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Fiserv, Inc. (NASDAQ:FISV)

Q3 2009 Earnings Call Transcript

October 27, 2009 5:00 pm ET

Executives

Jeff Yabuki – President and CEO

Tom Hirsch – EVP, CFO and Treasurer

Analysts

David Koning – Robert W. Baird

David Cohen – JP Morgan

Bryan Keane – Credit Suisse

Ashwin Shirvaikar – Citigroup

John Kraft – D.A. Davidson

Tim Fox – Deutsche Bank

Mayank Tandon – Signal Hill

Pradeep [ph] – Goldman Sachs

Glenn Greene – Oppenheimer & Co.

Kevane Wong – JMP Securities

Operator

Welcome to the Fiserv third quarter 2009 earnings conference call. (Operator instructions) Today's call is being recorded and it is also being broadcast live over the Internet at www.fiserv.com. In addition, there are supplemental materials that will be referenced on today's call available at the company's Web site. To access those materials, go to www.fiserv.com and click on the ‘access presentation’ link on the homepage.

The call is expected to last about an hour, and you may disconnect from the call at anytime.

Now, I will turn the call over to Jeff Yabuki, President and CEO of Fiserv.

Jeff Yabuki

Great. Thanks. Good afternoon everyone, and thanks for joining us today for our third quarter 2009 earnings conference call. With me on call is our Chief Financial Officer, Tom Hirsch.

Our remarks today will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We will make forward-looking statements about, among other matters, adjusted revenue growth, adjusted earnings per share, adjusted operating margins, cash flow targets, sales pipelines, our CheckFree integration efforts, the disposition of certain Fiserv businesses, and our strategic initiative, Fiserv 2.0.

Forward-looking statements may differ materially from actual results and are subject to a number of risks and uncertainties. Please refer to our earnings release, which can be found on our Web site at www.fiserv.com, for a discussion of these risk factors. You should also refer to our earnings release for an explanation of the non-GAAP financial measures discussed in this conference call and for a reconciliation of those measures to the nearest applicable GAAP measures. These non-GAAP measures are indicators that management uses to provide additional meaningful comparisons between current results and prior reported results and as a basis for planning and forecasting for future periods.

On September 28, we announced the sale of Fiserv Loan Fulfillment Solutions, which we will refer to as LFS on today's call. An 8-K was filed yesterday, which recaps our historic results excluding LFS. The results from this business, which we have referred to previously as home equity loan processing, are now included in discontinued operations. All financial metrics and comparisons to prior year exclude LFS and are factored into today's discussion. We anticipate that the transaction will close by year-end.

Earnings results for the quarter and year-to-date continue to be strong and in line with our expectations. The quality of our earnings continues to shine as margins expanded and free cash flow was up sharply as anticipated, $80 million sequentially in the quarter. Adjusted earnings per share grew 14% in the quarter to $0.92 with adjusted year-to-date earnings per share up 11%. We remain confident that our full year EPS results will be within our regional 2009 guidance range.

Adjusted operating margin was again exceptional at 28.9% for the quarter and year-to-date, expanding 110 basis points and 160 basis points respectively. Note that our overall margin, which no longer includes previous LFS results, is reset at a level more than 100 basis points higher than originally reported given the compression that LFS had on our historic financial results.

Free cash flow through September 30 is up 9% to more than $500 million over a strong 2008. That growth is even more impressive when you consider that in 2009 we have increased capital spending to best position your company to produce strong results today and tomorrow. Adjusted internal revenue declined 2% in the quarter and was down 1% on a constant currency basis. For context, a 1% revenue decline in the quarter translates to about $10 million. We continued to feel the pressure of the economic environment across our diverse revenue streams. At the same time, we again saw strong performance in our core payments businesses, such as debit and bill payment. For example, in debit, we saw improvements in the sequential quarter growth rates and also had month over month growth gains within the quarter. This resulted in the third quarter being the strongest transaction growth quarter of the year and ahead of the trends we highlighted at our recent Investor Day.

We shared three key enterprise priorities with you at the beginning of the year. As we near the end of 2009, we are still on track to achieve our full year objectives. Our priorities are – first, to meet our earnings commitments while maintaining capital flexibility; next, to continue integration efforts with an increased focus on revenue opportunities and product innovation; and last, to enhance our go to market approach leading to increased sales results to new and existing clients.

To our first priority, we delivered 14% growth in adjusted EPS in the quarter. Through September 30, earnings have grown 11% to $2.72 per share. While we are pleased with our earnings performance to date, we are most encouraged with the underlying quality of those earnings. Even though we have lost over $40 million in extremely high-margin contract termination fees and float income so far this year, we have still grown earnings, margin, and cash flow at healthy levels.

Mathematically, the decline in higher-margin revenue alone had a negative impact on our 2009 earnings of about $0.17 per share or 7 percentage points of earnings growth through September 30. As these revenue sources are naturally restored, we anticipate the impact will be quite positive to our results. We continue to see the natural operating margin of the company expand as a result of our various scale and network businesses, such as account processing, bill payment, debit, and Internet banking. We believe these areas will continue to produce high-quality growth into the future.

We repurchased 1.3 million shares of stock in the quarter and also repaid $125 million of our term loan. We continue to retain significant capital flexibility to allow us to build shareholder value across multiple fronts. We’ve continued to progress on our integration efforts with an increased focus on innovation. On the cost side, we generated $24 million in incremental operational effectiveness savings in the quarter and have now hit $73 million to date. The fact that we have already achieved $13 million more than our full year target is representative of the large efficiency opportunity, we believe, is available in the future.

Payments momentum continued in the quarter with 85 bill payment sales and 58 debit wins; competitive takeaways, again, represented the significant majority of these transactions. We’ve added more than 450 clients in these important payment areas in 2009. And as we shared at Investor Day, there are several key 2010 product opportunities which, we believe, will further increase our level of competitive differentiation.

Our third priority is to enhance how we go to market. As we shared at our Investor Day, we see meaningful opportunities to bolster market share across targeted client segments. Our market-leading solutions are in demand and the power of our integration and innovation story delivered within a single brand framework is resonating well. We are focused on turning our robust sales pipeline into recurring revenue and even more market momentum at a time when clients needed most.

Now, let me turn the call over to Tom for a deeper dive on financial results.

Tom Hirsch

Thanks, Jeff, and good afternoon, everyone. I will refer to the supplemental information included in the slide presentation, which, as we mentioned earlier, is available on our Web site. As Jeff highlighted, our financial results exclude LFS, which is now included in discontinued operations for all periods.

Before I move into the results, let me also say that we are pleased with our performance so far this year. While year-to-date adjusted revenues are down about $45 million this year or 1.5% on a total base of $2.9 billion, we are weathering well one of the most difficult years the financial industry has ever experienced. Our business model, which generates a significant amount of recurring revenue, has proven its resiliency. Notwithstanding the environment, our quality of earnings has never been better. We have generated over $500 million of free cash flow year-to-date, and our margin growth has been stellar.

Now, on to the detailed results. As shown on slides three and four, adjusted revenue in the quarter decline 1% to $945 million, and was down 2% year-to-date to $2.86 billion. Internal revenue, on a constant currency basis, declined 1% for both the quarter and year-to-date; and 2% on adjusted for currency fluctuations. As Jeff mentioned, a 1% decrease in revenue amounts to about $10 million on a quarterly basis.

Adjusted EPS in the quarter was $0.92, up 14% over the prior year. Adjusted EPS of $2.72 through September 30 was up 11% over 2008. Our adjusted EPS for the quarter of $0.92 per share excludes a $0.04 per share positive earnings benefit that was recognized for GAAP purposes resulting from the final settlement of a CheckFree acquisition income tax reserve. Due to the sale of LFS and the dilutive impact related to that business early in the year, our first quarter adjusted EPS has been recast to $0.90 from $0.88, as LFS had a $0.02 in the first quarter. Second quarter adjusted EPS of $0.90 remained unchanged as the business improved to break even.

We have anticipated when establishing our 2009 guidance at the beginning of the year that LFS would be accretive to our full year performance with revenue and earnings growth in the second half of the year.

Adjusted operating income was $273 million for the quarter. As shown on slide five, our year-to-date adjusted operating margin of 28.9% increased to 160 basis points compared to 2008. We have generated $506 million of free cash flow year-to-date, which is 9% higher than 2008.

As I shared last quarter, we anticipated free cash flow to be much stronger in the second half of the year; and as you have seen, we generated almost $200 million of free cash flow in the third quarter alone. We recognize that free cash flow per share is an important metric in building shareholder value. Our free cash flow per share is up 15% to $3.25 for the first nine months of 2009, and nearly 20% higher than our adjusted EPS of $2.72 year-to-date. We continue to see recurring revenue growing in a number of mission critical areas, such as account processing, online bill payment, and debit processing.

The strength of our value proposition is validated by our win rates. In 2009, we have signed 294 new electronic bill pay agreements, 164 new debit processing agreements, and continued to lead the industry in a number of new account processing wins in a very difficult market. However, our 2009 internal growth rate is being tempered by a number of environmentally driven items across the company. These include the significant reduction in termination fees, account declines in our investment services business, lower float revenue, currency impacts, reduced direct marketing engagements in our output solutions division, declines in check processing, and weakness in discretionary license revenue. That said we do believe that we will benefit from favorable comparisons in 2010 as a number of these items will not continue to decline.

The payment segment generated adjusted revenue of $474 million in the quarter, down slightly over a solid third quarter in 2008. On a year-to-date basis, adjusted revenues were $1.44 billion, up 1%, compared to the prior year. Adjusted internal revenue in the segment was down 1% in the quarter and is flat for the year-to-date. Excluding float and a large client re-price, our year-to-date growth rate is 2%. Our debit and bill payment businesses, which make up a majority of the segment, recorded combined revenue growth in the mid-single digits.

As we shared with you on our Investor Day, we are seeing strong double-digit debit transaction growth as some consumers may be trading credit transactions for debit. In addition, the consumers served by our community based institutions appear to be accelerating their debit usage since they tend to be earlier in the adoption and usage curve. Both of these trends along with strong new client sales are contributing to our success.

New bill payment sales continue to be robust, and most of our clients’ transaction volumes have been growing at around 8% for the year. However, the net growth has been impacted somewhat by lower than anticipated volume at certain larger clients and virtually non-existent float income.

Payment segment revenue performance has been negatively impacted by the following factors in the quarter. License fees declined almost $10 million in the quarter from $20 million in the third quarter of 2008, which impacted the growth rate by 2 percentage points.

Our investment services business has experienced double-digit percentage revenue declines all year. This deficit is due to large account losses earlier in the year, which then impact growth all year. This negatively impacted segment growth by over 1%. However, the business has seen improvements in account growth, which should position us to rebound in 2010.

Third, our output solutions division, which delivered strong performance all year, had revenue declined by 5% in the quarter, which translated to an approximate 1% negative impact in the segment. This decline is primarily related to a drop-off in demand for direct mail, as our client continued to manage expenses in this difficult market environment.

Segment adjusted operating income was $151 million in the quarter; adjusted operating margin of 31.7% was up 70 basis points over last year. Year-to-date segment adjusted operating income was up 7% to $453 million and adjusted operating margin was up 190 basis points to 31.5%. The increase in adjusted operating margin in the segment was driven primarily by strong operating leverage in our transaction-based EFT and bill payment businesses, positive synergies associated with the CheckFree acquisition, partially offset by the impact of lower license fees, float, and add-on revenues.

The financial institution segment generated revenue of $475 million in the quarter, down 2% compared with the prior year. On a year-to-date basis, revenues were $1.45 billion, down 4% compared to the prior year. Adjusted internal revenue on a constant currency basis contracted by 2% in the quarter and 4% year-to-date. Excluding the significant decline in termination fees, the revenue decline for the year would be approximately 2%. Similar to last quarter, revenue growth continues to be impacted by lower discretionary spending by our clients, leading to decreased license fees and fewer add-on product sales.

Termination fees in the quarter were $2 million in both the current and prior year periods. However, on a year-to-date basis, termination fees in this segment have decreased by $28 million to $6 million from the $34 million we received in the first three quarters of last year. The low termination fees in the quarter reflect a continued slowdown in voluntary merger and acquisition activity among financial institutions we have seen all year. We expect that termination fees will remain at low levels through the end of 2009 and likely into 2010. As a reminder, in last year's fourth quarter, we had roughly $8 million termination fees in this segment, and $9 million overall.

Notwithstanding the tough environment, the segment continues to generate high-quality earnings, reflecting an attractive product mix and operational efficiencies. While year-to-date revenue in this segment has declined $57 million, operating income for the same period actually increased $18 million to $428 million. These results led year-to-date margins to expand by 230 basis points to 29.6%. The margin improvement was driven by several factors, including strengthening our account processing businesses and overall operating efficiencies generated under our Fiserv 2.0 initiatives. These same factors also helped us achieve a 29.6% operating margin in the quarter, an increase of 310 basis points year over year.

Capital expenditures were $151 million through September, up $13 million over last year and are approximately 5% of adjusted revenues. As Jeff mentioned, we continue to invest in our business, recognizing that the dislocation in the industry is breeding new opportunities for us and our clients.

We repurchased almost 1.3 million shares for $61 million in the quarter, and we have repurchased over 3 million shares in 2009, and have 3.2 million shares remaining in our repurchase authorization. We repaid $125 million of our term loan balance in the quarter, and incurred net interest expense of $52 million.

We also finalized a financing agreement to lend $67 million to StoneRiver, our minority owned insurance business, which as we mentioned last quarter, was funded out of cash on hand. This transaction allowed StoneRiver to refinance its outstanding debt at an attractive rate.

Our discontinued operation results now include LFS, along with the remaining portion of Fiserv ISS. We recently received FDIC approval to complete the ISS disposition. We are awaiting state regulatory approval, which we expect to receive before the end of the year. We anticipate completing both of these pending dispositions by year end. We estimate proceeds in excess of $125 million, including tax benefits, from these transactions.

Our effective tax rate for the quarter was 37.7%, excluding the impact of a $7 million GAAP income tax benefit related to the final settlement of a CheckFree purchase accounting tax reserve. This, as I mentioned earlier, was also excluded from adjusted EPS. We expect our effective tax rate to be approximately 38.2% for the fourth quarter.

Lastly, while we don't use EBITDA as an internal performance measure, we do know that some investors and analysts do consider that metric. For compatibility, our EBITDA margin is nearly 500 basis points higher than our adjusted operating margin of almost 29%.

Now, I will turn the call back over to Jeff.

Jeff Yabuki

Thanks, Tom. Third-quarter sales were down a bit versus our strong Q2, and we now stand at 86% of quota attainment for the year. That said, pipelines have continued to build and are in very good shape going into the fourth quarter. While we continue to see longer sales cycles, we anticipate a strong finish to the year, which should benefit fourth-quarter revenue and get us off to a good start in 2010.

Integrated sales in the quarter were up slightly compared with Q2 to $28 million, bringing the year-to-date total to $75 million. We are on pace to meet our $90 million target for the year. Even in this challenging environment, our integrated sales are up $19 million over the same point in 2008. The leading areas of integrated sales this year have been in payments, customers' channels such as Internet banking and branch, and efficiency-based products.

Before I get to our outlook, let me update you on the environment, which is generally consistent with the view we shared at Investor Day a few weeks ago.

Through today, there have been 121 regulatory actions impacting 106 banks and 15 credit unions; it is well within our range of expectations for the year. Even as resolutions have accelerated in the back half of the year, we still estimate that only about 1% of all depository institutions will be subject to an action in 2009. Within Fiserv, we remain about even on wins and losses since the commencement of the regulatory actions.

Given the low level of traditional M&A activity this year, it is likely that we will end 2009 with a smaller decline in the number of overall institutions than we have seen over the last several years. As we mentioned at our Investor Day, we do expect the number of actions to accelerate in 2010, and then begin to level off in 2011.

We are pleased to see new capital appears to be slowly making its way into the market. We believe the amount of capital on the sidelines is building and expect entry to be more visible towards the middle of next year. This new capital, in combination with the actions of stronger players, would increase the level of overall health within the financial services industry, and therefore create more opportunities across the thin tax base.

Lastly, we are seeing important and attractive opportunities to deliver more value to clients today. The end consumers of financial products, be them retail or business, require the institutions and serve them to invest in products and technology to meet their needs, regardless of the economic environment.

In addition, institutions are clearly looking for ways to be more efficient, and while not spending frivolously, there is technology spend available to meet specific needs. That means financial institutions are being prudent and pragmatic about their level of spend, not that it is stopped. This stance generally translates to pure transactions and longer sales cycles, but make no mistake, there are attractive opportunities available across the entire market for a company that has the right products, the right value proposition, and the ability to creatively work with the market. We believe we are that company and the strategies that we shared at Investor Day provide us the platform that continue to lead the industry evolution.

As we shared at Investor Day, our 2009 EPS guidance remains unchanged. However, as we said at the time, we believe it to be prudent to narrow the likely performance range for the full year. We now expect 2009 adjusted earnings from continuing operations to be between $3.63 and $3.68 per share. We expect full-year free cash flow to be in a range of $640 million to $660 million. We expect revenue growth in the fourth quarter to be slightly positive, in a range of flat up to 2%. And finally, we continue to expect full-year operating margin to expand by 100 basis points to 150 basis points over the prior year, even after overall margin has stepped up as a result of removing LFS from our results.

Before we move to Q&A, I want to thank our nearly 20,000 associates around the world, who have persevered in one of the most tumultuous economic periods in history. Our people have charged forward each day, and in many cases, stand side-by-side with clients to help them navigate through these extraordinary times. I could not be more proud of the character of our associates, and the positive impact they have had on people's lives.

With that, operator, let us open the line for questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question is from David Koning of Robert W. Baird. You may ask your question.

David Koning – Robert W. Baird

First of all, I just wanted to pursue Q4. I guess Q4 revenue last year was $984 million. And you expect growth, I guess flat to up 2% year-over-year. So that implies a pretty good sequential ramp and I am just wondering – I guess what your thoughts are around that. It looks like about a 4% sequential ramp, is a little more than typical.

Jeff Yabuki

That is a good question. The first thing is, in our payments segment, as you look back in the last year, it also had a sequential ramp and the primary purpose of that is the Personix business, which is in our payments segment, is very seasonal with very strong Q1 and Q4 performance and that will continue again this year. It is just very seasonal from that standpoint. So there is a large amount of revenue that hits Q4 and Q1 in that particular business and I think you will see that historically, and that is a big driver of that particular growth.

Tom Hirsch

In addition, Dave, we continue to see very solid progressive ramps in our payments businesses as well as an expectation of some license sales coming together in the fourth quarter. Just based on the pipeline that we have seen, we have some reasonable visibility, we feel pretty good about those numbers.

David Koning – Robert W. Baird

Okay, that is great to hear. And then I guess secondly, the Q4 growth of the flat to up 2%, is there anything I guess in this quarter that would be different or any comp issues that wouldn’t allow that same type of growth to continue into next year and I guess maybe even get a little better, because I think some of the comp issues get a little easier even into 2010?

Tom Hirsch

No, I think, Dave, the – you know, I am not aware I can comment on 2010, besides the fact I did mention it, we had a lot of one-time items clearly that negatively impacted us from an environment standpoint, one of those, be it termination fees, currency et cetera. But again, to Jeff's earlier point, as we look into the fourth quarter, we are forecasting 0% to 2% growth, that is on a base of above $1 billion of revenue, and every 1% is roughly about $10 million of revenue. And clearly, in our payments segment, we had some license fees that were short of last year by about $10 million, which was about 2% and those can move around on a quarter-to-quarter, we are seeing a lot more of that obviously in the current year, just given the environment.

But again, we have a sound visibility into those as we go into Q4 from that standpoint, but clearly again, 0% to 2% is our guidance for Q4 going forward, and as we look into 2010, as I highlighted in my comments, we feel quite confident that many of these one-time items, whether they be investment services, output solutions, termination fees, or currency impact, it is going to improve.

Jeff Yabuki

And one of the examples would be items such as float; we feel relatively confident that we won't actually have to pay on our float portfolio, so that is fairly low at this point. Termination fees are way down. Tom did mention that we had $9 million last year in the fourth quarter. So that is working against us, but as we are not assuming any real termination fees in the fourth quarter, so we will be down at a very low level.

The other thing, Dave, is even last quarter, we had said that we were seeing light at the end of the tunnel, that we were getting the progressive benefit of the sales that we had been doing. Some of the sales that we had in Q2 will start to come on board at this point to move into 2010. So we believed at the time that we would see sequential kind of improvements over the next six quarters and we believe that we will be more positive certainly going forward than we have been over the last three quarters.

Tom Hirsch

That is really too, Dave, why we highlight our Investor Day. You know, we anticipate a stronger Q4 than Q3, which is what we had indicated at that time also.

David Koning – Robert W. Baird

Well, it is great that your things are stabilizing. Thanks.

Jeff Yabuki

Thank you.

Operator

Our next question comes from Tien-tsin Huang of JP Morgan. Your line is open.

David Cohen – JP Morgan

Hi, this is David Cohen for Tien-tsin. I was wondering what the – in the discontinued ops, if you could break out what the LFS revenues and non-GAAP EPS were in the quarter?

Tom Hirsch

Inside our discontinued operations, we really have two pieces in there. The revenues of that, I believe, were roughly around in line with the second quarter, which I think for LFS is around $30 million. We have two pieces of business in the discontinued operations - the Fiserv ISS and our LFS business. The Fiserv ISS loss in the current quarter was – as we have been getting that business ready for sale, we actually sold our investment portfolio and put it into very short term investment vehicles. Therefore, the spread on that business went down significantly in the third quarter, generating a loss in that business and we also had a slight loss in our LFS business, but that is really what we have there.

David Cohen – JP Morgan

And can you split out what the two pieces each contributed.

Tom Hirsch

No, we are not going to disclose that level of detail, but both of them are in there and we have, like I said, the revenues were around $30 million for the LFS business.

David Cohen – JP Morgan

Okay, great. And then, the other question I had was, are you seeing any change in pricing trends in the bill pay business?

Tom Hirsch

No, I mean the bill payment business as in most of the businesses have been competitive ever since certainly in the almost four years that I have been here. We haven't seen any material escalation in the competitiveness over the last year and in fact, most of our data would say across our various platforms that compression is either at or below historic levels.

David Cohen – JP Morgan

Okay, thanks guys.

Tom Hirsch

Thank you.

Operator

Our next question is from Bryan Keane of Credit Suisse. Your line is open.

Bryan Keane – Credit Suisse

Yes, hi. Just hoping you guys could update us on where we are with Fiserv 2.0 and the plan to take out $250 million of cost.

Tom Hirsch

Yes, hey, Bryan. I think we've said we were around $73 million so far this year in cost takeout and that is against both our original synergy target and the Fiserv 2.0. And the good news there is, that was against the target of $60 million for the full year and so we are in pretty good shape. We have been making more progress there so we continue to be quite confident that we will reach that number and likely exceed it over time.

Bryan Keane – Credit Suisse

And are we now done with the CheckFree synergies and what was the final total of cost takeout from CheckFree?

Jeff Yabuki

Yes, I mean, we are not done. That number is a combined number, but we are very close – we are not separately disclosing them, Bryan, but I will tell you that we are very close to what we originally stated as our target and in fact, we are estimating currently that we will be in excess of the 100 that we said we would be able to take out on the costs side.

Bryan Keane – Credit Suisse

And then, just Jeff, on the competitive landscape, with both FIS and Metavante now together, can you just talk about your thoughts on what that means going forward. Any changes in your guides of strategy?

Jeff Yabuki

Sure. So they have really only been formally together for about a month. And so, I think we are waiting, as everyone else is, to get a more clearer indication for what they are going to do. I think given on a scale basis, we are roughly the same size. So I think you will have – you have obviously about two players. So that will arguably make it a little bit easier for clients to see the differentiation between the parties. But I think we are waiting to see, I mean, they were both good competitors when they were separate. We assume they will continue to be good competitors together, and I guess the score will get tallied out eventually on the Street.

Bryan Keane – Credit Suisse

Okay, just a last question from me, Tom. Just a clarification. If I add $0.02 back into the first quarter for the discontinued op, I think for quarter then EPS range is $0.91 to $0.96; do I have that right?

Tom Hirsch

That is correct, Bryan.

Bryan Keane – Credit Suisse

Okay, thanks a lot.

Tom Hirsch

Thank you.

Operator

Our next question is from Ashwin Shirvaikar of Citigroup. Your line is open.

Ashwin Shirvaikar – Citigroup

Hey, guys. I have a question. You have benefited to some extent from the transition to debit, but as things get better in the economy, do you expect some of this to (inaudible) and how should we think about that?

Jeff Yabuki

We don't think the debit trend is a temporary trend. I mean, one of the things that we talked about at our Investor Day is, you really have at least two pretty important macro trends helping us on the debit side. The first one is that our debit business tends to focus below the top 25 institutions in the US and that group is what we would call earlier on the debit maturity curve in some of the larger institutions. So we have that group issuing cards at a higher level of frequency, and then having ramped. And so that is a very good thing.

The second benefit is, we are selling that, we are having a lot of success on the sales front. We have sold I think 58 in the quarter and somewhere around 164 or so for the year. So we are adding institutions and we are adding institutions that are early on that macro trend. So that is very good news.

But the second thing is, I think estimates are – is that the younger generation, who significantly favor debit, are going to move from about 14% purchasing power in terms of number of transactions today to 40% over the next five years, and therefore, those who have planted the most debit flags will get the benefit of that macro tailwind. So we feel pretty good about that moving forward and again, our growth in the quarter was significant and we anticipate that that will continue.

Ashwin Shirvaikar – Citigroup

Okay. If I can add one question from a modeling perspective, as we go from 4Q to 1Q and beyond, is there any particular seasonality or any other quirk to be aware of there?

Tom Hirsch

No, I don't think – actually I think the biggest thing we have is in the – like I indicated earlier, in the payments segment. The Q4 and Q1 is generally a bit stronger with our output solutions business and that tends to kind of carry through on a little bit higher level of revenues in those two quarters from that standpoint. But those are probably the biggest factors that we have. If I look onto 2010 clearly, we are going to have a lot less of the one-time type items such as float and termination fees, et cetera, from that standpoint.

Ashwin Shirvaikar – Citigroup

Right. And will you provide either an 8-K or a 10-Q, will you provide the ex-LFS information going back for all the quarters of this year and last year?

Tom Hirsch

Yes, we did provide that in an 8-K that we filed on Monday.

Ashwin Shirvaikar – Citigroup

You did? Okay.

Tom Hirsch

Yes, so it should be out there. It has got all the quarterly history back for 2008 free cash flow internal revenue growth, all those statistics.

Ashwin Shirvaikar – Citigroup

Okay, good. Thank you.

Tom Hirsch

Thank you.

Operator

Our next question comes from John Kraft of D.A. Davidson. You may ask you questions.

John Kraft – D.A. Davidson

Hi, Jeff; hi, Tom. Nice work at least on the expense side.

Jeff Yabuki

Thank you.

John Kraft – D.A. Davidson

I wanted to follow up on the last question, specific in the debit side. You know, you guys are really bucking some trends out there and I understand that the transaction growth would be faster at your smaller size customer institutions. But you are also seeing some acceleration or at least some pretty stable new contract, absolute contract signings, and I was just curious, what is the driver there, is that just the integration that you have done to build that into the rest of your platform?

Jeff Yabuki

Are you talking about, John, why we are able to continue to win?

John Kraft – D.A. Davidson

Yes, and why so – I mean, it looks to me like you are taking share.

Jeff Yabuki

Yes, I mean we have spent – I mean, and one of the benefits that we are getting is the aggregate effect of all these sales. I mean, we have, over the last couple of years, we have really worked hard to create what we call integrated desktop, which is a very tight integration between our debit products site and our account processing or our core platforms. And that is resonating well with our clients. The clients like the fact that they have a single vendor of choice. So that has been a very strong selling tool, as well as some of the fraud and risk management tools that we have been perfected to the point where our platform and the products and tools that we have is generating a level of I think five basis points to six basis points less or fraud than is on average.

So good value proposition, better integration, and frankly, it has become top-of-mind for our entire sales force. We – our people are in there, talking not about a single solution, but about a holistic how can we help you run your institution, and frankly, that is why it is paying off the way it is.

Tom Hirsch

And John, it is very helpful just to add to that. Obviously, on all the account processing renewals that we have, we are clearly bringing that from the value proposition to all those renewals as they come up in our service-driven businesses across the Credit Union Bank and thrift marketplace. And the other thing I would highlight is that we are now over the last two-and-a-half years in debit. You know, 630 or odd so wins in that particular area as far as number of clients. So we have really done a nice job there.

Jeff Yabuki

Yes, we are still only at about 40% level of penetration. There is still a fair amount of room.

John Kraft – D.A. Davidson

Any guesses to what percent of those wins are competitive takeaways?

Tom Hirsch

Yes, I mean, it is a very, very high number.

John Kraft – D.A. Davidson

Okay. And then moving on to some of the international deals that you mentioned in your release, I guess specific to Mexico and Indonesia, were those existing customers – it is not like they were existing customers and then these were direct sales to them or are you going through another channel? What sort of a presence do you have there again?

Jeff Yabuki

It is all direct. We are – as we said a little bit at Investor Day, we have been more opportunistic and certainly, we are working to change that, but these are relationships that we have expanded, you know, whether it is Panin or (inaudible), we have relationships. I think Panin is a 10 or 12 year client, so it is just a matter of continuing to go with the entire solution set. Mobile money, mobile has a very strong attention span outside the US, just as it is getting here, so it is really a matter of integrating more product knowledge into our sales force has really kept us – has given us a little bit of a lift to date. I think next year you will see a much more programmatic approach to how we go to market.

We mentioned last quarter that we had a very large win outside the US. We will be able to comment on who that is and what we are doing for that customer in the fourth quarter of 2010, but we are very excited about that. We think that is going to resonate well across other institutions who want to do similar things.

John Kraft – D.A. Davidson

That is helpful. Thanks, guys. That is all I have.

Jeff Yabuki

Thank you.

Operator

Our next question comes from Julio Quinteros of Goldman Sachs. You may ask your question. Mr. Quinteros, please check your mute button.

Jeff Yabuki

Maybe we should move on. We'll put Julio back in the queue.

Operator

The next question comes from Tim Fox of Deutsche Bank. Your line is open.

Tim Fox – Deutsche Bank

Hi, thanks. Good afternoon. My first question was around investment services business. I think, Tom, you gave some statistics out there, but it was down mid-double digits. I was just wondering if you could expand a little bit on that business relative to how strategic it is to the overall Fiserv business and some of the large account losses that you mentioned earlier in the year, if those were competitive in nature or more around sort of the downturn in the overall market and what you are looking forward to in that business looking out to 2010.

Jeff Yabuki

Sure. And Tim, I will take it, and then Tom will add additionally.

That as a business has a very, very strong competitive position. The account losses are organic losses and that was really due significantly to the volatility that we saw in the markets between last September and really the end of April. And we really saw firming, we began to see firming at that time and then we have actually seen growth over the last three or four months. The challenges in that business, and this is a business that is really providing separate account management to a number of larger financial organizations and once those accounts fell off the system earlier in the year, because you basically lose 12 months of revenue and then 11 and 10 and sequentially, you dig yourself into a hole and it is almost impossible to get out of that hole. And that is what has happened there.

As the market has reaffirmed, we see that organic account growth coming out of there, and we are actually feeling pretty good about what that business is going to generate for next year, but unfortunately, the damage was done and we just have to ride the storm at a lower level.

Tom Hirsch

And to Jeff's point, this is not a competitive lock situation with clients or anything else associated with that. It is also down a little bit, as I mentioned, in the license fee areas; it does have some software also internationally.

Jeff Yabuki

Yes, and I guess I should have also commented – strategically, it is certainly not account processing, but it is clearly a processing business, it has got network and scale oriented economics, it has got a superior competitive position, and it serves the large financial institutions in the US, who tend to be our clients as well, and so it gives us a deeper relationship with those clients. So we feel good about that, given the business has had a rough year this year economically, we remain very committed to that business and that strategy and we are going to keep delivering.

Tim Fox – Deutsche Bank

Great, that is helpful. And the second question I had was around discretionary spending and you mentioned I think $10 million down on license versus $20 million last year. I think – believe that was within the payment segment itself. And just, you comment on whether you think the bulk of that discretionary pressure has been from the overall profitability pressures your customers are seeing or do you think there is anything to do with the special assessment that have been a major overhang and what are your clients telling you about their view about special assessments going forward and is that a big headwind still on closing deals?

Tom Hirsch

Yes, I think the – this is Tom and I will turn it back over to Jeff also, but I think overall, that discretionary spend, as far as our clients are continuing (inaudible) discretionary areas, not around the EFC, bill pay, things they have to have but other things that they like to have – you know, it goes three or four or five levels higher up, the pipelines remain good, but again, to get those licenses close is taking a lot longer than we anticipated. And they are continuing to control their expenses. So they really control that discretionary spend tight. We have not seen a lot of that change.

We see a little light, but clearly it was a difficult quarter from a license standpoint. We fortunately don't have a lot of license fees, but in our payments segment, in total in the company, we have about 5% of our revenues tied into license. And we have a risk management business, again, the licenses in that business were down and the investment services, as I mentioned and some additional seat licenses in there, too. So, it was fairly unusual from that standpoint. We had a strong Q3, but as you know $5 million of license fees in that segment is about a 1% impact on our growth rate for the quarter. So it can have an impact, but again, we see some stabilization of that as we look into Q4, but again that discretionary spend continues to be tight.

Jeff Yabuki

And Tim, just environmentally, it's been a bit of a roller coaster out there. In the first part of the year, I think, you had a number of institutions trying to figure out what was wrong or how – not what was wrong, but how wrong were things. So when people got their arms around that, then you have the assessment. And I made this comment a couple of times and my take is once people got passed the middle of the year and they had made it through the year without spending a lot, I think people just said you know what? I am going to get through this year.

I'm going to keep these plans on hold, and unless I really need it or it is going to move me forward in a way that I can really see the return on a risk adjusted basis, be awfully high, I think people have just gone a bit on hiatus. And what's interesting about some of these licenses is, I think sometimes people think about licenses, they think about these very large licenses. For us, many of these licenses are relatively small and you can have – they could be $100,000 licenses, they could be $50,000 licenses. There aren't that many $1 million licenses. License fees at that level are probably a little bit easier to see than the lower levels of license where people have really gone on hold. I believe that will begin to come back in the second half of next year.

We've not factored, as I mentioned at Investor Day, much improvement in that kind of behavior. But we are getting more visibility into those people who are moving forward. I was with some clients last week who are picking up other institutions. So you have got a real divide being created between those institutions who view the turmoil going on right now as an opportunity to grow. They are looking at the institutions being resolved and they are excited about that, and they are spending money and they are looking to expand their platforms. And we think there is opportunity there.

Tim Fox – Deutsche Bank

Thank you, Yabuki.

Jeff Yabuki

Thank you.

Operator

Our next question is from Mayank Tandon from Signal Hill. You may ask your question.

Mayank Tandon – Signal Hill

Yes, thank you. I had a question, Jeff, just on the bill pay side. How do you view the competition between billers and banks? And I think some data suggest that the Biller Direct model is winning, how does that impact your business longer term?

Jeff Yabuki

Sure. It's a good question. Most of the data that we've seen actually says that the bank’s consolidator model is finally overtaking Biller Direct. My take on that is actually the e-Bill element of the bill payment strategy is really important. It's one of the reasons why we believe the CheckFree model is superior because they have such a strong level of distribution on the e-Bill side. The benefit of a Biller Direct side is you can go to the site and know what you're bill is. You don't need paper. To the extent that those e-Bills are being delivered within the bill payment, that's very good news and it's good for the biller as well.

We enable billers to do what they want to do. So we don't view them as competition and we clearly don’t view the banks as competition. So I think both models are going to persist over time. We are working on a variety of different strategies on the analytic side as well as on the behavioral side for us to continue to improve share. I think today, the number of bills paid electronically per month is around two of the average of about 14 per household. So there is plenty of room for everyone to survive. We believe the consolidator model will win over time, and obviously that's where we are investing majority of our resources.

Mayank Tandon – Signal Hill

Okay, that's helpful. Also just on the pricing side, again, on the biller pay front, are you seeing any discrepancy between the big banks versus small banks? I'm just trying to get a sense of if you are moving downstream more and more and kind of squeezing out smaller players as the big banks maybe sort of holding off on any new initiatives?

Tom Hirsch

There's always been a pricing difference between those organizations, no matter what you are talking about. Those organizations that have very sophisticated procurement organizations are going to typically be able to squeeze a vendor more than someone who does not have a sophisticated procurement organization. So I think you see that in the larger sophisticated organizations plus those large organizations – they have significantly more volume and so they are going to be a different placing tiers than some of the smaller institutions.

The majority of our wins are obviously below the top 25, and well below that, because most of the top 25 are already using us, and most of the top 50 are using us today. So wins for us are moving down into the landscape, and in fact if you look at our – which we don't share publicly, but as we look at all of our transaction growth data, not unlike what we are seeing on the debit side, we have a lot of growth coming from the small institutions, but the growth in the absolute is so small relative to the billions of transactions that CheckFree – the old CheckFree processes today it gets lost in there. What doesn't get lost in there is the revenue and a margin that is associated with those transactions.

Mayank Tandon – Signal Hill

That's helpful. And just finally on the margins, I don't know if you've talked about long term margin trends, but just wanted to get a sense from you, in terms of, you had great margin improvement. What is the thought process in terms of what the threshold would be for a company like Fiserv based on your business mix?

Tom Hirsch

If you will, our long-term performance characteristic as far as margin expansion goes, we continue to believe in this business model, 50 basis points to 100 basis points is something we can do. We clearly still have, as a kind of highlighted on Investor Day, a number of different opportunities under our Fiserv 2.0 operational efficiency initiatives to be able to work on a number of things internally, and we continue to do so. So with the scale, the businesses that we are in today, especially in the payments and the account processing, the network businesses that we have, we think that's a good area to think about over the longer term.

Jeff Yabuki

Yes, that 50 basis points to 100 basis points a year is something that we think we can do without doing things that damage the business, and quite contrary we have the ability to invest and still grow margins because of the, as Tom talked about, the network scale and operational efficiency characteristics of the company.

Mayank Tandon – Signal Hill

That's terrific. Thank you very much.

Jeff Yabuki

Thank you.

Operator

Our next question comes from Julio Quinteros of Goldman Sachs. You may ask your question.

Pradeep – Goldman Sachs

Hi, this is Pradeep [ph] on behalf of Julio. I don't know if you can hear me.

Jeff Yabuki

Yes, we got you. Thanks.

Pradeep – Goldman Sachs

I have a question with regards to your margin trends and going on with the question that is asked previously. I was wondering, do you have the potential to accelerate your cost synergies from Fiserv 2.0 and CheckFree synergies? Is there a potential to that going forward even if revenue growth was moderate?

Tom Hirsch

Yes, I think we've shown that obviously in the current framework.

Jeff Yabuki

Yes. As we talked about in Investor Day, we have very purposefully moved as much of our energy as possible over the last 6 to 9 months to a lot more focus on products, product innovation, revenue growth. And we are seeing the early signs of that. It takes time to accelerate. And we are continuing to obviously – we talked about we take out costs. And there was a chart in our investor conference, which showed the level of value that's been created or been extracted out of five or six different areas. And it's pretty early in the majority of those. So we think there's a lot of room to grow. And if for some reason and we don't believe this to be the case – but if for some reason, we felt like we weren't going to be able to grow revenue, we would nearly transfer some additional effort over to the cost side. But we believe we are going to be able to do both and that's what we're doing.

Tom Hirsch

And I think if you look at our margins, just going from 2008, we were probably at 26.3, we're up to 28.9; our margins in 2007 were 24.4. So we've shown through this environment, especially the businesses that we are in today and what we do from an operational efficiency standpoint that we will continue to expand those going forward.

Pradeep – Goldman Sachs

Okay, perfect. And with regards to the products set, both on the financial and payment side, where do you see the greatest traction with clients right now?

Jeff Yabuki

Where we see the greatest what?

Pradeep – Goldman Sachs

Traction with clients?

Jeff Yabuki

Clearly, on the payment side, debit, bill payment, areas like source capture or anything around remote capture, the deposit gathering, and efficiency-based products. We are also seeing a fair amount of energy around multi-channel strategies. So how do I get a single view of the customer whether they are Internet, ATM, call center, in branch whatever it is, so lot of energy there.

Pradeep – Goldman Sachs

Okay. And on the financial side, are you seeing any incremental volume from, let's say, regulatory and fraud compliancy solution just because the landscape business is getting a lot more complex right now?

Jeff Yabuki

Not yet. The areas – we have a very strong anti-crime suite. So we are very focused on that. But everyone in the industry us included is really waiting to see what the regulators are going to do and what changes they are going to put in place. And as that happens, I do think you'll see a lot opportunity in terms of better managing risk, and obviously it's going to look like better management of credit risk, is one of the reasons why we think our analytic strategy is going to be quite helpful as we assist clients to get ahead of loss mitigation.

Pradeep – Goldman Sachs

Okay, perfect. That's it from me. Thanks a lot.

Jeff Yabuki

Thank you.

Operator

Our next question is from Glenn Greene of Oppenheimer. You may ask you question.

Glenn Greene – Oppenheimer & Co.

Thank you. Good afternoon, Jeff and Tom.

Jeff Yabuki

Hi, Glenn.

Tom Hirsch

Hi, Glenn.

Glenn Greene – Oppenheimer & Co.

I guess, just the first one is sort of a high-level view and maybe it's early, but any view from your talking to your customers in terms of bank IT spending plans going into 2010? There may be a contrast between the large banks and the mid-tier banks. How they are dealing with the environment? Most of the uncertainties, obviously known at this point maybe banks are getting back to business, but on the other hand you have got commercial losses escalating for the mid-tier banks. So, any thoughts on a high-level for IT spending going into 2010?

Jeff Yabuki

Glenn. Your last comment is probably the most important. Right now, lots and lots of people are ferreting their way through their commercial portfolios, and especially in those areas where land and land development had been going on. So you had a period where people felt more optimistic. I think right now, and I think we saw recently, the regulators are encouraging the institutions to maybe be a little bit more forthright on their portfolios, in other words, let’s get all those bad news out there.

But, the conversations that we are having with people right now sound much more optimistic than they did at this time last year where frankly people were just worried about their survival. But I would say that's institution by institution based. And that is across all tiers, whether it is in the very largest institutions or across even the smallest community-based institutions. It really does depend on who you're talking to. But the tenor of the conversations feels more optimistic, and people are looking at what they need to do to serve their clients. So, there is much more discussion around there.

So, at least a sense around the organization is a bit more optimism than we felt last year. We are seeing that in pockets there are people who are focused on spending. But I think I would have to leave it to some other pundits to be able to speculate on what's the actually growth rates will be for next year. So I think they are still going to be tempered. I just can’t tell you if they will be more or less than this year. They just feel a little bit more optimistic right now.

Glenn Greene – Oppenheimer & Co.

Okay. And that’s consistent with what we're hearing. On the contract renewal side, could you just remind us what 2010 is looking like? Any big contracts coming up for renewal that we should be aware of? Is it sort of a normal renewal cycle on both the financial and payment side, or how to think about that?

Jeff Yabuki

We have a couple of larger institutions who are going to be renewing either at the end of next year or early in ’11, and obviously we are working those. For right now, I can't see anything that is going to cause any kind of issue. By the same token, we are working very hard and we understand that we need to always get all of our clients renewed again regardless of where they are on the spectrum of value. And we will talk more about that when we give guidance for next year.

Glenn Greene – Oppenheimer & Co.

Is that more on the payment side now?

Jeff Yabuki

It's more on the payment side.

Glenn Greene – Oppenheimer & Co.

All right, great. Thank you.

Jeff Yabuki

Thank you.

Operator

Our next question is from Kevane Wong of JMP Securities. You may ask your question.

Kevane Wong – JMP Securities

Hi, guys just two things. Just looking at the bill pay growth, just looking at the bill pay transactions sequentially, obviously relatively flat, sort of similar to what we saw first quarter to second quarter. Is there some color you can give us if we back out Bank of America, which is obviously a big sort of transparent customer there, what kind of growth is underneath it that you would be really looking at? Is there is a good way to quantify it or give some color on there?

Jeff Yabuki

Yes, absolutely. Obviously, we can’t talk on an institution by institution basis, but our numbers generally reflect what's going on in the industry. And certainly in some of the larger institutions, some of those institutions are gaining deposits and some of those institutions are not doing quite as well. And that is clearly when we look into the data, we can clearly see where we are being impacted. And some of that is also because not everyone is marketing at the same level that they had been doing historically for obvious reasons.

When you start to look down into the base and you look at the non-acquired CheckFree base and you look at the institutions that we’ve been adding, I think over 1,000 institutions over the last six or seven quarters, we are seeing some not surprising very attractive growth. Some of that is organic, people who have actually just added bill payment for the first time.

But frankly, we're getting good growth because when people add our technology it's a much richer experience for their customers and that's turning into more bill pay growth. So those numbers are big. The problem is that it just doesn't move the needle very well because the base is so large. It shows up in revenue and it shows up in margin, but it doesn't show up in the actual tran growth.

And frankly, I don't think it's going to show up in tran growth probably for six or eight quarters because that's going to take that long to build up enough mass, not unlike what happened with our debit business three or four years ago.

Kevane Wong – JMP Securities

Got you. That makes sense. And then also maybe just a clarification from me. You guys have sort of missed that. I was looking at the growth in the payment segment going from – the internal growth going from 2% (inaudible) down to negative 1%. The slide didn't show the one-time thing though you're talking about. Is that really just the flow sort of stuff that you talked about or is there anything else that really caused that sequential drop in the internal growth for that segment?

Tom Hirsch

Yes, I think, this is Tom – and I think I kind of held out a little bit in our prepared remarks. I think, again just to back up a little bit, 1% change in that segment is about $5 million of total revenue. But we did in the third quarter, which I highlighted, the biggest change we had was a decrease in license fees from about $20 million last year in the third quarter to $10 million this year. That was really a 2% impact on the segment.

Our output solutions business, which is in our payment segment, their revenue declined also 5%, which was unusual for them. They had a fairly strong first half, but they did see some of their client spending down. So that was another factor. And our investment services business has been there all year, but the biggest thing was we had a strong Q3 last year and [ph] license fees. Those came down with some visibility – more visibility into those as we look into Q4. But those are really the changes. And I just again like to say that we didn't highlight those in the slides, but I did have those comments in the script. And I think, that can move around again, when you're talking about $5 million or $10 million, or $15 million of revenue, clearly that's a fairly small number on a quarterly basis. And that's why those rates can move around a little bit on quarter over quarter basis.

Kevane Wong – JMP Securities

Perfect. That's helpful. All right, thanks guys.

Jeff Yabuki

Thank you.

Jeff Yabuki

All right. Well, thanks everyone for joining us. We appreciate it. If you have further questions, please don't hesitate to call our investor relations group.

Operator

This does conclude today's conference call. At this time, all parties may disconnect.

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Source: Fiserv, Inc. Q3 2009 Earnings Call Transcript
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