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The Western Union Company (NYSE:WU)

Q3 2009 Earnings Call

October 20, 2009 8:30 am ET

Executives

Michael Salop - Senior Vice President, Investor Relations

Christina Gold - President & Chief Executive Officer

Scott Scheirman - Chief Financial Officer

Analysts

Greg Smith - Duncan Williams

Kartik Mehta – Northcoast Research

Bryan Keane – Credit Suisse

Tien-Tsin Huang – JP Morgan

James Kissane – Bank of America-Merrill Lynch

Jason Kupferberg – UBS

Julio Quinteros – Goldman Sachs

Ashwin Shirvaikar – Citigroup

Christopher Mammone – Deutsche Bank

Robert Napoli - Piper Jaffray

Darrin Peller - Barclays Capital

Operator

Welcome to the third quarter 2009 Western Union Company earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call Mr. Michael Salop - Senior Vice President, Investor Relations.

Michael Salop

Thank you and good morning. I am pleased to have recently joined the company and I look forward to working with everyone in the future. Today's call will include comments from Christina Gold, President and Chief Executive Officer, and Scott Scheirman, Executive Vice President and Chief Financial Officer. Christina will provide a brief overview of the third quarter, Scott will give a more detailed review of the financial results, and then Christina will update you on the company's strategic initiatives. After the comments, we will have time for your questions.

As we indicated in our press release, we have prepared slides to accompany this call and Web cast. These slides are available at www.WesternUnion.com under the Investor Relations tab and will remain available after the call.

Before turning the call over to Christina, I want to remind you that today’s call is being recorded and that our comments include forward-looking statements. Please refer to the cautionary language in the earnings release and in Western Union's filings with the Securities and Exchange Commission, including the 2008 Form 10-K, for additional information concerning factors that could cause actual results to differ materially from the forward-looking statements.

During the call, we will discuss some items that do not conform to generally accepted accounting principles. We have reconciled those measures to the most comparable GAAP measures on our Web site, www.WesternUnion.com, under the Investor Relations section.

All statements made by Western Union officers on this call are the property of The Western Union Company and subject to copyright protection. Other than the replay, Western Union has not authorized and disclaims any responsibility for any recording, replay or distribution of any transcription of this call.

I would now like to turn the call over to Christina Gold.

Christina Gold

Thank you and welcome to our third quarter call.

The company delivered solid results in the quarter with reported revenue of $1.3 billion and earnings per share of $0.26, or $0.33 excluding a charge for an anticipated settlement involving the State of Arizona. As you are probably aware, the legal and regulatory environment in Arizona has been challenging for our company for a number of years.

During the quarter we accrued $71.0 million related to an anticipated regulatory settlement. The anticipated settlement includes resolution of all outstanding legal issues and claims of the State of Arizona, as well as a multi-state agreement to fund a not-for-profit organization which will promote safety and security along the entire U.S. and Mexico border.

We have always had common policy goals with Arizona but have differed on the best procedures to achieve these goals. Our objective is to move forward without the uncertainty surrounding this issues, as well as to contribute to improving conditions along the border.

The legal matters date back to 2003 and the compliance procedures involved are not an issue today. Over the years, we have made significant improvements to our compliance program, which we believe are the best in the industry. The agreement is not yet finalized but we anticipate completion before the end of the year. Scott will give details on the settlement accrual in his financial review.

Turning to the business, in the third quarter we were pleased with our operational performance as transaction and revenue trends were consistent with the second quarter. The geographic diversity of our business enables us to shift investments in response to changing economic conditions.

C2C revenue declines 5% in the quarter, or declined 3% constant-currency adjusted, on 3% transaction growth.

Average revenue and principal amount per transaction were consistent with the levels experienced in the first half of the year. Our objective is to gain market share and we believe we have continued to make progress on this goal in 2009.

On a regional basis Europe, Middle East, Africa, and South Asia posted a revenue decrease of 3% with 8% transaction growth. Western Europe experienced consistent transaction growth whereas compared to the second quarter, while Spain and Russia continued to be challenging markets in the region. The Gulf States delivered strong transaction growth, although growth moderated compared to the second quarter. In India revenue grew 8% and transactions increased 16%.

We completed several agent signings in the region, including Quick Money SA in Morocco, which operates 1,500 locations, Oolu[?] Exchange in the United Arab Emirates, and Sonali Bank, which is the largest government sector bank in Bangladesh. The Tartar Sand Post in Russian, which as the potential to add 1,000 locations, also joined the network.

The Americas region experienced a 10% revenue decline and a 4% transaction decrease. These rates showed slight improvement from the second quarter. Mexico results were stable relative to the second quarter as revenue declined 18% and transactions declined 13% in the quarter. While Vego and our independent class of trade underperformed market data, our larger regional and national agents performed in line. Our U.S. outbound business, the largest revenue component of our Americas region, continued to post stable transaction trends.

In the Americas we are executing on our go-to-market strategy, which includes growing the network through the banking class of trade, introducing new products with the expanded prepaid programs, and repositioning of our domestic money transfer business through pricing, targeted marketing on customer segment expansion.

The U.S. domestic money transfer business declined 15% in revenue and 9% in transactions in the quarter and has exhibited negative trends for an extended period. In the fourth quarter we are implementing a repositioning of our domestic money transfer business. On October 1 we implemented new domestic pricing that established standardized national prices and brought more consistency relative to U.S. outbound pricing. We launched a marketing blitz around the new pricing campaign and we will continue with significant promotional activity throughout the holidays.

The repositioning is designed to drive accelerated customer usage and improvement in transaction growth in the U.S. domestic market. The price actions are included in our 2% pricing reduction outlook for the year and we believe this is the right repositioning to turn around our domestic money transfer business.

Moving to Asia Pacific, revenue in the quarter increased 5%, with a 15% increase in transactions. China's trends improved relative to the first half, with transaction and revenue growth of 7%. Our strategies to drive growth are beginning to pay dividends. Our targeted market efforts reflect an enhanced understanding of the diverse groups within China and the distinct related send locations.

We were pleased to renew our agreement with the Agricultural Bank of China with an additional 15,000 locations expected by 2011. Once activated these additions will bring our total location count in China to approximately 40,000.

We are further developing other Asian countries with promising long-term growth characteristics. Indonesia is a prime example. The country represents a top 20 inbound remittance market. During the third quarter we had strong transaction growth in Indonesia and we launched our 10,000th agent location in the country.

We strongly believe Asia is a great long-term opportunity for us as it represents 20% of the global remittance market but only 8% of Western Union's revenue.

The Philippines remains an important market, although transaction growth moderated from the second quarter, given the country's connection to the Gulf States.

As you are aware, many parts of the Philippines have encountered devastating flooding brought by tropical storm, Ketsana. The Western Union Foundation and our regional operating center in the Philippines have begun a number of initiatives to assist in relief and reconstruction efforts. The Western Union Foundation is also contributing to emergency response to the hardships inflicted by disasters in Indonesia, Samoa, and India.

Turning back to the business, globally we continue to focus on growing our core through a variety of channels, including our intra-country transfers, WesternUnion.com and Account to Cash. Each of these channels represents less than 2% of existing company revenues but they are growing rapidly and offer significant opportunity. Our intra-country money transfer business outside the U.S. grew transactions at a double-digit rate in the quarter.

The .com service is available in 14 send countries, including the top five European send markets. The profitable and high-growth channel posted double-digit transaction growth in the third quarter, including over 40% transaction growth internationally.

Our Account to Cash transactions have grown more than 60% year-to-date with 10 banks currently offering the service. Account to Cash provides Western Union connectivity to millions of account holders, many of whom are new to our brand. As we focus on expanding partnerships with banks, we expect our Account to Cash offering to become a more significant part of our business.

Turning to global business payments, revenue declined 3% while transactions increased 2%. Revenues were aided by $8.0 million from the Custom House acquisition, which closed on September 1.

Our consumer bill payment offering in the U.S. provides same-day bill payments through our relationships with more than 4,000 billers. We can leverage these relationships in our systems to offer convenience to mainstream bank consumers, as well, and we are pleased that Western Union's expedited bill payment services is now being offered to Wells Fargo online banking customers.

Overall, we were pleased with the company's operational performance in the third quarter as revenue and transaction trends stabilized.

Now, I would like to turn the call over to Scott for a more detailed financial review.

Scott Scheirman

Revenue for the third quarter was $1.3 billion, down 5% on a reported basis, and down 2% constant currency adjusted.

Custom House added $8.0 million to revenue and had a $5.0 million operating loss, primarily due to acquisition-related expenses, including amortization and integration costs.

We reported GAAP earnings per share of $0.26, or EPS of $0.33 excluding the settlement accrual. On a constant-currency basis, EPS excluding accrual was $0.01 lower. EPS of the third quarter of 2008 was $0.33.

During the quarter the company recorded a pre-tax accrual of $71.0 million related to the anticipated resolution of issues with the State of Arizona and a multi-state agreement to fund a not-for-profit organization. A significant portion of the accrual relates to funding this organization, which will promote safety and security along the entire U.S. and Mexico border.

In addition, as part of the agreement, the company anticipates committing to make further investments to its compliance programs in the U.S. and Mexico border area over the next two to three years. The incremental EPS impact from these investments is estimated to be less than $0.01 per year over that period.

We do not expect the terms of the anticipated settlement agreement and the related compliance investments to have a material, adverse impact on the company's future performance. We will work closely with our agents, customers, and other key stakeholders to reinforce confidence in our compliance programs.

Turning back to the business performance, third quarter transaction fee revenue, which made up 79% of company revenue, declined 5%. Foreign exchange revenue represented 18% of total company revenue and it was flat year-over-year. Both transaction fee and foreign exchange revenue were negatively affected by foreign exchange translation.

The key trends in the business were consistent with the prior quarter. We experienced year-over-year C2C transaction growth of 3% while the average principal per transaction was down 4%, constant-currency adjusted.

Revenue and principal amounts per transaction were comparable to the first half of 2009. Most importantly, we find that our customers continue to send money and we believe we gain share in a cross-border of mixed markets. In the third quarter the amount of consumer-to-consumer cross-border principal transfers through our network declined 5%, or was down 1% constant-currency adjusted. For the first nine months the amount declined 5%, or was flat constant-currency adjusted.

The World Bank custom mix for full year 2009 market for remittances to developing countries will decline 7% to 10% while our AD forecasts a 7% decline for cross-border remittances. These organizations are forecasting slight market growth in 2010.

Cost of services represented 56.5% of revenue and improved 50 basis points compared to the third quarter of 2008. Operational improvements enabled the company to maintain strong gross margins despite lower revenue and included the benefits of taking FEXCO direct cost reductions, selected agent commission initiatives, and overall expense management.

SG&A was 22% of revenue in the quarter as reported, including an impact of 5% related to the $71.0 million settlement accrual. Excluding the accrual, SG&A as a percentage of revenue was consistent with the second quarter. Costs related to the FEXCO and Custom House acquisitions also impacted SG&A trends.

Marketing totaled approximately 4.5% of revenue for the quarter. Investing in marketing remains a priority for Western Union to build awareness and drive transaction growth and we plan to spend 5% of revenue on marketing for the full year.

Consolidated operating margin was 21% in the quarter, or 27% excluding the settlement accrual. This compares to 27% in the third quarter of 2008.

Our cost structure is about two-thirds variable. This fact, combined with headcount reductions, call center relocations, selected agent commission initiatives, and the consolidation of C2C regions, contributed to strong margin performance on an operational basis.

When the market improves and revenue grows, we believe our business model will support margin expansion.

The tax rate for the third quarter was 27% compared with 28% in the third quarter of 2008. In 2009 we have benefited from a higher proportion of foreign-derived profits, which are taxed at a lower rate compared to U.S.-derived profits and the effect of tax-efficient strategies implemented in 2008.

Now turning to our segments, C2C, which was 85% of total revenue, declined 5%. Constant-currency-adjusted revenue was down 3%. Transaction growth was up 3% in the third quarter, in line with the second quarter of 2009. Our international C2C business saw revenue decline 3%, or flat constant-currency adjusted, while transactions grew 6%.

The portion of the international business representing transactions that originate outside the U.S. saw revenue decline 2%, or growth of 1% constant-currency adjusted on transaction growth of 9%.

C2C operating margin was 28%, consistent with the comparable period last year. The settlement accrual is not included in segment results.

The difference between revenue and transaction growth rates for the C2C segment was approximately 8%. The difference was primarily due to currency translation, geographic mix, product mix between intra- and cross-border transfers, and pricing. Currency translation totaled about ¼ of the difference. The combined impact from the other factors has remained generally consistent with recent quarters. The company continues to expect pricing decreases for the full year to be approximately 2% of revenue.

Our global business payment segment, which includes results from the recently completed Custom House acquisition was 13% of Western Union's revenue in the quarter. Segment revenue declined 3%, or declined 7% excluding Custom House.

The operating margin was 24%, although excluding the Custom House acquisition, it would have been consistent with last-year's margin at 26%. In the near future segment margins will continue to be impacted by Custom House-related costs, including investments to grow the business.

The company's financial position, as demonstrated by our cash balance, cash flow generation, and our A-/A3 credit ratings remain strong.

In the third quarter we repurchased 6.9 million shares at an average price of $18.19 for a total of $125.0 million.

Year-to-date cash flow from operations was $958.0 million, capital expenditures were $67.0 million, and stock repurchases totaled $225.0 million. We now expect our full-year capital expenditures to be closer to $100.0 million than $150.0 million.

We continue to target full-year share repurchases of $400.0 million.

As expected, on October 1 Western Union received cash from First Data, which was invested in a portfolio in a portfolio supporting our retail money order business. Beginning in the first quarter of 2009 these investments, which should average approximately $800.0 million, will appear as settlement assets on our balance sheet with related increase in settlement liabilities.

We remain our prudent investment philosophy by investing in high-rated, liquid debt securities.

At quarter end we had $1.6 billion of cash on hand, with slightly more than half in the United States and $3.0 billion of debts. Our nearest debt maturity is November 2011 and we also have a fully-available $1.5 billion line of credit that expires in 2012.

The company has narrowed its revenue and EPS outlook to the higher end of its previous expectations, excluding the impact of the settlement accrual. The company now expects the following full-year 2009 financial results, including Custom House:

Constant currency revenue to decline 1% to 2%; GAAP revenue to decline 4% to 5%; GAAP operating income margin of approximately 25%, or approximately 27% excluding the settlement accrual; GAAP EPS of $1.15 to $1.20, or $1.23 to $1.28 excluding the settlement accrual; constant currency EPS $0.01 lower; cash flow from operations to exceed $1.1 billion; and a tax rate of 25% to 26%.

Our previous outlook was for constant current EPS of $1.16 to $1.26 and GAAP EPS of $1.18 to $1.28, which did not include the diluted impacts of $0.08 from the settlement accrual or $0.01 from the Custom House acquisition. In the current outlook Custom House positively impacted revenues by less than 1%.

Through nine months of 2009 operating income margin, excluding the settlement accrual, was 27.5%, while our full-year outlook is approximately 27%. Key operating reasons for the fourth quarter margin include the timing of marketing and investment spending. For example: marketing spending is more heavily weighted to the fourth quarter to support the holidays, including the additional investment behind the domestic business; a full quarter of Custom House amortization and integration costs and investments for growth; and the retail money order conversion, which will negatively impact operating margin by approximately 50 basis points in the fourth quarter due to investing the float in tax exempt securities.

Although the conversion negatively impacts operating margin, the overall EPS impact will be minimal, as there are offsets in interest income expense and the tax rate.

In addition, foreign exchange rates may also swing against operating margin percentages relative to the first nine months. Although a weakened dollar benefits top-line revenue, our foreign-denominated profits are largely hedged so the margin percentage may be negatively impacted.

Our outlook does not include any impact from our patent infringement lawsuit against MoneyGram. As you may be aware, a jury recently awarded Western Union $16.5 million in damages from MoneyGram for infringing on our patented money transfer by phone service. And since the verdict is still being contested by MoneyGram, we have not included the $16.5 million award in our outlook.

I will now turn the call back to Christina for an update on our growth initiatives.

Christina Gold

Our priority growth initiatives stem from one central strategy, growing a profitable portfolio of complementary businesses which extends our leadership position in moving money around the world quickly and in a compliant manner. These five key initiatives include banking, the payment services directive in Europe, business-to-business cross-border payments, prepaid, and mobile.

Our banking strategy is gaining momentum. The large bank relationships that are currently operational are performing well and early experiences indicate they are bringing new customers to Western Union. In fact, in the first year of these relationships, over half of the transactions involve customers who had not used Western Union during the prior 12 months.

Banks, which were nearly non-existent in our U.S. and Canadian network a year ago, now represent over 10% of our location distribution in those countries and the pipeline is encouraging.

U.S. Bank is operational. We are preparing to launch Pittsburgh locations. And Fidelity National Information Services has begun signing relationships with small and medium size financial institutions. In the European Union, the payment services directive is effective on November 1 and we received approval for our license from the U.K. regulatory authorities.

We have integrated the sales force and operational infrastructure acquired through FEXCO and we are utilizing this platform to grow in Europe. Through PSD we expect to attract additional customers while expanding the classes of trade that offer money transfer services in countries that previously limited our agents to banks and post offices. We recently signed three letters of agreement with Ortel, Pay Up, and LaGardere, providing the potential for 15,000 additional retail locations throughout Europe.

In the global business payment segment, we completed our Custom House acquisition on September 1. Custom House offers small- and medium-sized businesses exceptional customer service, reliability, and competitive pricing when making cross-border business payments. We estimate this market for SMEs to generate global revenue comparable to, or larger than, the consumer-to-consumer money transfer market.

With a proven track record of success, we are glad to have the Custom House team on board as we focus on integrating and expanding this scalable opportunity. We are investing now in order to more deeply penetrate existing markets, adding sales offices and staff in the United States, Canada, the U.K. and Australia. We are also enhancing our Web site capabilities and preparing to open offices in new markets.

Custom House offers exciting opportunities across a wide range of geographies and we are well on our way to establishing the platform for growth.

In prepaid, our testing over the course of the past few months has provided valuable information for us to expand our offerings. We currently have two reloadable prepaid programs in the market. First, our MoneyWise Visa prepaid card provides a strong value proposition to consumers, particularly the underbanked. This card enables consumers to add money conveniently, including the ability to load a Western Union money transfer directly onto the card.

Our new prepaid Visa Gold Card has all of the same great benefits of the MoneyWise program and it integrates our industry-leading Gold Card Rewards. We continue to pilot both programs and are expanding them through a variety of marketing efforts, including direct mail, online email, and in retail locations.

Cash-to-cash money transfer remains a dominant preference among the consumers moving money today. However, mobile is emerging as a complementary channel for money transfer and there is a long-term opportunity in transforming mobile phones into virtual Western Union locations.

The potential of mobile money was recently described in an economist article which highlighted the success of Safaricom and Pesa. This rapidly growing offering provides intra-country mobile money transfer within Kenya. This is a somewhat unique situation where the leading network operator and mobile wallets have been widely adopted. We are actively participating in the Kenya opportunity through cross-border mobile money transfer.

We have expanded our service with Vodafone and sister company, Safaricom. We now have more than 40 Western Union locations in the U.K. where consumers can send money directly to the phones of more than 6.0 million Safaricom subscribers with M-pesa wallets. We are targeting all the major Kenya send locations in the U.K. and by year end we expect to have 80%, or 2,000, of these key locations enabled for mobile transfer.

The Philippines is another one of the few countries currently equipped with mobile wallets. Through partnerships with Smart and Globe we enacted pilots for mobile transfers to that country from the U.S., UAE, Hong Kong, and Singapore. We also plan to expand connectivity in these markets in the fourth quarter.

In addition, we recently announced an alliance with Maxis, a major mobile operator in Malaysia. We are working together to launch a service in 2010 that will allow the 11.0 million Maxis subscribers to send money cross-border remittances directly from their mobile phones. Recipients will have the ability to pick up the funds in cash at any Western Union location in over 200 countries. This represents the first Western Union offering of cross-border remittances from a mobile phone for worldwide cash payouts.

Western Union is well positioned in mobile money transfer. Our current trials already provide access to more than 14.0 million subscribers who have phones enabled for money transfer in Kenya and the Philippines. Western Union provides flexibility and convenience in the transfer process, whether it's an agent location, a computer terminal, a mobile phone, or a prepaid card, our infrastructure connects it all.

While mobile is a longer-term opportunity, we are building the foundation today to capitalize as the market evolves.

In summary, we are pleased with our financial performance and strategic advances. We have delivered solid results in a challenging environment and key operational trends have stabilized. We remain focused on gaining market share, and we believe we are, with a world-class brand, 400,000 agent locations, strong balance sheet and cash flow, encouraging progress on key growth initiatives, including our banking strategy, retail expansion in Europe, business-to-business payments and great strides on our channel strategy, including mobile, Account to Cash, WesternUnion.com, and intra-country money transfer. And we have great confidence in the future.

Thank you very much for listening to us today. And we will take our first question.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Greg Smith - Duncan Williams.

Greg Smith - Duncan Williams

Christina, you talked about prepaid. I was hoping you could expand a little on that and what you think the market opportunity is and how the play out for Western Union.

Christina Gold

As you look at the market for prepaids it's in the billions of dollars. It's a very large category and what we're trying to determine exactly is what space are we playing in and we really are trying to look at our customers and see a couple of things.

Firstly, we are looking prepaid as an alternative in terms of using it for home delivery and direct to consumers. And that's one of the tests that we're doing with the MoneyWise card, and we're seeing good uptake on that and good performance there.

And then the other piece of it is how do we expand our Gold program, where we have about 8.0 million consumers in the U.S. on the Gold card, and can we move them over to the prepaid, and we're seeing uptake on that as well.

So I would say that as we come into 2010 we will be in a better position to clarify exactly the size that we are looking at because we are testing a lot of alternatives. But preliminary, we are very pleased with what we see. We also see good metrics in terms of profitability and in terms of return for the company, so we're not giving ourselves a difficulty in terms of margin.

So I think all of the things are lining up extremely well and as we bring our plans to you for 2010 we can give you a little more detail on that.

Greg Smith - Duncan Williams

Just a few more comments about the payment services directive. You have obviously had some nice announcements, the new agents. Have things met your expectations on that front and progressing as you expected or has there been an stumbling or roadblocks in any way?

Christina Gold

It's gone really well because there are a couple of things. Firstly, the acquisition of FEXCO has been an important part of this and our integration has been excellent. And then with the 15,000 announcement, and the letters of agreement, that was something we are very pleased with.

But certainly we see there is a lot more runway to grow here so our team is working actively to sign up more locations so look for more news from us over the next couple of months.

Operator

Your next question comes from Kartik Mehta – Northcoast Research.

Kartik Mehta – Northcoast Research

Scott, you mentioned as far as margins and why they would be down in the fourth quarter and I think you mentioned three things. And I was just trying to understand on the marketing side, is it this fourth quarter? Will you be marketing more this fourth quarter than you have previously or is this normal for seasonal?

And then on the money order, the negative impact you are going to have in the fourth quarter, would that also play out for the remaining three quarters as well, or can you talk about how that might work.

Scott Scheirman

Sure. Let me first start with money order and then I will come back to marketing here in a minute. Money order in simple terms, yes, will play out for the next three quarters in 2010 because we've invested those funds in tax-free-type investments, so there will be some geographic issues on the income statements as far as operating income, but we believe the net income will directionally be the same as we have been earning historically.

And marketing, what you might recall is we entered the year cautious just because of the economic landscape and what 2009 may shape up to be. So actually in the first quarter of the year, we were closer to 4% of our marketing spend, so as we have moved through the year, as we have seen the economy and the markets develop, we are going to invest more in the fourth quarter compared to earlier in the year and probably a tad bit more compared to prior year, really in a goal to continue to gain market share, which we believe we've done. But also to support our domestic business.

But our goal is to invest for growth and continue to gain share as we move forward.

Kartik Mehta – Northcoast Research

Christina, can you talk a little about what you are seeing in terms of immigration trends. If you are seeing them overall improve or remain the same.

Christina Gold

It's varied around the globe but I think what we see as we look at the United States in terms of particularly for the U.S./Mexico business, we are not seeing new immigration coming into the country. We are not seeing people leave but there is not a new level of migration in.

Around the globe I think the one area where we are seeing some exit is from the Middle East. We have seen some reduction in migration but I think that is very much connected to the price of oil, so we may see some uptick and come back as the price of oil goes back.

So we are not seeing big changes in trend. I think a little bit, we are seeing it in Russian, there are some issues. And obviously Spain continues to be challenged and that is very much driven by unemployment.

But as we look at our numbers and we look at the World Bank, there is a call for a return to modest growth in 2010.

Kartik Mehta – Northcoast Research

And just one last question. You talked a little about repositioning the domestic business. Do you think is the repositioning the result of just what has happened in the economy or it's because competition has changed? Or there some other factors that are forcing you or wanting you to reposition this business?

Christina Gold

I think we've looked at the domestic business having a lot of challenges over the last period of time and clearly a lot of that has come from the economy and also the high percentage of Hispanic consumers within the domestic business. But as we looked at it and we looked at our, let's say pricing, let's say from U.S. to China versus New York to Chicago, there just seems to be some inconsistencies.

So Stuart's team did an excellent job of doing a lot of research and a lot of work to test different price points and also different points in terms of marketing. We now have a standard pricing and that's really critical for us because as we go to market and whether we advertise in one city or another, we don't have to change anything now. It's a common price point across the country, excellent value. Still premium priced but I think the margin that they put in place, and we are heaving up, we are putting a little bit more than we normally would in the fourth quarter on domestic because we feel it's an opportunity now to go back in and push hard to get people back into the business, to gain market share and be ready for 2010.

Operator

Your next question comes from Bryan Keane – Credit Suisse.

Bryan Keane – Credit Suisse

Christina, can you talk a little about compliance? I know with the settlement with Arizona higher compliance procedures are in the costs there. Can you talk about what the competition has to do for compliance as well and how that will evolve.

Christina Gold

As we look at compliance, we really feel we have the state-of-art and really best-in-class in terms of compliance. And over the years we've invested and really improved our systems more and more. But this is an ongoing process. As you go into new technologies and new products, like prepaid, like mobile, it requires even more investment and so that is something that we have continued to do over the years.

From a competitive point of view, being the preeminent player in a marketplace you are always the one that people look at to set the standards. And as we look at the issues that we had in Arizona, I think that we all agree in terms of wanting to do the right thing and have a safe and secure border, but maybe not in terms of some of the operational procedures, so we really feel this is something that goes back to 2003 and we are really pleased that we can have a multi-state agreement and put this issue behind us.

Bryan Keane – Credit Suisse

And on China, I saw that bounce back nicely to 7%, both in revenue and transactions. Can you give us a little color as to what happened there?

Christina Gold

I think it's a couple of things. Obviously, the economy there is starting to bounce back so you see that, which has been a help to us. But also, the team is really focused on the grassroots marketing, we've opened offices in other cities. Really looking at China very much like we looked at how we expanded India. Delighted that we have 15,000 more locations are going to be coming from the Agricultural Bank. So we are going to expand our footprint in China, working on our grassroots, and really pleased to see that 7% revenue and transaction growth in the quarter.

Bryan Keane – Credit Suisse

And just overall, I know you took up the guidance to the high end of the range. But just some general comments. Do you believe kind of the worst is behind us and do you think the global economy or the remittance market is starting to recover?

Christina Gold

We feel good about the stabilization. I think obviously from second quarter to third quarter was stable and then some markets picked up a little bit so we feel very good about that. Clearly, there are still some challenges in the Middle East, which was the high growth. It's still growing but not at the same pace.

I think there are different parts of the world are going to have different impacts. There is still the big question in the U.S. on the level of unemployment because that does come to our Mexico quarter. And also the unemployment as it relates to Spain.

But we see stability and also if we look at the World Bank, they are projecting modest growth for next year versus a minus 7 to minus 10 this year, that augers well for us as we look to the future.

Operator

Your next question comes from Tien-Tsin Huang – JP Morgan.

Tien-Tsin Huang – JP Morgan

Just expand on Bryan's question, were there any major surprises in the quarter in terms of country or regional performance?

Christina Gold

I would say no. I think it's pretty consistent with all of the other quarters. If we look at different countries, there was no major deterioration or things that kind of did not perform consistently. So I think we felt pretty comfortable that things have stabilized for us in our business.

Scott Scheirman

And I would add is U.S. outbound trends were consistent with the last few quarters. Western Europe, we're consistent. And those are major send areas for us. Gulf, although the transaction growth rates are stronger, there was some moderation, but C2C transactions, both Q2 and Q3 were 3%. And then the average principal per transaction on a constant-currency basis was down 4%, which was a slight moderation from the second quarter. So the average ticket price is hanging in there, too.

Tien-Tsin Huang – JP Morgan

And on the Mexico front, just the Vego branded underperformance, how much of that is tied to the proactive store closings last quarter versus the other factors? Can you give us an update there?

Christina Gold

We're seeing the small retailers and the Vego, that's really where we're seeing the underperformance so obviously it is tied to Vego performance and the small independents. But if we look at our major chains, they are performing up to the market level. So we're not seeing the same number of closures or the same issues that we had in the first half, but obviously it rolls into the second half, because those locations are no longer there.

But Stuart and his team are looking aggressively to try to increase the number of independents in the network.

Tien-Tsin Huang – JP Morgan

So the solution is to bend the network from here. Any other changes that might be on the horizon?

Christina Gold

For the Mexico business? I think we are looking at in terms of—I think the real issues for that will be a lot related to the U.S. economy and the level of unemployment. We do feel that that is a key indicator that is impacting that business.

Tien-Tsin Huang – JP Morgan

Last one for me, Scott, just a housekeeping question. How big was the integration and acquisition expense of Custom House in the third quarter?

Scott Scheirman

The loss for Custom House was about $5.0 million in the quarter on $8.0 million of revenue and I would say the majority of the $5.0 million loss was related to both integration costs, but also deal costs, as you pay attorneys and accountants and so forth to close the deal.

Tien-Tsin Huang – JP Morgan

So that should ease as we exit the year, correct?

Scott Scheirman

Yes, it should ease. One of the opportunities we see with Custom House in the B2B space—and we've used the word game changer before. Last quarter when we announced that we believe there are opportunities to invest behind that business, to grow it. And to put it in context, we think that the B2B space, the size of that revenue market, is equal to a greater than size of the C2C revenue market and we've grown that to over a $4.0 billion business, 17% share, so we think Custom House is a good investment opportunity for us to drive investment behind as we move forward.

Operator

Your next question comes from James Kissane – Bank of America-Merrill Lynch.

James Kissane – Bank of America-Merrill Lynch

Scott, you mentioned that $100.0 million of capex this year. Is that the number we should be thinking about longer term? Is that the normalized level?

Scott Scheirman

Yes, we have historically run in the neighborhood of $150.0 million the last couple of years. This year we're closer to $100.0 million than $150.0 million. And so what I've got in my mind is somewhere maybe 2% to 3% of our top line, which would be $100.0 million- to $150.0 million-type number.

James Kissane – Bank of America-Merrill Lynch

And the trends in signing bonuses? It seems like your commissions are coming down. It also seems like the signing bonuses have come down somewhat as well.

Scott Scheirman

We've been very successful in signing new agents. We crossed the 400,000 agent mark this quarter. We're very pleased with that. We have renewed key agent relationships. We've had no major agent losses. So we feel like we're in a very good spot with our agents and able to renew those and at times get economic terms that are a little more favorable to us.

James Kissane – Bank of America-Merrill Lynch

Christine, the 15,000 retail locations in Europe, those are not in the 400,000 agent count, right?

Christina Gold

No. The ones that we announce—we only announce the numbers when they are actually active so they won't even be starting to roll them out until after November so they're not in there at all.

James Kissane – Bank of America-Merrill Lynch

How quickly do you think these agents can ramp and what is your sense of their productivity versus the post offices and bank channels in Europe?

Christina Gold

It will depend in terms of exactly where they are located. Obviously there are some agent locations that are in ethnic communities so that does a quicker ramp up. It's also dependent upon the retail company, whether they're willing to ramp out in the middle of their Christmas time, so we kind of balance their needs with our needs. But we would be going through that as quickly as we could, but it could take a year or so to put them all into place. Depending on the 15,000, maybe you get 5,000 or 10,000. It just depends on the network.

And the ramp up, normally we see one to three years in terms of productivity, but because these are on the send side and they offer a unique service, because they will have better hours for our customers, I think they should do very well.

James Kissane – Bank of America-Merrill Lynch

Outside of domestic, can you give us a sense of the pricing trends? It sounds like domestic is coming in but you are sticking to the 2% for the year.

Christina Gold

Yes. And really, the domestic price change was in that 2%.

James Kissane – Bank of America-Merrill Lynch

So it sounds like international might be a little bit better than what you were thinking about in the beginning of the year.

Christina Gold

Well, it varies because it's a mixture of all different quarters and timing but we feel we did do some pricing in international to gain market share but we feel good about our price position and where we are.

Operator

Your next question comes from Jason Kupferberg – UBS.

Jason Kupferberg – UBS

I had a question, to follow-up on the payment services directive. As you look out to 2010, since that will really be the first full year of implementation, can you help us frame the potential incremental revenue opportunity here? Obviously you have already signed up a good number of new locations and it sounds like more to come. So any frame of reference for the incremental revenue opportunity would be great.

Christina Gold

I think we look at the location count as something that will give us incremental revenue, but in terms of 2010 we will be talking to you early in year in terms of our projections and we will be able to give you a little bit more color in terms of what we expect the PSD to deliver as part of our outlook for 2010.

Scott Scheirman

What I would add is where we believe PSD will be helpful in Europe, too, is that it allows us to get retail presence, such as in places as France and Germany, where we traditionally had banks or post banks. Those have been good agents. But what retail will help is the hours of operation and often they speak the language of our customers.

So we believe on a long-term basis getting into the retail establishments, particularly countries like France and Germany, will be helpful to our business model.

Jason Kupferberg – UBS

What percent of your agent contracts are up for rebid over the next 12 months and how will that compare with a typical year and does it create any additional opportunities to push on the commission levels a bit? I guess sometimes you do renegotiations but can you talk about that a little bit?

Christina Gold

It's really a rolling schedule in four- and five-year increments so there's really not one year with a spike. There are a couple of contracts that come up a few years back that are quite high but we don't have anything major. It's the normal type of renewals that are coming through.

And we have a waterfall in terms of as the contracts come through, we try to target in terms of commissions and working through that commission rate to bring it to a more effective rate for us.

Jason Kupferberg – UBS

And lastly, on the balance sheet and capital deployment, I am particularly interested to get your thoughts on the dividend. I know it's pretty small but I guess that means there's room for increase, potentially, but if you can talk about that in the context of the other cash deployment options, I am assuming that you are going to continue to buy back a decent amount and keep your eyes open on the M&A front.

Scott Scheirman

Our objectives generate $1.1 billion of cash flow to this year, which is strong, especially in the environment we're operating in.

And our priorities for cash continue to be to invest in the business. And we spoke about our capex being closer to $100.0 million, which is modest for a company our size. Another priority for cash is really investing in the business. You know, acquiring companies, if you will, such as we've done with FEXCO and Custom House.

And then finally, returning value to our shareholders is important, both through stock buyback—we targeted $400.0 million for that—and then on the dividend front, we continue to receive input from investors and others and we have ongoing dialogue with our board on that, so we will continue to evaluate that, the best ways to return cash to our shareholders.

Jason Kupferberg – UBS

Would we assume that on your next call, since its year end, that's when we might have an update on the dividend situation?

Scott Scheirman

Well, we continue to have dialogue at the senior management and with our board. And when we have news on that we will be sure to share it with you.

Operator

Your next question comes from Julio Quinteros – Goldman Sachs.

Julio Quinteros – Goldman Sachs

Just to push a little bit on the 2010 situation and picking up on the comments that as things begin to improve here you would expect to see some margin expansion. Any way to sort of frame or bracket what type of margin expansion we should be thinking about in this model as you get back to growth into 2010?

Scott Scheirman

It's probably a little early to talk real specifically about 2010 in specific terms, but let me give you some of our thinking and how we're thinking about the business. We want to balance strong margins with investing in the business, which is very important for us and our shareholders. If you look at 2009, we are projecting 27% margins, in a year when revenues will be down 1% or 2% on a constant-currency basis.

We have also made investments in the business with Custom House and FEXCO, which have clearly impacted our margins, but still able to deliver 27%. So as we look at the future, we believe when the market improves, as revenue grows, our business model, to your point, will support margin expansion. But our objective is to deliver strong margins but investing the business for future growth is important. And as I mentioned earlier, Custom House with the B2B space is one of those areas.

But we have an objective as a management team to have strong margins, for sure.

Julio Quinteros – Goldman Sachs

Just for perspective, is there any way to break out the incremental amortization from 2009 versus 2008, just to get a sense on what the additional amortization has been to the overall operating line from both the FEXCO and the Custom House?

Scott Scheirman

I don't have that number at my fingertips. I know in the financial schedules we have disclosed what our amortization is year-over-year but let us think about providing that additional detail on a go-forward basis.

Operator

Your next question comes from Ashwin Shirvaikar – Citigroup.

Ashwin Shirvaikar – Citigroup

The changes that you made in U.S. domestic, when do you expect to see that business improve? Is it possible to lay out what specific expectations you have over the next few quarters?

Christina Gold

I think, obviously, we will have impact on our revenue line but what we expect to see is a marked improvement in our transaction rate in terms of gaining back share. And we anticipate going back to a positive transaction growth rate in 2010. And we are pleased with what we are seeing already in the month of October so we are confident that we can move this business forward.

Ashwin Shirvaikar – Citigroup

And a longer-term question relative to mobile, do you see that as a fragmented market from the technological perspective. In other words, do you have to build-out a sort of unique set of capabilities for each geography? Or is there more standardized approach where you can use your existing infrastructure that benefits margins also?

Christina Gold

I think for us, we're in a unique position, because we can connect to any carrier. So that for us, in terms of technology, for us it is not as complex as it is for the mobile carrier who has to have the right M-wallet in their phone. So we are uniquely positioned to take advantage of the channel, particularly across-border, which we have done in Kenya now and we are ramping up that to learn more about that. We have also connected, as well, into the Philippines and we're adding connectivity on our send side.

The challenge for us, which is not complex but it's really to make sure we train the people at the point of sale in terms of how to do a mobile transaction. So as we scale this and we drive more locations it will just be another type of transaction. Do you want to send it mobile, do you want to send it overnight, do you want to send it on a prepaid card, or next day? So it's another one of our offerings. So I think we're very uniquely positioned to take advantage of this opportunity. It's really a challenge in the countries. And I think that Safaricom and Enpesa, by having the carrier and the phone enabled, are in a unique position to take advantage of us sending money across. But it's taking time for countries and mobile carriers to get there.

Ashwin Shirvaikar – Citigroup

In terms of the new EPS range that you have, that does include the dilutive impact of customer sight[?]

Scott Scheirman

Correct.

Ashwin Shirvaikar – Citigroup

And that's about roughly $0.01.

Scott Scheirman

You are correct.

Operator

Your next question comes from Christopher Mammone – Deutsche Bank.

Christopher Mammone – Deutsche Bank

Just focusing on 2010 and realizing that your constant currency revenue growth this year is reasonably outperforming what the World Bank is forecasting for the market as a whole. And just looking at the World Bank's forecast for slight growth in 2010, as a baseline how are you thinking about your own top line next and how it relates to what the World Bank has been saying.

Christina Gold

We are working our way through it in terms of what the World Bank has been saying, but the other thing to remember, every time they put out a projection, they keep drawing down. So as we look at 2009 we are pleased to see that we are outperforming in terms of the World Bank numbers. Obviously they are looking at a zero to a 3 or 4, so that's where they are. And we're just working through our numbers in terms of where we feel we will be in 2010. And so it's a little bit early for us to give that type of information. But we normally outperform the World Bank.

Christopher Mammone – Deutsche Bank

And I think the Custom House revenue contribution around $8.0 million to $9.0 million?

Scott Scheirman

$8.0 million.

Christopher Mammone – Deutsche Bank

And that's just a month's impact. So I was wondering is that a good number to use for a monthly revenue run rate or was there any lumpiness there?

Scott Scheirman

No, it think that is a fair 30-day period, the $8.0 million.

Operator

Your next question comes from Robert Napoli - Piper Jaffray.

Robert Napoli - Piper Jaffray

A follow-up on Custom House. I was hoping you would give a little more color on your growth strategies there and some of the thoughts around the investment dollars that you are planning on putting against that business next year.

Christina Gold

We've actually started already in the fourth quarter in terms of what we want to do with Custom House. I think there are a couple of things that we're focused on right now, is really enhancing and expanding some of their offices in key markets like the U.K., Australia, the U.S., where we see that there are opportunities to further penetration. And so one of the keys there is the sales force and so they are training people to go out and sort of feet-on-the-street to drive that traffic, which will give us more growth in 2010.

Also, on the ecommerce side, we have invested more in terms of the technology for our Internet site, connecting them to the Western Union site.

We do have plans, in terms of market roll outs, which from a competitive point of view we really don't want to say where we're going next, but we do have a clear path in terms of what countries and then what level of performance we want to see and then kind of a waterfall of different countries over the next 12 to 18 months. But as we move forward we will be investing to do that. It will require opening of offices and hiring of sales personnel. That's the biggest expense that we do have.

And the other thing is we want to make sure that they are well trained and continue to perform at the highly professional level that Custom House delivers to its consumers.

Robert Napoli - Piper Jaffray

As far as dollars of investments, any color on that?

Scott Scheirman

Not at this time. We clearly want to invest. We want to gain market share. Just as we globalized the C2C Western Union international business, we see the same opportunity to globalize the Custom House business over the next two to three to four years, so as we get to the 2010 time frame, in our February earnings call, we'll give you some more color on how we're thinking about Custom House and maybe some of the investments we're considering there.

Robert Napoli - Piper Jaffray

As far as mobile goes, further development in Kenya, are you getting any better feel for what the economic model for the mobile is going to look like?

Christina Gold

What we're seeing now is a little bit higher average send. It's at about $74. I think when we talked to you a few months back it was in the $50s. In terms of margins, it is margin supportive. I think we are learning a lot about mobile. We don't have the definitive answer because there are very few markets where we can send to.

The other thing is one of the things that we are seeing, particularly as we look at our UAE, Singapore, and some of the other markets of the Philippines, is how do you get customer acceptance of using that method of distribution or that channel to send money, because there is still a very strong preference to the cash.

I think that these are things that we are learning, but it's margin supportive but over the long term I think we feel very good about the metrics but it's still early days yet as we learn about this industry.

Robert Napoli - Piper Jaffray

On the prepaid business, are you anticipating rolling like a cash-reloadable card out into the retail market and compete with other brands out there like a GreenDot or a NetSpend or a BlackHawk?

Christina Gold

We're looking at all kinds of alternatives in terms of the prepaid and I think one of the things right now is we're trying to maximize on the 8.0 million Gold Card consumers that are in our network to see what the advantages of us being able to move them onto a prepaid and get the positive in terms of the positive margin dynamics from that group. But we will look at all different opportunities as we expand our prepaid offering.

Operator

Your final question comes from Darrin Peller - Barclays Capital.

Darrin Peller - Barclays Capital

Can you give us some idea for transaction trends within some of your key corridors throughout the quarter? Maybe focus on September versus the rest of the quarter.

Christina Gold

Our trends have been pretty stable out through the quarter. I think the one thing that is unique in this particular quarter is Ramadan and it shifted, so when you shift Ramadan you shift the trends. But everything came in basically as we expected and so we are feeling very comfortable in terms of our transaction trends.

Darrin Peller - Barclays Capital

And was there any so far into October? You mentioned briefly that you were pretty comfortable with the domestic side. Are you seeing any pick up there or in any of the other key corridors?

Christina Gold

We are happy with the domestic side and I think we have given guidance for the rest of the year and we feel confident in the guidance that we've put forward.

Darrin Peller - Barclays Capital

With regard to revenue growth versus transaction growth, it improved in international to a 9-point spread from 13 last quarter, and in domestic it seemed to have gone the other way. It was about 6 points versus 3 last quarter. Can you help explain that?

Scott Scheirman

Let me start macro-ly with the overall C2C business, where we saw some narrowing of the spread would primarily be currency, from that standpoint. So on the international business it would have been currency. Other factors that relate to say, geographic mix with intra-pricing, all those type of things, those differences have been relatively consistent the last couple of quarters.

On the domestic business, there was a little bit of widening of the spread. We did do some selected price reductions in the Q1 and Q2 time frame, that took more of a full impact as we went into the third quarter. Then clearly, on October 1 we just did a repositioning of the domestic business but there was some smaller earlier pricing reductions that we did in domestic that had some of that difference.

But again, our goal with domestic is to continue to drive growth there and position that business to continue to gain share.

Darrin Peller - Barclays Capital

How have the banks been performing with the [inaudible]. I know you touched on it earlier, but USB—has the transaction volume been comparable to other agents? Have the sizes been comparable? Is there any chance for another large bank sign up in the near term?

Christina Gold

What we have seen so far, we are very pleased with what we're seeing from the banks. Obviously we've talked quite a bit over time about Scotia bank becoming 2% of Canadian revenue and now doubling itself in the second year. We're very pleased with the ramp up of US Bank. Right now they're at retail and we're hoping to be able to go Account to Cash when the bank is ready to do that. Fifth Third is just being rolled out as we speak, so again, another opportunity.

We're seeing really good numbers. On the first year of operation we're seeing about 50% of the customers are new to our business and new to the franchise so that's really incrementality, which is very good.

So we have a lot of high hopes and a lot of positive opportunities with the expansion in the banking channel. It's now 10% of Canadian and U.S. locations and we expect to expand that over time.

Christina Gold

Thank you very much for being on the call today. We really appreciate your time. We were delighted with the quarter. It was a challenging environment but we delivered solid financial results and also really pushed forward in terms of our strategic agenda. So I want to thank our employees and our agents for their continued commitment to our customers.

Operator

This concludes today’s conference call.

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Source: The Western Union Company Q3 2009 Earnings Call Transcript
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