issues may not seem as heated to non-migrants, let me assure you that this is a major issue for both documented and undocumented migrants, and especially the Latino demographic in the United States.

Most of these migrants come to the United States to find work and, in many cases, send money back home to support their family. The last thing these people want is to find themselves the target of controversy or suspicion. Even those in this country legally may now have concerns about their paperwork or undocumented family members. Although these factors have been building for a while, their effects are really starting to come home in this last quarter and we did not anticipate the magnitude and the impact on our business.

It's worth taking a moment to think about how migrants in the U.S. are feeling today and the questions they are asking themselves when they consider going to a money transfer agent. Do I need to hang on to my cash? You would, I would, if you were worried about paying back taxes, fines or legal fees; or, if the state government had seized remittances from people and they cannot prove their legal residence. Am I going to get harassed? Would be a question I would ask.

Many immigrants feel backlash as a result of all the controversy, whether they are documented or not and may now even be more fearful about law enforcement and the possibility of being deported.

Another question. Am I going to be arrested? In May and June more than 2,000 migrants were arrested across the United States. You can imagine the ripple effect that these arrests are having on the community, as they have been heavily covered in the ethnic media. It's inconceivable that these developments would not have an impact on the money transfer industry.

In fact, Banca de Mexico, which is Mexico's central bank and leading authority on the Mexico remittance market, reported remittance transaction growth of 14% for the first two months of the second quarter, down 8% from the 22% transaction growth that they reported in the first quarter. One of our competitors recently reported 11% deceleration in Mexico transaction growth for the second quarter.

When you consider these facts and the issues our customers are struggling with at the street level, it is not surprising that as the leading money transfer company -- that's us -- we would be impacted sooner and to a greater extent than other money transfer companies.

During the quarter, Western Union saw a noticeable decline in transaction growth to Mexico across all three of our brands: Western Union, Orlandi Valuta and Vigo. Total Mexican transactions, excluding Vigo, grew 6% in the second quarter, down from 17% transaction growth in the first quarter. That's an 11% deceleration.

Western Union branded transactions to Mexico, which exclude Orlandi Valuta and Vigo, increased 10% in the quarter, also a slowdown from the 23% in the first quarter.

Furthermore, our domestic money transfer business, which includes transactions set by our Latino demographic within the United States, grew 2% in the quarter, down from 5% in the first quarter. Revenue growth for this business was flat compared to 5% growth in the first quarter.

In summary, we estimate that the US immigration activities in the second quarter negatively impacted Western Union's total revenue growth by 2% and total operating profit by 3%.

The uncertainty surrounding immigration will eventually be resolved. Until then, there will be an impact on our business. We are confident that over time our presence in nearly every country in the world will more than compensate for sporadic events that occur in a particular country or region, even if that country is the United States. Remember, 50% of Western Union's consumer-to-consumer revenue never touches the United States. This revenue, excluding Vigo, has grown at 17% year-to-date. We are clearly growing rapidly in the rest of the world.

We remain extremely encouraged by the results throughout the rest of the world where international growth remains strong. Some statistics on that. International transactions increased 32% in the second quarter, or 24% excluding Vigo. International revenue grew 20% or 17% excluding Vigo. India transactions growth exceeded 100%. China transaction growth exceeded 40%.

Total international intra transactions, which is an important metric for us, was a strong 70%. Mexico outbound -- we just started that up recently, we send money out from Mexico as opposed to in -- grew 66%. Finally in the second quarter westernunion.com increased transactions by 37% and revenue by 43%.

We are optimistic about our global position and long-term opportunities. Our strategy to diversify distribution is clearly driving our results.

Additionally, economics continue to stimulate migration and the related remittance market growth around the world. As populations of large industrial economies continue to age, they will need valuable contributions from millions of immigrants to keep their economies growing strongly.

Furthermore, we are continually investing in the business. In the second quarter, marketing spend increased 9% year-over-year and remains about 7% of total Western Union revenue.

The Western Union Loyalty program is growing and we now have 6.5 billion active Loyalty Card customers. We are well on our way to reaching 8 million cards by year end.

This quarter clearly demonstrates the diversity of the Western Union business. We remain extremely confident in Western Union's underlying growth and its long term prospects as a standalone Company. Speaking of standalone, it is about time for an update on the spin.

We are committed to keeping you updated on the progress of the Western Union spin. At this stage I'm very pleased with the milestones we have met and the status of ongoing activity. On June 8th we filed our Form 10 with the SEC. We recently received SEC comments and we are looking forward to responding very soon to those comments.

We also will re-file the Form 10 with Western Union's results for the first six months of 2006. We'll do that later in August. On May 12th we filed a request with the IRS for a favorable tax ruling and discussions with the IRS are continuing to progress well. We are actively working with credit agencies and various regulators around the globe. I'm pleased that these meetings are going very well.

Spin-off activities are progressing as expected and we should separate the two companies towards the end of the third quarter or beginning of the fourth quarter. We have a full-time program managed group of FDC employees as well as outside help to make sure that we have a smooth separation and we meet our timetable.

Our search for Western Union board members continues to progress well. We will have specifics to announce to you very soon.

Finally, I think all of you saw this week we hired David Barnes. He will be joining the Western Union team as Executive Vice President of Finance and Strategic development. We are always looking for strong talent. We thought this was an ideal time to bring a strong person to complement an already strong Western Union management team.

We also announced that Scott Shireman has been named Executive Vice President and Chief Financial Officer for Western Union and will be reporting to David. We believe strongly that a fast-growing global company like Western Union requires management strength and depth, particularly in the financial area. We are very fortunate that we both have David and Scott to lead our Western Union financial team.

Commercial Services had a great quarter and continues to outperform our expectation. Commercial Services reported revenue growth of 11%, or 9% excluding reimbursable debit network fees. We are clearly on track to achieve our full year revenue growth target which was originally 8% plus or minus. Then we up drafted last quarter to 8% plus. Now we are up drafting again to 9% plus.

This quarter's operating profit reflects a 27% year-over-year growth. Excluding the integration costs that we recorded last year, operating profit growth was a very strong 12%. Our profit margin for the quarter was 26.9% versus 23.4% in the last quarter. Excluding reimbursable debit network fees and integration costs, profit margins improved to 33.3% from 32.3%. These are fantastic numbers for us.

This quarter's results and our continued success are a direct result of executing on our four main strategies:

1. Driving sales through each of our distribution channels;
2. Expediting activation of our new merchants;
3. Retaining our existing merchant base; and,

4. Expanding our offerings, especially to non-traditional strategic challenges.

We are clearly executing well in all four areas. We are particularly pleased this quarter and last quarter with the performance of our alliances. During the quarter we signed three new revenue-sharing alliances and two new referral banks. Sales productivity through our alliances remained strong. This quarter we added a number of brand name wins across credit, debit, prepaid and check.

In the area of new merchant activation, we launched the roll out of our Automated Merchant Activation system, we call that AMA, in early April. As of the end of the quarter, we had more than 2,500 new merchants utilizing this product and more than half of our regional sales account executives now utilize the product. With the implementation of AMA and many other initiatives designed to improve boarding time, we have already seen noticeable improvement.

In the second quarter, almost 20% of all new merchants signed were enabled to do business within two days. That's up from less than 5% in 2005. That's a fantastic statistic there too.

Merchant attrition trends continue to improve as a result of expanding retention efforts across all of our business lines. This improvement will continue to benefit the results into the second half of this year.

We continue to focus on expanding our offerings through non-traditional strategic channels. We recently formed two important partnerships that will help us move in that direction. The first is the Discover Financial Services one, which we announced last week. First Data is stepping up to provide an all-in-one payment processing solution for small to mid-size merchants. This will lower their costs and simplify their process.

Today small merchants have too many statements, too many fees and multiple customer service numbers to call. Through our new agreement, merchants will now have the convenience of having Visa, MasterCard and Discover transactions processed under one agreement, with one discount rate, one integrated statement, one funding source, and one customer service number. While other acquirers may eventually begin to provide this service, this agreement signals a monumental shift in the marketplace. We are pleased to be the first to market with this valuable service which we think will provide a significant improvement to the services provided to small and mid-sized merchants.

The second new agreement we have is with ADP. Through this unique partnership, we are equipping our sales force with a key new product to sell, Small Business Payroll Solutions. We are targeting a nationwide roll out of this later this year. We believe this agreement will give First Data another leg up in the sales gains by offering broader solutions to our Merchant customers.

Additionally, we announced an agreement to provide a co-branded pay card with ADP. Through this agreement, First Data's money network will be responsible for back office operations and program implementation for employers seeking a pay card solution as an alternative to paper checks. This agreement will drive increased processing revenues and will help fuel the secular change at the point-of-sale from cash and checks to cards.

Both of these new relationships are providing value to our small and mid-sized merchants. I want to remind you here, that group comprises more than 80% of our locations and 75% of our merchant processing revenue. Let me repeat that so I'm real clear: the small and mid-sized merchants comprise 85% of our locations and 75% of our merchant processing revenue. Clearly, given our current size and with the 10% revenue growth in this segment year-to-date, we are the leader in this space.

I am very pleased with the progress being made at commercial. With year-to-date revenues of $2 billion, the success we are having this year will provide us with great momentum entering 2007.

Let's move to financial institutions. Financial institutions second quarter results were in line with our expectation. Keep in mind here, last year's second quarter results included $17 million worth of revenue and $16 million worth of operating profit from contract termination fees. That's why the grow over issues here in this segment are so significant.

The largest impact of the segment's revenue and operating profit for 2006 has been the grow over of Chase, Fleet and People's Bank Card deconversion and their resultant contract termination fees. Thankfully, we will anniversary the last of these deconversions at the end of July.

As we stated in the first quarter, to give you a better view of the state of this business, we believe it's important for you to look at the revenue growth from our existing client base without the impact of reimbursables, and without the impact of these deconversions.

During the quarter, deconversions negatively impacted revenue growth by 13%. Excluding reimbursables and these deconversion deductions, revenue growth was a positive 4%.

Looking at some highlights for the quarter:

At the end of the second quarter First Data successfully converted Citi Sears retail private label and Citi Sears MasterCard accounts into First Data's processing platform. This was the largest account conversion of any type in the history of our industry. We feel that we have the best conversion team in the industry and I would like to offer a congratulations to Rocky and his team, Rocky runs the group. You guys are the best.

This conversion, along with several others in the quarter, helped increase our domestic accounts on file by approximately 100 million, bringing our total domestic accounts on file to 533 million cards. First Data has also been awarded the right to process Citi's retail private label petroleum accounts which currently run on an in-house platform. The conversion to First Data will occur in the first half of 2007.

Finally, I wanted to announce that USAA, a significant and long-term client of ours, has renewed its processing client agreement with us and we're very grateful for that.

As part of our plans for future growth, we have spoken to you many times in the past about leveraging our core capabilities into adjacent markets. We recently announced that First Data has signed an agreement to acquire P Software, a leading product company, that develops and licenses advanced software for managing utility bills and customer care.

The utility market is an adjacent market that First Data has been exploring for some time. Since many First Data businesses and relationships with utility clients, this acquisition puts us in a position to offer compelling value propositions to the worldwide utilities market.

We will continue to support Peace Software's licensing clients similar to our VisionPLUS model. We intend to convert this to a service offering model as we are not looking to remain in the software sales business long term.

On the healthcare front, we were selected as the provider for processing service for PayFlex Systems USA, a leading administrator of health spending accounts and other tax advantage plans. We will deliver state-of-the-art transaction processing solutions for this company, and we will allow their customers to access their funds at the point of care.

Our underlying growth rates, in combination with our entry into adjacent markets, position us well to return this segment to the 8% to 10% growth we are targeting.

Now let's go to First Data International. First Data International had another great quarter, in line with our expectations with one exception being the acquisitions, and I'll touch on that later. In the quarter, First Data International generated revenue growth of 41% on a reported and constant currency basis.

Organic revenue growth on a constant currency basis was 15%. By the way, I would like to remind you on this one, our expectation in January was 8% to 10% organic growth. So we are well ahead of our expectations in this segment.

Operating profit increased 43% and 41% on a constant currency basis, and operating margin inched up to 11.2% from 11%. Our strong financial performance continues to be driven by acquisitions and superior operational execution in this core.

Here I've got some numbers for you. Point-of-sale locations increased 627,000 to nearly 1.4 million; ATMs increased over 7,000 to almost 18,000; transactions increased to 87% to 1.1 billion. We ended the quarter with 56 million accounts on file, 24 million higher than the same period last year.

First Data International continues to execute on the three major planks of our global strategy: driving growth through new sales, new products and existing clients both in the issuing, merchant processing and ATM markets; executing on our global platform strategy; and targeting strategic acquisitions and partnerships.

Some highlights for the segment:

During the quarter we signed a multi-year global acquiring agreement with Microsoft. First Data will provide payment processing solutions for Microsoft's global online consumers and business clients, as well as risk management service.

In the ATM space we have enhanced our product offering by enabling the distribution of public transportation tickets in Australia.

Another example of a service innovation is the development of the capability for Austrian merchants to refund VAT tax to foreign customers at the point of sale. This is a great convenience. I never can find out how to get refunded here and at the airports, but for merchants and their customers, this is a really great service.

Our VisionPLUS international issuer processing platform continues to gain momentum. We completed a major conversion with the Riyad Bank, and renewed our processing contract for five more years with them. Chase Paymentech has chosen OmniPay, which is our global multi-currency merchant platform, to provide payment processing service to its portfolio of global e-commerce merchants.

Now on the acquisition front. On June 13th we closed the acquisition of GZS in Germany, making First Data the market-leading processor of card-based payment transactions in Europe's largest economy. I would like to extend here a warm welcome to the nearly 800 GZS employees who have recently joined the First Data family.

GZS is Germany's leading processor of card-based payments serving 227,000 merchant locations, 6.6 million German and Swiss credit cards on file, and processing nearly 200 million transactions per year.

Germany has an under-penetrated electronic payment market in terms of point-of-sale terminals and ATMs providing some great growth potential for First Data going forward. The acquisition of GZS makes First Data a truly pan-European provider with the expertise to enable banks to comply with the new single European payment area which is called SEPA, their regulations that are coming forward.

All this is definitely getting us noticed. We were named Card Processor of the Year at Cards International's 2006 Global Awards Ceremony.

Finally with respect to the $250 million in planned acquisitions that we did discuss at the January conference, we continue to be pleased with the progress we are making on acquisitions and the number of opportunities that exist in the marketplace for us to make acquisitions.

The timing of these acquisitions is always difficult to predict. As a result, we are making a change to our estimate here. We now believe that this year's revenue from acquisitions will be closer to $130 million and as such, we have anticipated a small negative impact to profit in this segment of approximately $10 million.

We remain very excited about our international business as a growth engine for First Data and it now comprises a $1.2 billion annual run rate business. As we said before, we believe the new First Data will be in 8% to 10% top and bottom line growth.

I think you can understand why we feel so confident about achieving these growth rates when you consider that our commercial segment is on a revenue run rate of over $4 billion and our International segment is on a revenue run rate of $1.2 billion. That's $5.2 billion of new First Data's revenue, which today is organically growing at double-digit rates of both revenue and profit.

We continue to be extremely pleased with the performance of the segments that comprise the new First Data both for the remainder of the year and for 2007.

Now I would like to turn it over to Kim who will give you some more local color here on the financials.

Kimberly S. Patmore

Thanks, Ric and good morning. Overall we had a very solid quarter with revenue growth a strong 10%. Earnings per share for the quarter was $0.55, excluding items and was $0.56 on a GAAP basis. Items in the quarter included $0.01 of costs related to the planned spin-off of Western Union and a $0.02 gain primarily related to the redemption of the MasterCard stock and the release of litigation settlement reserve in excess of ultimate requirements.

Quarterly results also included stock-based compensation expense of approximately $21 million, an incremental $19 million over 2005 or $0.02 per share, principally as a result of the adoption of FAS-123 R effective January 2006.

Cash flow from operating activities was approximately $580 million versus $395 million last year. Our free cash flow components for the quarter were as follows: Net income was $436 million, depreciation and amortization was $199 million, CapEx was $82 million, and dividend payments were $46 million.

Year-to-date, cash flow from operating activities was approximately $1.2 billion versus $917 million last year. We remain on track to generate cash flow from operating activities of $2.4 billion to $2.6 billion for the year, excluding the impact of the spin-off.

In preparation for the impending spin, we are positioning ourselves to be as cash flexible as possible. Accordingly, we have not been paying down debt and have limited stock buybacks to levels necessary to fulfill employee benefit plan obligations.

The buy-backs net of proceeds were approximately $70 million during the quarter and borrowings were $5.4 billion at quarter end, up $232 million from March 2006 and up $50 million from year end.

Cash and cash equivalents were $1.7 billion at quarter end, up $460 million from March 2006 and up approximately $520 million from year end. Interest expense was $73 million, an increase of $18 million over 2005, is principally reflective of higher interest rates. However, the increase is in part offset by a $9 million increase in interest income, driven by higher cash and cash equivalent balances, in addition to certain Western Union loan activities.

The effective tax rate from continuing operations was 27.8% compared to 25% for the second quarter of 2005. The primary reason for the increase is the increase in the pre-tax profit.

I am also pleased to say that Visa and First Data have brought their litigation issues to closure earlier this month. New management at both companies concluded we could mutually benefit by working together on various product and business development initiatives. Visa is going to provide financial support for those initiatives which will improve the electronic payments industry for the benefit of consumers, merchants, issuers and acquirers.

As a result of this settlement, we will recognize a benefit of approximately $0.035 in First Data's third quarter reported earnings per share from continuing operations.

With respect to the spin-off, we know that many of you have questions about the amount of the cost that will ultimately be incurred to effect a spin. At this point there are still significant uncertainties that we're working through, including stock option valuations and the cost we incurred to restructure the debt. Therefore, we are unable to estimate the final cost within a reasonable range.

Furthermore, there are additional operating costs related to separating the companies and restructuring both First Data's and Western Union's cost structure going forward, some of which were incurred this quarter, and we will continue to incur during the balance of the year.

Finally, our guidance of $2.35 to $2.42 from continuing operations is a GAAP range and excludes any impact of the spin-off in cost. We are still in that range. However, because the $0.035 benefit from the Visa lawsuit settlement is accounted for in our GAAP continuing operations, we are required to include it in our EPS from continuing operations guidance.

However, we recognize that many of you will not consider the Visa settlement when reviewing our full-year results. So to be clear, we do not need the $0.035 from the Visa settlement to achieve the low end of the $2.35 to $2.45 range, even if the current performance and trajectory of Western Union continues.

Now I'll turn it back over to Ric.

Ric Duques

Thanks, Kim. Overall it was a great quarter for us and I would like to thank all my FDC hardworking colleagues for their effort. They really are a great team. They delivered the largest revenue in our history. The Commercial Services outperformed our expectations. First Data International continued to deliver strong organic growth and our cash flow generation was consistently strong. We're real happy with this quarter. Now, operator, if you could let the questions begin.

Question-and-Answer Session

Operator

Our first question comes from Adam Frisch from UBS.

Adam Frisch - UBS

Thanks. Good morning, guys. Ric, I just wanted to go through the margins going forward. So post-spin, do you expect the margins in each of businesses to be materially different from what you reported in 2Q?

Ric Duques

No.

Adam Frisch - UBS

No. Okay. Are you guys pulling forward any kind of investment initiatives across the business line ahead of the spin?

Ric Duques

Adam, we think they will be about the same. Post-spin I think Western Union talked about $65 million to $75 million in the Form 10 as additional costs. Now, that's got to be compensated for somewhere or it's going to affect the margins. So on that one, that's to be determined.

But generally speaking in the new First Data we should be in about the same range. You're going the see improvement, I think, in the First Data institution services. Also you're already seeing improvement in First Data International, but I think in terms of about where we are.

Adam Frisch - UBS

Okay. The card and merchant business, what you used to call them, seem to be making more progress and faster than you expected. Just to finish up this conversation, are there any one-time gains or costs take outs that won't be recurring in future quarters that were in the second quarter?

Ric Duques

No.

Adam Frisch - UBS

Okay. That's great. Final question: can you provide some color on your ability to buy back stock in the open market today? How much can you buy back? What are your plans are once the spin is effected?

Ric Duques

We could buy back, we got to get out of this period of releasing the earnings here, but we could buy back now if we wanted to. I think Kim addressed a little bit of that in her talk. But we're going to wait and see. I mean, we're building cash in here pretty substantially. We want to remain very, very flexible on that. We do have an acquisition program in place Internationally. You're seeing we're starting to make some acquisitions in the national institutions space with the Peace Software. So we want to be flexible.

Once again, we'll review it post spin. By the way, I'll probably speak to this, Adam, when we're on the road show in the middle of September. I think you'll get some more flavor of that then.

Adam Frisch - UBS

Are you more inclined to buy now or after the spin?

Ric Duques

Not now.

Adam Frisch - UBS

Great. Thank you.

Ric Duques

Okay.

Operator

Our next question comes from James Kissane from Bear Stearns.

James Kissane - Bear Stearns

Ric or Kim, can you give us the growth trends for Western Union throughout the quarter? And possibly July to date?

Ric Duques

Throughout the quarter?

James Kissane - Bear Stearns

Monthly.

Ric Duques

Well, it dropped about. I have it for March/April/May; April/May/June, no. But I will tell you, we are, as you know, we watch it every day. So we're about where we were in the second quarter for the first 19 days or 20 days of July. So if the thrust of the question is, is it getting worse or is it getting better in Western Union, we're saying it's about the same.

James Kissane - Bear Stearns

Okay. So Mexico is still mid single-digit or so?

Ric Duques

I think what I tried to point out, the uncertainty of it we just don't know. I mean, when we have situations like this in the past -- not as dramatic as this maybe -- but there tends to be a reaction and then kind of levels off, bumps along until things turn around in some way, shape or form. As soon as uncertainty is removed in this marketplace we expect this to come back. How fast, we don't know. But it will definitely come back.

James Kissane - Bear Stearns

How are you sure it's just immigration, maybe not the economy slowing, particularly housing construction?

Ric Duques

That's a good question. Because a lot of the workers are – we certainly haven't been able to see that as the reason. It's really the things I try to hit on in immigration that are more causing anxiety here and causing people to freeze up. You could be right, but that's being overshadowed by the main issue.

James Kissane - Bear Stearns

One last question. The spread between international transactions an international revenue growth narrowed somewhat, which is a good thing. What's your sense in terms of what's behind that?

Ric Duques

The international spread tightened by about I think 6% or 7%. The strong euro accounted for probably 2.5% of that. Normalized growth trends in intra or within the country added another 1.5% so about 4% plus of that narrowing was either the euro or the intra corridors, which are good for us.

James Kissane - Bear Stearns

Thanks, Ric.

Operator

Our next question comes from Liz Grausam from Goldman Sachs.

Liz Grausam - Goldman Sachs

Good morning. Just on your international business you mentioned the SEPA initiative out in the European market. With investments now in Austria and Germany, can you help us frame the opportunity you see for First Data broadly in the European market, and how you'll achieve that with the assets you currently have and potentially through further M&A?

Ric Duques

I think one of the issues with the SEPA thing is that basically the European Union countries have to be able to handle cards from other countries and ATMs and point of sale devices. So since we're all over the place there, it gives us a unique advantage. GZS would be one example; the ones that allow the banks to do that, and they have to do it in a cost-effective way. So it's an ideal outsourcing opportunity.

To size it, I couldn't even give you a number -- unless one of my colleagues has a number right on the top of their head -- but obviously it's a major economic community there, and the banks in this particular case will probably look to outsource some of this.

By the way, I think that's why we have a lot of these acquisition opportunities. It does take investment there. I think some of the banks are saying, we don't want to spend our money in that direction but someone else be the service provider that provides that at the point-of-sale. I think we are now building a real scale advantage there, which even the big banks there will say this is one thing we'll let somebody else do.

Liz Grausam - Goldman Sachs

Should we expect to see the M&A pipeline in Europe heat up a little bit more as a result of this initiative? I think 2008 and 2010 are some of the main milestones in the project.

Ric Duques

You know, I wouldn't say any more than they have been. I would think we are in other parts of the world they are equally not because of a regulation, but because of other factors. I think you should look for things outside of the European community on an acquisition basis.

Liz Grausam - Goldman Sachs

The change in your relationship with Visa, will you be partnering with them at all in international markets or is this more of a U.S. settlement that you came to? How does that affect your First Data net strategy if at all?

Ric Duques

It's basically U.S. would be the answer to one question. The First Data net strategy really is, we agreed to basically settle the transactions that we do at the point of sale directly with Visa. That was part of the settlement. So from that standpoint Visa net really never got any traction anywhere. It certainly wasn't a big contributor to revenue or profit; or even a contributor.

But with Visa, it's a friendly environment now, or at least more friendly. Therefore, we expect together when they offer a product like a few years back they offered signature debit. Well, you know, we would help them with some of the design on that maybe, and be able to process some of those things. Signature debit is already out, of course, but I'm saying the next thing that comes along, we're going to be more collaborative with them.

We're going to meet regularly at the senior level to discuss things we can do together. So it's an evolving process. I'm real happy that we're able to do this and I think so are our clients. Our clients do not like two of their major providers to be squabbling, and now we'll be collaborating.

Liz Grausam - Goldman Sachs

Great. Thank you.

Operator

Our next question comes from Greg Smith - Merrill Lynch.

Greg Smith - Merrill Lynch

Yes, hi. Just wanted to circle back on the issue of the cash building and not paying down debt or buying back stock. You talked about wanting some flexibility, but just given the cash flow you're generating every quarter, it seems like you would have that anyway even if you were paying down debt or buying back stock. So it begs the question, potentially might you do a larger acquisition or something else out there? Can you talk about that a little bit more?

Ric Duques

That's nothing imminent but since I didn't satisfy you with my answer I'll let Kim try to do it. There's nothing big out there, Greg, that we have right now. I mean real big.

Kimberly S. Patmore

Greg, I think what we're trying to do is really just in anticipation of the spin and how we structure the debt ultimately that is on Western Union's books as well as on First Data. So we're just really trying to get that flexibility right before the spin. I think you know, in general you would see it be more at normal levels going forward. But it's really just related to the spin.

Greg Smith - Merrill Lynch

Okay. And then at Western Union, just given this issue over immigration, is there anything you're doing that's impacting expenses? I mean, stepping up advertising or marketing? Can any of that potentially help, or are you really just running the business as usual and kind of waiting out this storm?

Ric Duques

It's closer to the latter. We called out that we had 9% year-over-year growth in marketing. So we're continuing to market. But that's not so much tied to making anybody feel good. It's just our normal opening up new agent locations. We're still on track. We think we're going to be close to the 300,000. When we do that we do marketing and promotion around that. So that part of it is business as usual.

A lot of this thing, it's the uncertainty and it's a political hot issue right now.

Greg Smith - Merrill Lynch

I don't believe you gave any metrics on India and China growth at Western Union, possibly the revenue growth and amount of total revenues they contribute?

Ric Duques

We gave 100% transaction growth in India and 40% in China. Kim, do you have the rest?

Kimberly S. Patmore

Yes, and right now we're actually about 4%, if you combine China and India as a percent of revenue. If you remember last quarter, we talked about being at about 3.4%; so now we're right around 4%.

Greg Smith - Merrill Lynch

Great. Thank you.

Operator

Our next question comes from Bryan Keane - Prudential.

Bryan Keane – Prudential

Hi, good morning. Kim, I guess I still find the guidance a little bit confusing. The range of $2.35 to $2.42 now includes the $0.035 as a one-time litigation gain. Doesn't it by definition, if we pulled out that gain like some of those analysts do, that range falls to $2.315 to $2.385; but you guys feel comfortable with the $2.35 type level? That's what you you're trying to say?

Ric Duques

Go ahead, Kim.

Kimberly S. Patmore

Yes. We feel very comfortable on the low end of that range of $2.35 without the benefit of Visa. Maybe you want to amplify, Ric.

Ric Duques

I mean, here is what the issue is: we issued two sentences in the release. One said because we got the settlement we have to include it there. We always include that because of GAAP accounting. But you have to read the second sentence which says even if Western Union continues the trend that it's on, we do not need that $0.035 to meet the bottom end of the range; and the bottom end of the range is defined as $2.35 to $2.42. So we apologize for any confusion there. We don't really need that $0.035 that's going to be there. We know you guys deduct it out anyway, so.

Bryan Keane – Prudential

Right, but analysts, we're going to pull that out and by definition you're saying it's $2.315 to $2.385 even though you feel comfortable with $2.35. That's what I'm trying to get at.

Ric Duques

We tried to get you off of the $2.315 by saying specifically that we felt that taking that out, excluding that, we would still be at $2.35 so we did what I think you just concluded, that we said it's $2.35 at the bottom.

Bryan Keane – Prudential

Right. Right. Right. Just another clarification. On that $2.35 to $2.42 range, is the 2Q '06 earnings $0.56 for that or $0.55?

Ric Duques

The reported earnings is $0.56. I think you'll pull out the $0.01 and you'll call it $0.55. I mean, our issue is we report GAAP earnings. We report GAAP earnings and then someone decides that GAAP earnings that have one-time things in there, the one-time things should be deducted. We're open. We give you the numbers. But to answer your question, the $2.30 – the $0.56 would be $0.55 by those of you that are doing the arithmetic here because there's a couple of items in there. One goes one way, one goes to the other; it nets out to a plus $0.01 to make it $0.56. After we go through all that work, you take it away.

Bryan Keane – Prudential

Right. But you include $0.56. We're going to pull it out

Ric Duques

Yes, I know. We report GAAP earnings. $0.56 is GAAP earnings. The accounting police, you know, require you to do that if you're reporting GAAP earnings.

Bryan Keane – Prudential

No I know, it just gets confusing because you're calling it something continuing operations –

Ric Duques

Well you could use GAAP.
Bryan Keane – Prudential

No. It's just confusing because you're calling stuff continuing operations because the accountants are forcing you guys; although us analysts, we don't count litigation costs.

Ric Duques

Let me tell you, next year we'll have a chance to revisit it. Maybe we'll report it some other way, but whatever we do, we'll have to reconcile it back to GAAP. If we report something other than GAAP, like in this case $0.55, then we'd have to reconcile it back to GAAP. So we thought since we're all accountants, we thought we'd start with GAAP. But obviously that's creating some confusion.

Bryan Keane – Prudential

All right. Then just finally I want to circle back to the immigration issue on Western Union. I guess MoneyGram, they said they didn't see any weakness except for maybe during the strike period. So I was caught by surprise that you guys saw that large of an impact. What's the discrepancy there?

Ric Duques

They declined 11% in transactions, but I think we're a bigger target. We're just more prevalent in the marketplace and so I think that's the explanation for it. When you're the leader and there's tension in that marketplace you're the one that's going to be impacted first. You are the one that's probably going to be impacted most severely.

So that's the explanation for that. But all the trends, the Banca de Mexico, MoneyGram, I don't know if anybody else is going to report the second item here, probably not, they're all smaller players. We talked to agents, we talked to customers, we talked to a lot of people. So we know it's happening.

Bryan Keane – Prudential

Right. The crux of the issue is that the immigrants are afraid that you're going to turn them in or their data somehow? That’s why they are not using?

Ric Duques

They get arrested, they have been harassed. Do they have the documentation they need? Does some family member not have it? They have it, but their family doesn't have it. I don't think we think about that because we're citizens, most of us are citizens. So I think the anxiety that is created there is far more severe than the folks sitting around the Beltway or the folks around this table in the business community think it is.

I mean, it's not a good thing. We talked about it, there's 40 million people here, maybe 10 million or 11 million of them, maybe 20% or 25% are illegal, but that means 75% are regular upstanding citizens like us.

Bryan Keane – Prudential

Right, but I just don't see it possible that Western Union is going to turn data over and try to round up these illegal immigrants; that people could be fearful of.

Ric Duques

No, it's not us, it has nothing to do with us.

Bryan Keane – Prudential

Right. Okay. Thank you very much.

Operator

Our next question comes from Charlie Murphy from Morgan Stanley.

Charlie Murphy - Morgan Stanley

Thanks. Hey, Ric. I was wondering why the immigration issue would have affected the domestic business the US to US, US to Canada business? Is it safe to say that that business is well above Western Union's segment average margin?

Ric Duques

Yes. It's well above the average margin. I think the way I would describe it is it's very, very Hispanic focused. So within the US, we have a very strong Hispanic community wiring money across the United States and to Canada. That's a pretty mature business, very stable, not real high growth but real good margins. So we got some impact there. I think I said it went down from 4.5% transactions to 1.2% transactions. That doesn't sound like a lot but that's a pretty important segment.

Charlie Murphy - Morgan Stanley

How many agent locations did you have at the end of the quarter?

Ric Duques

About 280.

Charlie Murphy - Morgan Stanley

And if we expect Western Union margins to stay similar to second quarter for the rest of the year, what segment is going to pick up the slack?

Ric Duques

Commercial is way outperforming what we expected. First Data International has got on the top line I think we'll be in relatively good shape there. You have to make the adjustment, if you had $250 million of revenue for acquisitions, it is going to be $130 million now. There's $10 million less of profit.

But I think the primary one, it would be commercial and secondarily these enormous grow overs, we can say goodbye to them starting in August. So in First Data Institution Services, you're going to see a change there, a positive change there.

Charlie Murphy - Morgan Stanley

Very quickly, how much in spin costs were incorporated into Western Union operating costs in the quarter?

Kimberly S. Patmore

It was about $2 million, a little over $2 million in their regular operations.

Charlie Murphy - Morgan Stanley

Thank you.

Operator

Our next question comes from Pat Burton of Citigroup.

Pat Burton - Citigroup

Hi. Good morning. I have a separate question. That has to deal with the stock options at the Company, Ric. Once Western Union has spun off, how will that be recognized from each management team's perspective? Will the Western Union people just get Western Union options and you guys will keep options just in new First Data? Or will you get them in both companies? Thanks.

Ric Duques

Basically that's not final. I think I need to have you hold that question until the call in mid-September when we're out there talking to you and I think we'll give you some more specifics on that.

Pat Burton - Citigroup

Okay, thanks. As a follow-up, apparently you didn't see any weakness on the Commercial Services side from falling retail same-store sales and the rising price of gas. I just wondered about that. Is that correct?

Ric Duques

That's a good question. No, I mean really we haven't. We had 13% transaction growth in there. I do think we're doing a better job retaining customers. That's a huge thing. You know, if you retain the customers as opposed to losing them and then having to back fill, that's big. In the past we've had many merchants that we haven't boarded, started processing for too long a period of time. I'm embarrassed to tell you how long. But now we're getting them boarded in two days.

So I think you're seeing a positive impact on that, which basically is overshadowing any slowdown at the point-of-sale. It could be a slowdown meaning someone paid a little bit less, buys a little bit less but they do buy. That's a transaction for us and that's positive.

Pat Burton - Citigroup

Thank you.

Operator

Our next question comes from Kartik Mehta from FTN Midwest.

Kartik Mehta - FTN Midwest

Good morning. Ric, I had a question on Mexico. As you see the slowdown, are you at all concerned or have you seen any price degradation in the market from other competitors?

Ric Duques

No, we pointed out that the branded Western Union transactions grew at 10% in revenue and 11% on the bottom line.

Kartik Mehta - FTN Midwest

10% transaction, 11% revenue.

Ric Duques

10% transaction, 11% revenue, which would suggest any price compression there is stabilizing, which would be the answer to the question. Transactions were up more than that.

Kartik Mehta - FTN Midwest

So you have not seen any sense then as competitors get a little scared about their transaction growth?

Kimberly S. Patmore

Meaning there wasn't anything from the competitors, really the pricing remained --

Ric Duques

No, I think there's some stability in the pricing in that corridor.

Kartik Mehta - FTN Midwest

Is the same-store growth for Western Union, did that slowdown just reflect it because of Mexico, or would there be anything else related to that?

Ric Duques

I think that's about it. I think we had 16% last year, last quarter and 12% this quarter. I think that's really what you just said. Mexico.

Kartik Mehta - FTN Midwest

A question on guidance. If we take out the $0.035 you talked about the $2.35 to $2.42 you feel real good about the low end of that. Is not meeting the high end, just reflective of the Western Union slowdown and that $10 million loss in First Data International? Would there be anything else?

Ric Duques

I think you got the two items right there. The $0.01 for the First Data International, that's $10 million; and you said 3% or so on Western Union. But those are the two items.

Kartik Mehta - FTN Midwest

Okay. Thank you very much.

Operator

Our next question comes from Tim Willi from A.G. Edwards.

Tim Willi - A.G. Edwards

Thank you. Good morning. Two questions if I could. First, to the degree you can, talk about the ADP payroll partnership just in terms of any insight into the economics your sales partners will receive when they are able to sell a payroll contract into a small business? Is it a finder's fee, is it an ongoing residual payment to those sales partners? How will that work?

Ric Duques

No, first, it affects the commission, if you will. So that's good and it's another product we can serve, clearly that's good for ADP. The payroll card that I mentioned behind that, that one has recurring revenue, processing characteristics that we get. So the ability in a warm environment, if you will, to sell an employer to issue payroll cards that we process is a significant thing for us.

As this relationship goes forward, we expect to expand it into other areas but basically that's what the deal is. It's another product to sell. It's different than the regular merchant salesman that goes into a small business to try to sell merchant acquiring.

Tim Willi - A.G. Edwards

The second question is you mentioned improvements in merchant attrition or retention depending upon how you want to phrase it. Can you give us in general terms, are those retention rates up 5% from last year, 20% from last year? What's the magnitude of the improvement?

Ric Duques

I think what we've said in the past is we want to see a little history here before we either declare victory or start throwing numbers around, because there's a lot of attrition. Then you have to separate out going out of business merchants as opposed to going to a competitor. So I think it's a tricky disclosure, if you will. I don't want to misrepresent anything. So basically we're just saying we're seeing a trend go down and when we have something really we think is meaningful and long term we'll give it to you.

Tim Willi - A.G. Edwards

Okay. Thank you.

Ric Duques

Operator, I think we have time for just one more question if we could.

Operator

Thank you. Our last question comes from Paul Bartolai - Credit Suisse.

Paul Bartolai - Credit Suisse

Thanks, good morning. Ric, you guys have seen some pretty nice progress on the commercial side. Just curious if you could give us any more color on what you think is driving that acceleration of the organic growth from 1Q to 2Q.

Ric Duques

I think the team was focused in commercial on the Concord integration for two years. I think there was a pent-up desire, if you will, on the part of the team, and we had Ed Labry in there who is really sales focused, and it is a sales culture and a sales business. I think now they have been unleashed. They are just doing a terrific job for us. That's why I try to coin it; it's really just basics but the basics are sometimes hard to do.

I think we're doing really, really well activation, in keeping the clients that we have, going through alternative channels, working with the alliances. It's just real good right now.

Paul Bartolai - Credit Suisse

Same type of question internationally. I think organic growth went from 3% in Q1 to 15% in Q2.

Ric Duques

Listen, it's a management team. Pam Patsley is there. She's got team, we met them a couple of weeks ago. They're a terrific group. They're fired up. They feel like they're on a winning team and it's a good feeling.

Paul Bartolai - Credit Suisse

Great. Then just one last question, did you say anything about your expectations for 3Q in terms of guidance?

Ric Duques

No. There's too much going on in there. What we did say and I'll say it now. When we go on the road show I'll give First Data guidance, and give Western Union guidance, and I think that will help you.

We're comfortable with the year as we just described, but we didn't give any guidance. You got hooked on that. We gave you guidance in the first quarter, we gave you guidance in the second quarter, but that was atypical. That was a lot of stuff going on, so we'll just come out with our positions in September.

Paul Bartolai - Credit Suisse

Great. Thanks, Ric.

Ric Duques

Thanks, everybody. I think that's the end of the call. Thank you.

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