First Data Q3 2006 Earnings Call Transcript

First Data Corp. (FDC)
Q3 2006 Earnings Call
October 24, 2006 8:00 am ET

Executives

Colin Wheeler - VP Corporate Communications
Ric Duques - CEO, Chairman
Kim Patmore - Executive VP, CFO

Analysts

Greg Smith - Merrill Lynch
Tien-tsin Huang - JP Morgan
Adam Frisch – UBS
James Kissane - Bear Stearns
Patrick Burton - Citigroup
Liz Grausam - Goldman Sachs
Christopher Malone - Deutsche Bank
Charlie Murphy - Morgan Stanley
Craig Peckham – Jefferies
Wayne Johnson - Raymond James
Mark Sproule - Thomas Weisel Partners

Presentation

Operator

Welcome and thank you for standing by. (Operator Instructions) I would like to introduce your host for today's conference Mr. Colin Wheeler. Sir, you may begin.

Colin Wheeler

Good morning. This is Colin Wheeler, Vice President of Corporate Communications. I'm sitting in for Alex Holmes, who is out with the new baby, but will back in the next week or so.

Thank you for joining us. With me today are Ric Duques, Chairman and Chief Executive Officer and Kim Patmore Chief Financial Officer. We are pleased to host this teleconference and webcast to announce our financial results for the third quarter, provide highlights from each of our main business segments, as well as provide a number of financial metrics, reconciliations and outlooks. As always, we'll have time for you questions following our prepare comments.

Today's call is being recorded. Our comments today include forward-looking statements, and I ask that you refer to the cautionary language in the earnings release and appendix to today's slide presentation for additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements.

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

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

Now I'll turn it over to Ric.

Ric Duques

Thanks, Colin. Good morning everybody, and thank you for joining us today. As we stated in September, our measure for success for the remainder of 2006 will be the performance of our three main business segments. During the quarter, all three performed in line or above our expectations. Consolidated revenue grew a solid 9% and earnings per share from continuing operations for the quarter were $0.17 or $0.29 excluding items, and Kim is going to take you through the details of that a little bit later.

Our solid results for the third quarter were driven by an above-expectation performance by our commercial services segment. Additionally, First Data International delivered strong double-digit organic growth and our Financial Institutions segment, where the last of our previously announced deconversions are now behind us, recorded significant improvements in profit margin. Across the company we continue to focus on sales, client retention, superior operational execution and on making the right investments to ensure the long-term success of First Data.

We are building great momentum as we move toward 2007. With the Western Union spin behind us, we are now 100% focused on the needs of financial institution and merchant clients around the world.

Our recurring revenue base of $7 billion, our global portfolio strong growth businesses, our superior cash flow, and our exceptionally talented management team truly place First Data in a class by itself. We see a strong finish to 2006, and while our 2007 operating plan has not yet been finalized, we are confident that we will meet or exceed our stated segment guidance.

Now, let's take a look at the segments, starting with our largest commercial services. Looking at slide 6, commercial services had another strong quarter. The reported revenue reflects 10% year-over-year growth or 7% excluding reimbursable debit network We are clearly on a track to meet our up-drafted full-year guidance of 9 plus% revenue growth. Operating profit grew 22% year-over-year. Excluding integration costs recorded in 2005, operating profit growth was a strong 10%. Our operating profit margin for the quarter was 27.8% versus 25.0% last year. Excluding reimbursable debit network fees and integrations costs, profit margin improved to 34.5% up from 33.8% in 2005.

Turning to slide 7, year-to-date, we have invested more than $40 million directly aimed at our strategic objectives, which are: driving sales through each of our distribution channels, expediting activation of our new merchants, retaining our existing base of merchants, and bringing innovative product solutions to market.

Driving sales remains our top priority through all distribution channels. Year-to-date we have added more than 300 sales professionals focused on our most profitable regional states. We now have more than 2,100 sales reps. These resources will drive growth in our new and existing bank alliance partnerships which represent our strongest and largest distribution channels.

These alliances provide a significant competitive advantage for First Data. We continue to add alliances and independent sales organizations -- we call them ISOs -- as a referral network. This investment in sales will ensure that we maintain the broadest and most diverse sales force in the marketplace today. This quarter we added more than 160,000 new merchant locations. This represents more than a 30% growth over 2005, and I think you should note here more than 90% of the locations were small and regional merchants.

New merchant activation has been a priority for us this year. To ensure that newly signed merchants become revenue generating as quickly as possible, it is critical to minimize the time it takes to activate merchants onto our system. Investment in our automated merchant activation tools and other initiatives are directly aimed at reducing activation time. By utilizing these tools in the third quarter, almost 22% of new merchants signed were enabled within two days. That's up from less than 5% in 2005. We expect to see continued improvement here. This is a very big positive trend for us.

From the largest national retailers to the smallest mom-and-pop stores, we continue to place a greater focus on retaining our merchant base. We have made some significant investments this year both in customer service and relationship management. Within the national space, we have had several notable contract extensions that were directly attributable to our improved customer service.

Within the regional space we have seen an overall 8% improvement in retained sales volume. So, for example, if we lost $1,000 in sales volume in 2005, that would be reduce to $920 this year. Although it's early, we are excited about the returns on these investments and we will give you more information about this as we move into 2007.

Finally, we are committed to product innovation and increasing the contribution of new products to our growth rate. Our product investments not only generate revenue through new products but also drive retention and new cross-sales opportunities to our existing merchant portfolio.

Year-to-date we have announced several strategic partners including ADP, Microsoft, and Discover. These relationships will help bring innovation to the marketplace. A great example of our commitment to innovation is our new proprietary point-of-sale terminals. During the third quarter alone, we deployed more than 11,000 of these terminals. They are feature rich and utilize the Microsoft Windows Operating System. We feel that these terminals will improve retention rates and differentiate First Data in the marketplace. I think, as you can see, commercial services continues to gain momentum in all areas that are critical to the long-term health of the business. I'm very excited about the progress we have made in commercial services. Such strong momentum leading into 2007 in our largest division, which, by the way, represents well over half of our revenue now, is a very big positive for First Data as a whole.

Moving on now to Financial Institution Services on slide 8. We stated in previous quarters, to give you a better view of the state of this business, we believe it is important for you to look at the revenue growth from existing clients without the impact of reimbursables and without the impact of previously announced deconversions. Believe me when I say, I am very pleased to say that we have anniversaried the last of these deconversions which occurred at the end of July.

During the quarter, excluding reimbursables and these deconversions, revenue growth rate was a positive 5%. On a reported basis, Financial Institution Services for the quarter revenue declined 4% or 8% excluding reimbursables, operating profit declined 2%, while the margins now were up to 31.4% from 29.6%. That's excluding reimbursables.

With these kinds of profit margins, I think you can understand why we elected to keep this business and why we are not timid about making investments that we feel will jump start the growth in this segment. With operating profit margins excluding reimbursables over 30%, our return on investment in this segment should provide shareholders with very positive returns. In 2007, we expect to make further strategic investments in this business with product acquisitions in verticals where we participate already, specifically fraud, loyalty, and customer contact.

You'll see on slide 9 now that we ended the quarter with 544 million accounts on file. We have approximately 18 million accounts contractually committed and scheduled for conversion. These are primarily retail cards. In addition, we have a very healthy sales pipeline including several portfolios of significant magnitude. While we have nothing officially signed, we are encouraged by the momentum here.

As part of our plan for future growth, we have talked about leveraging our core capabilities to expand into adjacent markets. During the third quarter, we completed the acquisition of Peace Software, a leading product company that develops advanced software for managing utility billing and customer care. We are working diligently on acquiring our first outsourcing customer. I am confident that we will have some wins to announce in this market during 2007.

Also, we're making progress on our strategy to cross sell existing products into the FI client base of over 5,900 relationships. In fact, we are pleased to announce that a very large existing client that utilizes our credit card statement processing services today has now purchased mortgage and DDA statement printing from us. We started converting this business in September. Having said that, we clearly have a lot of work to do to fully capture more of the opportunities within our existing client base, and we will do that.

We continue in our efforts to improvement overall cost structure and to reach our target of $75 million in annual cost savings by the end of 2007, with $45 million or about 60% of that goal currently being implemented. The cost initiatives we have put in place continue to strengthen our already strong profit margin. The issue in this segment has never been about profitability. It has been about growth in revenue and profit and we are looking forward to a strongest reported revenue and profit growth rate going forward.

Our underlining growth rate, in combination with our entry into adjacent markets and cross-selling strategy, position us to deliver mid-single digit revenue growth and profit in 2007 and ultimately to drive us to return the business to an 8% to 10% revenue and profit growth by 2008.

Now let's take a look at our non-U.S. business on slide 10. The FDI strategy is squarely focused on globalizing the business, driving organic growth, extending the breadth of products and services, and achieving operational efficiencies. This strategy is clearly working. We are truly excited to report strong organic growth augmented by acquisitions which, by the way, are performing extremely well. This business is a growth engine for the new First Data.

Now I would like to walk through the international third quarter financial highlights, some investment and client developments. FDI achieved revenue growth of 45%. We posted strong constant currency organic revenue growth of 11% for the quarter. FDI's operating profit increased 9% for the quarter. Since we currently have modest operating profit in this segment, relatively small items can move the growth rate up or down in any quarter. Items impacting the profit growth in this quarter include higher incentive compensation in 2006 versus 2005, significant investments in business development and infrastructure and platform consolidation, and costs resulting from the Western Union spin that hit this operating segment this quarter.

We are still on track to meet our previously stated profit growth of 27% to 32% for the full year, excluding in-year acquisitions. However, due to the timing of conversion expenses and the extent of platform investments, this range may change slightly, but it will still be very strong.

For primarily the same reasons that I just described regarding profit growth, profit margins in the third quarter were approximately 10%. We believe we will achieve low double-digit margins for the full year 2006.

In terms of our key performance indicators, you'll see on this slide, FDI had substantial growth in all areas. Specifically I'll call your attention to transaction volume which increased 73% to $1.2 billion with an annualized run rate on the path to $5 billion. Much more importantly than this, I think, is the organic transactions increased 13%, which is an outstanding figure for us.

Looking now at slide 11, you'll see that we are taking a measured and targeted approach to investments that will pave the way for the long term. FDI continue s to invest in the future by developing new partnerships, products and geographies, and here are a few examples of investments we have made in this business:

We're focused on the development our VisionPLUS processing platform to add new products and functionality such as personal loans, finance at the point-of-sale, and revolving loans.

We are burying the cost of maintaining two platforms in the UK while we renew client contracts and accelerate their conversion to VisionPLUS. Our plan is to sunset the UK equation platform by the end of 2008. This is no small task, but we are absolutely on target to do this.

China is another area where we continue to invest; year-to-date in 2006, approximately $8 million. We are still uniquely positioned as the only third party processor in China. Here are two examples of how this investment in paying off:

China Union Pay and First Data reached an agreement that will enable millions of Chinese visitors to access their cash at First Data's 5800 ATM's across Australia. First Data will benefit from the increasing activity of Chinese nationals overseas.

In addition, we signed an agreement to provide fraud detection services as well as a JCB processing agreement with China Everbright Bank. These engagements will be future drivers of the growth for First Data International.

The major area of investment has been our sales engine. We have increased our sales force by 30% this year. This is an increase of approximately 150 sales reps in the last year and brings our sales force total to roughly 650. We believe this will generate significant future revenue and profit growth for us.

We have also signed some significant deals, and I think most of these you have already heard about. They are in the UK, Argentina, Canada, Baltic Regions, Panama, Korea, and Germany. This was another outstanding quarter for our international business, based on solid performance both in business development and acquisitions balanced with operational efficiencies and smart investments for the future.

As you can see, the international management team has continued to deliver an exceptional level of performance around the globe. The size of this business now is basically a revenue run rate exiting 2006 of approximately $1.5 billion. Together with the reduced size of First Data after the Western Union spin, the impact of First Data International as a growth engine for First Data will become much, much more visible to you in 2007.

With that, I'll turn this over to Kim. She'll give you more color on the financials, and then I'll close and we'll take questions.

Kim Patmore

Thanks, Ric, and good morning. I will start out this morning by taking you through our earnings per share results and a number of metrics. I will then take you through our outlook for the fourth quarter and full year 2006. So let's get started and for those of you following along in the presentation, I am on slide 13.

For the quarter, First Data reported earnings per share of $0.17 on a continuing operations basis or $0.29 excluding the items noted on this slide. Earnings per share results were negatively impacted by changes in derivative values related to FAS 133, a non-cash charge of $0.12. We talked during our conference in September about the negative volatility we expected as a result of the changes in derivative values this quarter related to hedge accounting.

We have completed the restructuring of the interest rate swaps on which the volatility was being incurred by integrating payment systems, so that we will qualify for hedge accounting and therefore do not anticipate volatility going forward in the fourth quarter 2006 or in 2007.

In summary, the impact from this item is the first six months were favorably impacted by $0.15. For the third quarter, we were negatively impacted by $0.12. In year-to-date and for the full year, rounding to a positive $0.02. Reorganization costs incurred because of the spin-off were $0.02. This relates primarily to external costs incurred for consulting services to assist in realigning the costs and operating structure for the new First Data as well as assessing our data centers and platform consolidations around the globe.

The majority of these reorganization costs are included in corporate, general and administrative costs, with the balance in First Data International. We do not anticipate any significant reorganization costs in the fourth quarter. Restructuring costs were $0.01. This was primarily head count reductions in First Data international, commercial services, and corporate. The restructuring and reorganization costs were in keeping with our objective to eliminate the impact of incremental costs post-spin-off, and leveraging operations around the world.

Earnings per share were favorably impacted by litigation and regulatory settlements of $0.03 primarily related to our settlement with Visa, which occurred earlier this quarter, and was partially offset by other settled matters.

Turning now to slide 14, on a nine-month basis, earnings per share from continuing operations were $0.78 and there are a couple of additional items to note here. During the quarter, we reclassified our primary payment systems business to discontinued operations due to the sale of the majority of our holding during the third quarter. The result of this is a reduction of about $0.01 of earnings per share from continuing operations year-to-date related to earnings primarily in the first and second quarters.

In addition, we had a $0.02 gain related to the redemption of MasterCard stock and miscellaneous divestitures which we are subtracting out to give a clear look at the reported earnings per share to date this year.

Next, on slide 15, you may have noticed that our discontinued operations earnings per share numbers for the third quarter and year-to-date do not directly tie to the earnings per share numbers reported by Western Union for the same period. Not to spend a lot of time here, I just wanted to mention that the primary differences are due to direct transaction costs incurred by First Data relative to the spin-off included in discontinued operations of $0.04 per share; and intra-company interest income and foreign exchange effect of $0.02 included in Western Union's results, but eliminated in consolidation in First Data's results; and the inclusion of PPS in FDC's discontinued operations on a nine-month basis.

Turning to slide 16, I will now take you through cash flow data from continuing operations. Key components of our cash flow for the quarter were as follows. Net income from continuing operations was $132 million. Non-cash charges incurred in marketing derivatives that did not qualify for hedge accounting to market, net of deferred tax impact, were approximately $96 million. Depreciation and amortization was $178 million. Capital expenditures was $87 million. Dividend payments were $46 million. The total of these items is $273 million for the three months and $779 million for the nine months ended September 30, 2006. This compares to $708 million for the nine months ended September 30, 2005. For the full year, we expect these key cash flow components to total approximately $1.1 billion.

Weighted average shares outstanding were 774 million for the third quarter. The effective tax rate from continuing operations for the third quarter was 3.7%. This effective tax rate was lower than normal, primarily due to the non-cash charge taken for the change in derivative values related to FAS 133. This reduced our effective tax rate by almost 18% from what it would have otherwise been of approximately 22%. It's important to note that the earnings per share of $0.29, excluding items, is based on this 22% tax rate.

For the full year, we anticipate a tax rate of just under 22% on a continuing operations basis, and for 2007 we expect a rate of plus or minus 24%. For a quick reminder about how to calculate our effective tax rate you can refer to slide 22 included in the appendix of the presentation, which will walk you through the steps necessary to get to the effective tax rate.

Moving now to slide 17. During the quarter our interest expense from continuing operations was approximately $72 million, or approximately 88% of the total interest expense of about $83 million for the company. The other 12% was allocated to Western Union for discontinued operations purposes.

The debt balances outstanding at September 30, 2006, were approximately $4.5 billion. Cash and cash equivalents were approximately $3.4 billion including $2.5 billion of cash received from Western Union at the spin-off date. Cash will be reduced in the fourth quarter by the ArgenCard purchase of approximately $200 million.

As we mentioned in September, we plan to use the $2.5 billion in cash received from Western Union to pay down debt over the next several months to achieve a debt balance of approximately $2.1 billion and cash balances of $600 million to $700 million. So for modeling 2007, you should use expected debt and cash balances to get a better baseline for 2007. Keep in mind, these cash and debt balances are intended to be directional and depending upon the timing of items like acquisitions and stock buybacks, the numbers will fluctuate from quarter to quarter.

One comment on Corporate and Other, we expect fourth quarter results on the profit line o be slightly better than the third quarter, and we will provide more details in January regarding 2007 outlook for Corporate and Other.

Slide 18 is intended to demonstrate the impact not qualifying for hedge accounting has had on the company as a whole and on the Integrated Payment Systems segment specifically. As previously noted, the derivatives in question were restructured prior to September 30, 2006, and we anticipate no impact to fourth quarter results from FAS 133. Accordingly, the highlighted values on slide 18 are a much better indicator of our fourth quarter expectations for the segment than the reported results. In January we will provide separate guidance for IPS as a stand-alone segment.

Turning now to our 2006 financial outlook as displayed on slide 19. Earnings per share from continuing operations in the fourth quarter is expected to be $0.33 to $0.35, in line with The Street consensus. We expect a sale of a component of one of our corporate and other businesses in the fourth quarter. This sale will generate a gain which will be offset by debt repayment costs and restructuring costs. Assuming this performance, full year earnings per share from continuing operations is expected to be in the range of $1.08 to $1.10, excluding items. Just as a reminder, in accordance with our prior practice, we will give you full year guidance for 2007 in January.

Finally, beginning later this week, we will restart our stock buyback program, and we anticipate buying back approximately $700 million of stock by the end of 2007.

Now I'll turn it back to Ric.

Ric Duques

Thanks, Kim. I'm often asked how an economic slowdown in the U.S. will affect First Data. My answer is, not much. That's unless we fall into either a major recession or depression. We feel very confident about the three to five-year outlook for the payment processing industry.

Specifically, the shift from cash and checks as a dominant form of consumer payment to credit, debit, and prepaid cards. The number of transactions on credit and debit cards alone is projected to grow from $43 billion to $69 billion by 2010. That's over a 60% growth in five years, and that does not include the explosive growth in prepaid cards, nor does it include any payments outside the United States where we see enormous opportunities.

A slowdown in consumer spending, a housing slowdown, an unfriendly to business interest rate environment or a slowdown in job creation will have some impact on us, especially if they are all negative at the same time. However, over the next three to five years, I don't see the cumulative effect of any or all of these dragging down the highly positive secular trend towards electronic payments by consumers.

The macro trends that I have just described have created a compelling logic to being an investor in First Data. As a shareholder of First Data, you are participating in the long-term transition to a cashless society with the leading company in the space. As an owner of First Data, you hold shares in a company that has publicly stated it will grow 8% to 10% in both revenue and earnings per share with a potential to exceed these growth rates in any given quarter or year. Being able to deliver on those goals, even during economic downturns, gives First Data unique characteristics as a public company investment.

In closing, I hope that the third quarter results help you understand why we feel so positive about the balance of 2006. Furthermore, we look forward with great enthusiasm to 2007 and beyond. Kim and I will be happy to take questions. So, operator, can you open it up for questions?

Question-and-Answer Session

Operator

Our first question is from Greg Smith - Merrill Lynch.

Greg Smith - Merrill Lynch

Good morning. Kim, the free cash flow number you said, am I correct that you were saying $1.1 billion for '06?

Kim Patmore

Correct.

Greg Smith - Merrill Lynch

Is that including dividends or excluding dividends?

Kim Patmore

That includes the deduction for dividends.

Greg Smith - Merrill Lynch

Okay. So that's sort of net of about $184 million of dividends for the full year?

Kim Patmore

Correct. And also includes the capital expenditures.

Greg Smith - Merrill Lynch

I think that might be higher than what people were thinking. Anyway, thanks for clearing that up.

Then you talked about buying back $700 million of stock, clearly the free cash flow at least by our estimates will be quite a bit higher in '07. Do you have any anticipated target then for acquisitions for how much you may use on a cash basis in '07 at this point?

Kim Patmore

Well, we really try to do a balance between the two. We have a very robust acquisition pipeline right now. We will balance in 2007 the buyback with the acquisition pipeline as we go through the year along with the investments in the business.

Greg Smith - Merrill Lynch

And would you anticipate if the acquisitions aren't materializing that the buyback could be higher than $700 million?

Kim Patmore

I think that would be reasonable and we just balance that with we've got about a $1.2 billion authorization remaining at this point.

Greg Smith - Merrill Lynch

And just lastly, on the proprietary terminal you're rolling out, the FD-100, is there any target for the number of terminals, and is this something you intend to take internationally?

Ric Duques

There's no target. Clearly some of these terminals, there's some merchants where these terminals aren't appropriate. For right now this is strictly a U.S. effort.

Greg Smith - Merrill Lynch

Okay. Thank you very much.

Operator

Our next question comes from Tien-tsin Huang - JP Morgan.

Tien-tsin Huang - JP Morgan

Thanks. A question on the Financial Institution segment. Should we continue to assume fiscal '06 will be flat year-to-year on revenue?

Ric Duques

Let me understand the question. The revenue is flat?

Tien-tsin Huang - JP Morgan

Year-to-year and full year 2006 in the Financial Institutions segment.

Ric Duques

I would say flat to slightly negative.

Tien-tsin Huang - JP Morgan

If that's the case, then just looking, it looks like it implies a pretty steep sequential step-up in revenue, so are there any acquisitions or potentially new clients we should think about in the fourth quarter?

Ric Duques

No. There's the issue with deconversions that you're not seeing, but I don't think there's any specific big revenue kick in there.

Tien-tsin Huang - JP Morgan

Okay. And then Kim, also the $0.02 in the Western Union spin-related costs can you detail again where exactly that sits on the P&L?

Kim Patmore

That's primarily in the corporate and other, general and administrative, as well as in First Data International. If you recall, First Data International and Western Union shared not only facilities but they also shared some of the backbone network and telecom. So as we split those apart, the other piece would be in First Data International in their G&A as well.

Tien-tsin Huang - JP Morgan

If I could ask a few quick housekeeping items as well. The $35 million run rate in other and corporate, is this a good quarterly run rate to assume going forward? And also if you can comment on the interest costs in 2007 on the $2 billion in debt, that would be helpful as well. Thanks.

Kim Patmore

On the $35 million in corporate and other we do expect to be slightly better in the fourth quarter. And then on the interest costs I would use in general a $2.1 billion assumed debt balance and then assume maybe 5.25% to 5.5% interest expense.

Operator

Our next question comes from Adam Frisch - UBS.

Adam Frisch – UBS

Thanks, good morning. Just to expand on Greg's question maybe from a different angle. On the buybacks, $700 million, some are viewing that as a little less aggressive than the commentary and the body language maybe given at the Analyst Day in September given you have a $1.2 billion left, lots of cash flow, et cetera. Should we take that as a shifting? I know you commented on where you're going to use your cash, but are you shifting priorities at all for cash or is that a conservative marker you intend to be near term?

Ric Duques

No, we're not shifting; it may be conservative.

Adam Frisch - UBS

Okay. Second question on the balance sheet. If you do get the debt balance down to 2.1, Ric, I know you said at the Analyst Day you don't like debt. But given where the stock is and so forth, do you view debt as a strategic tool here to get the stock either– what are the possibilities there I guess? I think you know where I'm going here.

Ric Duques

Listen, I think we're probably appropriately leveraged there but there is certainly no fear on our part for having that debt or more going forward. So I mean it's just the business situation, there are opportunities out there, particularly in the international and certainly in the Financial Institution Services segment that I tried to call out in fraud and loyalty and customer contact, the things that we might be doing there.

The acquisitions, you can't plan them. They just kind of there and we got to be prepared to take advantage of them. And we will.

Adam Frisch - UBS

Okay. And then final question, Ric you seem to throw out a bone for confirming segment guidance will meet or beat your current outlook for '07. But on '07 EPS guidance, Kim, maybe you can provide some ranges around what the issues are below the line, because based on our conversations with investors the ambiguity around these issues is really keeping a lid your stock.

Can you provide what the issues are and how much they could impact? Just general ranges and then we can figure it out from there. But the ambiguity there, I think, is holding you back here.

Ric Duques

We have never, as long as I can remember, provided a guidance for the next year in October of a year before that. So we try to be as clear as we could possibly be. There's no hidden message on corporate and other that we have. We just have not had the ability to share the operating plan which is still a work in progress with the Board. So we're not going to come out there and say, this is the earnings per share estimate.

We called out two specific items that we know are going to impact 2007. One is the stock option grow-over which is about $0.04, the FAS 123 option. The other is in the corporate and other is the [inaudible] which is a business we're going to de-emphasize. That's about $0.03. So there's $0.04 and $0.03, and also we called out a tax rate of about 24%. So I think with those two big items and then the tax rate, I think you can assume that there's no other huge item down there. I think maybe that's helpful to you.

Adam Frisch - UBS

It is. Because you did give guidance on the segment levels so piecing it together, I think the logic out there is out that there's some big huge numbers moving around below the line which is causing a huge range on your consensus.

Ric Duques

It really isn't there. And Kim has one other item.

Kim Patmore

I think if you look at the IPS data that we gave you on Slide 18, also you'll see the trends in the segment. So that can help you model a little bit for IPS. We'll give it to you separately in '07, but that might give you some general directional data when you look at the result if the hedge accounting treatment had been available. You can see the trends by quarter.

Adam Frisch - UBS

More importantly I guess, any read – you gave what you spent on dividends and CapEx and so forth. So is somewhere around a $1.3 billion for cash flow in '07; is that in the ballpark of what you guys are thinking about?

Kim Patmore

I think that's clearly trending off of where we have this year.

Adam Frisch - UBS

Great. Thank you.

Operator

Our next question comes from James Kissane - Bear Stearns.
James Kissane - Bear Stearns

Hi, Ric and Kim. I know you don't want to get into the '07 EPS guidance but it sounds like the base number is about $1.09 for '06. You said that you should be able to grow EPS in the 8% to 10% range . Is that too simplistic given what's going on in the other segment?

Kim Patmore

Well, I think the only other thing you would want to do is keep in mind around the interest expense. The interest expense will be pretty different in '07 and that's why I suggest you model off of the $2.1 billion in debt and call it 5.25% to 5.5% interest expense would be helpful.

James Kissane - Bear Stearns

Okay. And then your longer term target for international margins because I think they came in somewhat below what most people were expecting in the quarter.

Ric Duques

Well, I don't think we gave a target for margins. You know, we gave a target for profit growth in there. I think we said we did not expect the margins in that business to equal the U.S. margins but we thought we'd get it into the 20s.

James Kissane - Bear Stearns

Can you give a timeframe, Ric?

Ric Duques

As fast as we can.

James Kissane - Bear Stearns

That's helpful. And then your CapEx outlook? It looks like based on the third quarter it has stepped up. Is $350 million for next year about the right number? Or is it more in line with the $300 million for '06?

Kim Patmore

You know, we haven't given guidance on that but if we have anything over and above what we've done this year related to platform consolidation or data center consolidation or something, we will call that out separately. Then we'll give you specific guidance in January as well.

James Kissane - Bear Stearns

Okay. Great. Thanks.

Operator

Our next question is from Patrick Burton - Citigroup.

Patrick Burton – Citigroup

Hi. Congratulations again on the Western Union spin-off. Ric, I'm going to follow up on your comment about a potential fourth quarter restructuring charge being offset by a gain on sale. What would the charge be for and what would the cost savings be going forward?

Ric Duques

Kim will take that.

Kim Patmore

You know, we're continuing to do some consolidations, particularly internationally around some of where we've done acquisitions because we're getting scale. So we do anticipate we'll have some pretty small, but we'll have some restructuring maybe around a penny to a penny-and-a-half in the fourth quarter of this year. Like we mentioned, we'll have this sale and we'll also have debt repayment costs in the fourth quarter as well related to the spin.

Ric Duques

The sale, we haven't called it out because it's not actually closed yet but we feel confident it's going to close.

Patrick Burton - Citigroup

In terms of the outlook for IPS, Ric, what are the decision points you're looking at whether to keep that business or ultimately divest it? Thanks.

Ric Duques

Well, now that we removed the volatility from the hedge accounting, we're a little bit more comfortable as we go forward. So right now there are no plans to divest that business. We have a client base there that's pretty significant and we're going to do the best job we possibly can for them. Clearly, the $0.15 positive and the $0.12 negative were something that is not something we want to have on a go-forward basis and we really feel we've eliminated that. So we're a little bit more relaxed about this segment right now.

Patrick Burton - Citigroup

Thank you.

Operator

Our next question comes from Liz Grausam - Goldman Sachs.

Liz Grausam - Goldman Sachs

Building on Pat's question, in your other businesses outside of IPS, what's the process you're looking at there? It sounds like you're selling a business in the fourth quarter and you're winding down your patent business. Are you fully reviewing that portfolio or are you more focused on improving the operating profitability in those businesses and selling them?

Ric Duques

I think, Liz, you can think in terms of this for 2007. There's about six businesses left in there and we will pretty much move those to one of the three segments. There may be one or two left in there. You won't have many of those six businesses to kick around in 2007. Not because we're trying to move them around, it's just they more appropriately belong to a client base like Financial Institutions or there's a business in there that's very, very complementary to the Commercial Services segment. So we'll move those businesses around. We probably will not sell them. I think most of them are profitable. So that's what we're going to do with those six businesses. We're going to move them into the segments in 2007 with maybe one or two exceptions.

Liz Grausam - Goldman Sachs

Great. And then on your international acquisition strategy, was any of the somewhat dilutive effect of the margins in the quarter due to the GZS acquisition? How do you think about accretion and dilution in your International acquisition pipeline?
Ric Duques

None of them were GZS. As a matter of fact GZS was performing on revenue above where we thought it was going to be. And the second question was about margin?

Liz Grausam - Goldman Sachs

How do you think about dilution on your international acquisitions? How long do you expect the acquisition to take to come to breakeven on a margin base basis with your international ops?

Ric Duques

I think it varies all over the lot; sooner rather than later in terms of contributing. But I mean I think they are strategic in these various countries. We call out a growth rate in international in profit of 25% to 30%. I think that's the key focus for us. We're trying to make sure that we meet those guidelines. Longer term without acquisitions we think we called out the 16% to 20% revenue growth and probably 5 points higher on profit. So figure 21%, 25% growth longer term there and that's what's driving us.

Liz Grausam - Goldman Sachs

And then any update opt acquisition pipeline potentially in the domestic market? Is there anything you're looking at in particular areas of the portfolio?

Ric Duques

Not that we can call out right now.

Liz Grausam - Goldman Sachs

Okay. Great. Thank you.

Operator

Our next question is from Christopher Malone - Deutsche Bank.

Christopher Malone - Deutsche Bank

Hi. Just wondering about the CEO search. Is that underway yet?

Ric Duques

We're just kind of kicking it off. So the answer is it's not formally underway yet, but I think we called out both the management and the Board were totally focused on the Western Union spin. We're happy that is now behind us. So we can look at the CEO search, the Board is really conducting that and it is starting.

Operator

Our next question comes from Charlie Murphy - Morgan Stanley.

Charlie Murphy - Morgan Stanley

Thank you. Ric, could you describe the factors that give you confidence in a pick-up in Financial Institutions revenue growth in '07 and '08? Which of the five sub segments are going to be driving that? Card processing, output, debit?

Ric Duques

I called out that we think we have cross-selling which we just started. I mean, that was, it's probably more print mail type of stuff that is huge potential revenue, a little less on the profit margins. But there will be some core revenue growth, there will be some cross-selling of those products. The utility I called out, we just entered that adjacent market and I was there yesterday talking to the senior folks and they seem very confident that we'll be able to announce something in 2007. Then there's going to be some expense savings continue to flow through there.

So I mean those are the components. Now, we're talking mid single-digits here in terms of revenue growth so it's not like a rocket ship yet. But we're getting increasingly confident that we're going to be able to meet or exceed those numbers.

Charlie Murphy - Morgan Stanley

Great. And what's the operating margin the debit business within Financial Institutions?

Ric Duques

We don't call that out. I give the basic segment there. Which excluding the reimbursables is in the 30% range.

Charlie Murphy - Morgan Stanley

Okay. Thanks.

Operator

Our next question comes from Craig Peckham - Jefferies.

Craig Peckham - Jefferies

Good morning, Kim, the $0.04 in 2007 pertaining to stock-based compensation, is that a recurring $0.04 element? Will we see that again in 2008 at the same level?

Kim Patmore

What that is that's really based on if we do the same level of issuance of restricted stock and stock options going forward. The reason that you have it over the next couple of years through 2009 is because with the quick vest of what we did at the end of '05; now you have each of the four-year vesting periods over the '06, '07, '08 and '09. So you can expect around that $0.03 to $0.04 assuming we do it at the same levels and of course that will be subject to compensation committee review.

Ric Duques

And then it stops. Then after 2009 it's in the run rate.

Craig Peckham - Jefferies

Okay. I'll put that in my 2010 number then.

One more question for Ric. Thanks for the thoughts on the economic sensitivities. Could you give us your thoughts on how potential changes in interchange structures and more broadly the back and forth between Visa and MasterCard and the merchants might impact your business on basically the Commercial Services front, maybe the international front?

Ric Duques

Well, I think there's always tension between the associations and now the public companies which is probably a good thing because it is a lot more visible to all of us. We cooperate with them in some areas, in a lot of areas, and we compete with them in some areas. So I think the merchant and the associations thing there will always be tension there but I think Visa and MasterCard as a public company will be an interesting development.

I think the forms of payment, as long as they're electronic, we like them. Most of them are debit and credit cards but some of them are prepaid cards and gift cards and things like that. So the merchants, you can go to any of these big merchants, particularly the grocery stores and whatever, the Wal-Mart’s of the world and see lots of prepaid cards being used there. That's a good thing for us.

We don't even really have a good feel for that other than it's explosive. I mean, it's just people are using these cards. That's a good thing for our merchant business. That's why I'm calling out the next three to five years feeling really good about the forms of payment that are going to be used in merchants.

Craig Peckham - Jefferies

It doesn't sound like you're too concerned about getting squeezed in the middle here as some of these things play out.

Ric Duques

Well, I'm always concerned about getting squeezed anywhere but the pricing in the merchant arena, as all of you know, is vicious. So we have got to get better and better and better and we have to have scale in there because there's compression in pricing of 3%, 4%, 5% a year and we battle that every single year. So that's not going away, I don't think. I don't think it's getting any worse, let me just say that. That's a positive.

Craig Peckham - Jefferies

Okay. Great. Thanks for the insight.

Operator

Your next question comes from Wayne Johnson - Raymond James.

Wayne Johnson - Raymond James

Hi, yes. Good morning. Going forward, I was wondering as far as modeling cost of service and SG&A does the third quarter -- just to clarify again -- have any one-time items that we should be removing? Or should we assume that that's a base to work from and use that into ['04] and potentially annualize into '07?

Kim Patmore

I think the G&A, as we mentioned, does have some of those reorganization costs, particularly related to the corporate. I do think you'll be slightly better in the fourth quarter in the corporate and other line. Going forward like we mentioned I think you're going to want to take out in '07 you're going to want to take out the patent revenue and profit of about $0.03. Again, on share base compensation, assuming the same level of what we have done in the past to be another incremental $0.04.

Wayne Johnson - Raymond James

Okay. Terrific. Ric, what are the three bullet points, the reasons why First Data is being so much more successful this year compared to the last couple of years in winning the small and medium-sized retailers? Is it quality of service? Is it technology improvements? What's the feedback you're getting from customers? We want to work with First Data because… and what are the fill in the blanks there?

Ric Duques

You know, that's a tough question because there's no silver bullet there. We put a lot more client management and relationship management people in that segment. A lot more. So we invested in client relations there so they see us as a kinder and gentler and more friendly operation.

Clearly there's a sales culture there. Clearly there's a culture of we don't want to lose any client that we have. The senior leadership is not hesitant to get on a plane and go talk to a client that's thinking about leaving.

But to your first question, 85% of our location and 75% of the revenue are in the small to regional marketplace. So we were always there. I mean, there's a myth out there that we weren't there. We are there. We have been there. Now we have a little bit more on the ISO side so maybe like I said in the call, 90% of the new merchants that we have got, the 160,000 merchants, 90% of them were in that segment which is even a higher percentage than our basic base. So it is increasing there.

We have terminals, we have the one statement that we're doing with Discover. All of these things cumulatively help us retain clients and get clients. I think it was called it out in September, it is basic blocking and tackling and just doing things better and being more responsive to that client base.

Wayne Johnson - Raymond James

That's really helpful. Thank you. Of that 160,000 new clients, how many came from ISOs?

Ric Duques

I don't have that. Clearly still the strongest is the bank alliance partners. We put sales forces with them, they have the sales forces, they have the branches. So the more branches you have that people can walk into and say, I just opened a flower shop, can I get a DDA? By the way do you do credit card processing? Those are really, really good for us and for the bank.

Wayne Johnson - Raymond James

Terrific. Thank you very much.

Ric Duques

I think we can do one more question and we're right at the top of the hour. So Operator, if we can take one more.

Operator

You have a question from Mark Sproule - Thomas Weisel Partners.

Mark Sproule - Thomas Weisel Partners

Thanks. Just real quick here. On the international side, organic growth of 13% on the transaction side. What do you do to accelerate that? We know the international markets in Europe and emerging markets in Asia are growing at a much faster rate than the domestic businesses. So is it just consolidating the platform and investing in the business? And then expanding and then it just takes a year or so to ramp past that point? How do you look at that?

Ric Duques

That's organic growth. I hate to say win by leading because the management will shoot me because it takes a lot of hard work. But in various parts we try to make the acquisition in an area where we think that there is organic revenue growth there. If it's not fast enough we won't make the acquisition. So we are investing in areas where there is organic growth and as soon as we get the conversions done we should enjoy that.

Now, that doesn't mean we still don't try to sell new products into there to help accelerate the revenue. But basically we're in marketplaces that are going to be growing. That's a big positive for us.

Mark Sproule - Thomas Weisel Partners

Got you. And then I guess to harp back a little bit on the margin question there that was asked multiple times earlier, when you look at the margin in that business is it more a function of investing in the business and consolidating in platforms; and then getting the volume growth that will start to see that move towards the 20%?

Ric Duques

You just described it. That's accurate. The consolidation of these platforms basically the UK platform on to VisionPLUS, that's going to take two years to get that really done. But yes, that will definitely push the margins.

Mark Sproule - Thomas Weisel Partners

Okay. If I could ask one last tiny question on the Commercial Services on the margin there in the quarter was really strong. Maybe I was mistaken but I thought that from the September conference you referenced that Q3 would looking more like Q1, Q4 more like Q2. How do you look at the margin in that business as we go forward?

Ric Duques

You're exactly right. We were positively surprised. We're going to continue to invest in that business. I mean, I wouldn't say, oh, keep expecting better and better and better margins there. I think we're happy with the margins. We have scale that allows us to have those margins but we are definitely going to invest back in that business. There's no question that we're going to have products in there that are going to help us retain and get new clients. So I would not expect the margins to keep going upward there.

Mark Sproule - Thomas Weisel Partners

Thanks.

Ric Duques

All right. Thank you, everybody. Appreciate the attendance.

Operator

Thank you for your participation. Your call has ended.

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