First Data Q1 2007 Earnings Call Transcript

TRANSCRIPT SPONSOR

First Data Corp. (FDC)
Q1 2007 Earnings Call
April 20, 2007 8:00 am ET

Executives

Ric Duques - CEO, Chairman
Kim Patmore - Executive VP, CFO
Silvio Tavares - SVP and Head of IR

Presentation

Operator

(Operator Instructions) Now I would like to introduce your host for today's call, Mr. Silvio Tavares. Sir, you may begin.

Silvio Tavares

Thank you. Good morning, everyone. This is Silvio Tavares, SVP and Head of IR for First Data. Thank you for joining us. With me today are Ric Duques, Chairman and Chief Executive Officer; and Kim Patmore, Executive Vice President and Chief Financial Officer.

We are very pleased to host this teleconference and webcast to announce our financial results for the first quarter of 2007. We had a great start to the year and we'll be providing financial details for the company overall, as well as for each one of our main business segments.

Now please turn your attention to the agenda. Ric will start us off by covering our previously announced merger agreement with affiliates of Kohlberg Kravis Roberts. Next, Ric will review the company's first quarter highlights and finally, we'll discuss the significant progress we've made against our 4Q strategies. These are growing our core business, expanding our product offerings, improving our overall cost structure and expanding globally.

Kim will then take us through the corporate financials. She's also going to discuss the financial performance of our three keys segments: commercial services, financial institution services and First Data International.

Could you hold on for just one moment? It seems like we're having technical difficulty. Operator, if you could please mute the lines; we are experiencing some interference.

Operator

Yes, sir. I'll check on that right away. Thank you.

Silvio Tavares

Operator, do you have that addressed and are we ready to continue?

Operator

Yes, sir. We're addressing that right now.

Silvio Tavares

I'm going to go ahead and continue as we get those lines muted. Now, please note there will be no live question-and-answer session during today's call, so should you have any questions please don't hesitate to contact me at 303-967-8276, or you can also just drop me an email at [e-mail].

Please turn to slide number 4. 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 copyright protection. Other than the replay, First Data does not authorize and disclaims any responsibility for any recording, replay or distribution of any transcription of this call.

Now, I will hand it over to Ric.

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Ric Duques

Thanks, Silvio. Good morning, everybody and thank you for joining the call today. Before I go into the first quarter results, I would like to address the proposed transaction announced on April 2, 2007 with an affiliate of Kohlberg Kravis Roberts & Co., commonly referred to as KKR. Today's call is my first opportunity to speak directly with many of you about our agreement. First Data's board of directors unanimously approved the agreement with KKR, based on the recommendation of our board's strategic review committee, which is comprised of three independent directors.

As you can see on slide 6, KKR's offer of $34 per share in cash represents a significant premium of approximately 34% over the average closing share price during the 30 trading days prior to the announcement. In the days since our announcement, our shareholders have been asking a few common questions. I'd like to take a couple of minutes to address some of them before going through the first quarter results.

Let's go to slide 7. First question: what happens in the event of a termination of a First Data equity alliance? As we have previously stated with respect to our largest alliances, we have the right to retain our proportionate share of merchants and financial profit in the unlikely event of a termination.

Second question: will First Data pay its regular dividend until going private? This is a board of directors decision. However, we do not anticipate any change in dividend policy between now and the closing of the proposed transaction.

What regulatory approvals are needed to close the transaction? The regulatory approvals required for this transaction are discussed in the agreement and plan of merger dated April 1, 2007.

When will the proxy be filed? The proxy for this transaction will be filed within the next four weeks.

Why is First Data tendering its debt? This fits into the preferred capital structure of KKR. As part of this deal, we negotiated a 50-day go shop period which ends May 22nd. Because we are in the go shop period right now, we will not be discussing any further details of the proposed transaction. However, at firstdata.com you can access the Form 8-K which we filed with the Securities and Exchange Commission, containing both a press release and the agreement and plan of merger; that provides additional details.

We are extremely pleased and excited about this new chapter in the First Data story. Transitioning from a public to a private company will allow us to make strategic long-term investments that benefit our clients while simultaneously delivering immediate cash premium to our existing shareholders.

Now let's move to First Data's financial performance in the first quarter, outlined on slide 8. As you can see on this slide, we are off to a great start in 2007. Let's start with cash flow. In January of this year, we guided to $1.4 billion to $1.6 billion of operating cash flow from continuing operations for the year. We have already achieved a strong $440 million in operating cash flow from continuing operations during the first quarter.

Revenue also came in very strong. Overall revenue for First Data grew 12% and all three of our main business segments performed very well. Commercial Services and Financial Institution Services both grew 9% and First Data International delivered 39% revenue growth. While all of these numbers were impacted by acquisitions, our consolidated organic revenue growth on a constant currency basis was 7%, further demonstrating healthy growth. Both our core business and acquired businesses performed well in the first quarter.

Finally, in January we guided you to first quarter earnings per share from continuing operations of $0.21 to $0.23. I am pleased to say that earnings per share was $0.24 excluding items, or $0.23 from continuing operations. These numbers confirm that we are making significant progress against our four key strategies.

Moving to slide 9, this slide shows that our key strategies are really the platform for our success. Grow our core business: what this means is retain and gain new clients in our main businesses. Expand product offerings: our strategy here has been to acquire and develop products and services that can help attract new clients and be cross-sold to existing clients. Improve our overall cost structure: we have established a culture where operating costs are continually challenged and opportunities for improvement are identified. Finally, expand globally: we are the industry leader in the U.S. and we are leveraging that position in many of the world's economies by capitalizing on the secular trend away from cash to electronic commerce.

Let's look at our accomplishments in each of these areas in the first quarter. First, let's focus on our strategy of growing our core businesses. I'm on slide 10. These key performance indicators speak for themselves. I think you will all agree that these are outstanding numbers. Domestic merchant transactions grew 13% and we signed nearly 149,000 new merchants in the first three months. This clearly demonstrates the health of our Commercial Services business. Domestic debit issuer transactions grew 19% and domestic card accounts on file grew 34%, showcasing the continued strength of our financial institution services business. In our international business, transactions, point of sale locations and cards on file all showed very healthy growth in the quarter. What these numbers indicate is that our core electronic payments business is not only growing, it is thriving.

Moving to slide 11. We had a number of important new contract wins, cross-sales and significant conversions in the first quarter. Starting with new contracts, in our Commercial Services business we closed two new revenue share alliances that delivered over 350 new bank branches. Our international business had a number of wins around the globe. Especially significant is the successful launch of a joint service capability giving China Union Pay customers access to their cash via more than 5,800 cash card ATMs in Australia. This strategic partnership provides tremendous growth opportunities for First Data and advances CUP’s goal for internationalization. You'll be seeing more and more CUP logos in other countries in the future as they partner with us to leverage our global presence at the point of sale at ATM locations around the world.

Another notable win was a five-year card processing contract with Samba Financial Group, the second-largest bank in Saudi Arabia and the country's largest credit card issuer. Samba selected us as their partner because of our worldwide payment expertise, local market presence and the power of our VisionPLUS platform. We completed the conversion of their in-house system to VisionPLUS in March. This contract further extends our market presence in Saudi Arabia and the Middle East where we have been operating for over 12 years.

The second area you see on the slide is cross-sales and contract renewals. We continue to see great success in the adoption of TeleCheck's electronic check acceptance product, we call that ECA. The roll out to several major retailers has led to double-digit growth in TeleCheck business this quarter. We issued a press release announcing Office Depot's implementation of this product and we continue to see additional retailers such as Wal-Mart and Valero deploy ECA in their stores.

We acquired the instant cash service business from Wells Fargo. This business fits squarely in the core of what we do and delivered over 500 community banks, credit unions, thrifts and non-financial institutions as clients for our debit and ATM processing business. Instant cash exited 2006 with an annualized revenue run rate of $34 million.

Finally, internationally we have been extremely busy with conversions. In addition to Samba we also converted Bancosal and Banistmo, plus two partner card programs for BarclayCard.

We are excited about the growth opportunities of our core business, both in the U.S. and around the globe. The first quarter also demonstrated that we are committed to innovation by developing and acquiring new value-added products and services.

Looking at slide 12, we acquired four companies in the first quarter, each with an innovative and unique product set, aimed at the electronic commerce marketplace. We are taking many of the products from these recent acquisitions and leveraging them across the enterprise. An example of this is Datawire, which provides an Internet-based transaction delivery network that connects a wide range of point-of-sale devices to payment processes through any public Internet connection. We will market this service to our clients in both Commercial Services and First Data International.

Another example is our acquisition of Size Technologies which develops and licenses the most advanced loyalty programs available in the marketplace. Both our merchant and bank clients seek loyalty solutions to reward and track consumer behavior.

Finally, just this week we announced the acquisition of FundsXpress, a premier provider of online banking and bill payment services serving more than 500 community financial institutions. We believe these services will provide us with an attractive cross-sell opportunity into our existing large base of similar clients.

First Data has developed a reputation as a premier partner in electronic commerce. We leveraged our reputation by signing the three large partnerships you see on this slide. The Microsoft and Hewlett-Packard partnership is one that we have mentioned previously. Steve Ballmer, the CEO of Microsoft, talked about this new product launch at the National Retail Federation show in January. The First Data point of sale value exchange continues to generate excitement as a fully integrated store management point of sale solution for small retailers.

The last point on this slide is an example of how we have also developed some of our own new products. We are one of a very select group of companies that can provide global merchant acquiring to large multinationals. In the first quarter we went live, providing global merchant acquiring for Microsoft, IBM and Lenovo. We are very pleased with the first quarter progress we made in expanding our product offerings.

Now let's move to discuss our strategy of increasing the efficiency of our infrastructure on slide 13. The first two bullets address our international efforts. Regarding international data center consolidation, we have already closed one of our German data centers and will close another by the end of May. We plan to complete most of the European mainframe data center consolidations in 2008.

For the international data center platform initiative, we have made great progress with the additional build out of our VisionPLUS processing capability. In addition, we had multiple portfolio conversions in the first quarter of 2007. Besides the ones I have already mentioned, we successfully converted BNL Positivity to our OmniPay platform. To facilitate these efforts in First Data International, we spent an incremental $6 million in the quarter in comparison to the prior year.

Moving to Financial Institutions Services segment, we have completed or identified approximately $62 million in cost savings out of our $75 million annualized savings goal. As a result of these initiatives profit margins, excluding reimbursables, showed continued strength at around 30% despite ongoing price concessions.

In our Commercial Services segment we undertook several actions within our sales and sales support team to improve the overall efficiency and effectiveness of our sales process. These actions are part of our evolution towards a more customer and sales centric culture which focuses on bringing all of our products closer to all of our customers. We continue to concentrate our efforts on our core distribution channels -- those are national, regional, feet on the street and ISOs. We have eliminated sales forces that were not integral into one of these core channels. This may slightly impact revenue performance in the near term, but will produce immediate and ongoing benefits to operating profit.

Finally, we have also advanced our U.S. data center consolidation program. In January, we promised to give you an update on this initiative and I have more details on slide 14. Our plans include reducing our U.S. data center locations from 12 down to three and command centers from seven down to two. Our best current estimate is that the cost in 2007 will be approximately $45 million. This is comprised of $24 million in capital expenditures plus $21 million of direct project expenses. For the entire project, we are presently estimating a total cost of $225 million, made up of $145 million in capital expenditures plus $80 million in direct project expenses. We expect to incur these costs between now and the second half of 2009 when we anticipate the project will be complete.

Much of the capital spend represents acceleration of costs we ultimately would have incurred over a more extended period of time in order to upgrade our present facilities. However, the consolidation enables us to incur these costs in a much more focused manner and in far fewer locations.

I'm sure you're asking yourself, what should we expect in benefits from this projected cost? The answer is simple: this consolidation will add surety to our long-term revenue and earnings growth objectives of 8% to 10%. Our infrastructure will be state of the art, enabling us to provide even better performance for our clients. Our systems operating cost will decrease. We will have better ability to manage fast growth and changing business needs. Finally, we expect to achieve an estimated $65 million in annual cost savings or cost avoidance subsequent to the completion of the project.

This brings us to another exciting aspect of our strategy, our continued expansion into global markets outside the United States. Outlined on slide 15, international markets continue to exhibit a trend away from cash to new forms of electronic payment. In the first quarter, we announced our exciting acquisition of POLCARD, the leading independent merchant acquirer and card issuer processor in Poland. POLCARD is a very healthy business which will provide us with accretive operating profit, excluding depreciation and amortization, in 2007. It's projected five-year revenue compounded annual growth rate is above the high end of First Data International's long-term revenue growth rate target of 16% to 20%. POLCARD exited 2006 with a $52 million annualized run rate.

Now turning to Asia. As we previously announced, our merchant acquiring partnership with Standard Charter is called Merchant Solutions. In the first quarter we obtained approval to include Malaysia in addition to the initial seven markets scheduled for implementation this fall. As planned in the first quarter, we invested approximately $1 million related to Merchant Solutions.

In Latin America, our Argencard acquisition from 2006 is off to a very strong start in the first quarter. This business is really a mini First Data, providing the full range of services to merchants and financial services institutions, and it's based out of Buenos Aires, Argentina and Montevideo, Uruguay.

All our main segments started off 2007 with strong performances and the opportunities for continued future growth are as bright as they have ever been for First Data. Now I'd like to turn it over to Kim Patmore to walk through the financials in a little more detail.

Kim Patmore

Thanks, Ric and good morning. I will start this morning by talking about our very strong cash flow for the quarter. So let's get started and for those of you following along in the presentation, I am on slide 17. There are many things that make First Data unique, but our strong, consistent cash flows continue to stand out as one of our key financial attributes.

This slide describes our free cash flow for the quarter. Our income from continuing operations was $172 million and after adding back depreciation and amortization and subtracting both CapEx and dividends, you see free cash flow of $232 million, which is very much in line with previously provided full year guidance of $1.2 billion to $1.25 billion. As Ric mentioned, operating cash flow from continuing operations was a strong $440 million and, again, tracking very favorably toward previously provided guidance of $1.4 billion to $1.6 billion for the full year 2007.

Turning now to earnings per share on slide 18. If you remember in January we guided you to an earnings per share range of $0.21 to $0.23 from continuing operations for first quarter 2007. I'm pleased to tell you that our earnings per share was $0.24 excluding items or $0.23 per share from continuing operations. Earnings per share from continuing operations includes a $0.01 per share charge related to the non-cash impairment of goodwill and other intangibles as the direct result of our decision to wind down the Official Check and Money Order business.

Items to note relative to earnings per share results include the following: first quarter results included legal, accounting and other advisory fees of $5 million related to the proposed private equity transaction. The tax rate from continuing operations for the first quarter was 18%, but would have been 19% excluding the impact from the Official Check and Money Order impairment. As discussed in January, we continue to guide to a full year tax rate of 22 to 23%. This excludes the impact of the Official Check and Money Order business wind down and the proposed private equity transactions.

Finally, first quarter 2006 earnings per share from continuing operations of $0.28 included a favorable $0.08 of items, primarily comprised of the impact of the FAS 133 derivative accounting restatement. Excluding items, earnings per share was $0.20 in the first quarter of 2006 compared to $0.24 in the first quarter of 2007, a strong growth rate of 20%.

Let's turn now to the forecast for the full year 2007. The $1.20 to $1.26 earnings per share guidance from continuing operations remains unchanged. Please note that this guidance specifically excludes all costs related to the proposed private equity transaction as well as costs related to the wind down of the Official Check and Money Order business, which the company is not able to accurately estimate at this time.

There are two additional items that are noteworthy with respect to our full year guidance. Income from our patent business will be more favorable than originally expected and conversely, we have more data around the expenses related to the U.S. data center consolidation. These two items are currently expected to materially offset each other with a neutral impact to our overall guidance.

Let's now turn our attention to our use of cash in the first quarter. First quarter was a very busy time for First Data and our use of cash reflects that. The top portion of the slide reminds you of our full year 2007 guidance for acquisitions, capital expenditures and strategic share repurchases. Acquisition guidance has been updated to a range of $900 million to $1.1 billion, primarily related to the recently announced acquisitions of POLCARD and FundsXpress. We have also updated the capital expenditure guidance to plus or minus $400 million to reflect the U.S. data center consolidation as well as to incorporate the capital costs of integration and routine operations of the incremental acquisitions.

Finally, strategic share repurchases have been reduced to zero to reflect the present expectations as a result of the proposed private equity transaction. Acquisitions closed during the first quarter were $240 million, capital expenditures were $98 million and strategic share repurchases were zero, as shown on the bottom portion of the slide.

Moving now to slide 21. I will provide more color on our progress to date relative to the wind down of the Official Check and Money Order business. Our customers understand the business rationale behind our decision to wind down the business and we will continue to work with them to ensure a balanced transition plan is put in place. Through March 31, 2007 we converted approximately 5% of the municipal bond portfolio from long term to short term. Net losses of approximately $2 million were generated and have been netted against revenue in the investment income line of our income statement.

For economic reasons, we initially targeted selected bonds in a loss position for conversion, so the result was as anticipated and is not necessarily indicative of expectations regarding the remainder of the portfolio. Based on our current status, we still expect the majority of the wind down of the business to take two to three years in order to honor all existing customer contracts and we expect a repositioning of the portfolio to be completed in 2007.

The principal goal of this wind down was to improve our focus on our core business, although an added benefit is the ability to free up approximately $250 million to $300 million of cash for alternative uses, most of which will be available in 2007.

Now let's turn our attention to the business segment starting with our largest segment, Commercial Services. Our Commercial Services reported revenue reflects 9% year-over-year growth or 5% excluding reimbursable debit network fees, which is about 70 basis points lower than the first quarter of 2006. For the full year, we still expect revenue growth, excluding debit network fees, to be in the 7% to 9% range.

Our reported profit growth was 5%, the Discover revenue sharing buyout was an unusual opportunity that occurred in the first quarter. The buyout is part of our new larger relationship with Discover Financial Services. As we mentioned in January, the accounting of this transaction resulted in a first-quarter expense charge for the purchase price which we will recoup over the next three to four quarters. Excluding this transaction with Discover, operating profit growth was 9%.

Finally, the profit margin for Commercial Services improved over 1 percentage point to a very healthy 29.6% excluding debit network fees and the Discover revenue sharing buyout. Reported margin for the quarter was 22.1% compared to 23% in the first quarter 2006.

Now let’s look at Financial Institution Services. Financial Institution Services turned in a very solid quarter. Excluding reimbursables, revenue growth was a positive 7%. Operating profit growth showed strong leverage coming in at 15%, though some of the growth was a result of approximately $5 million in termination fees that we had anticipated. Our strong quarter was a result of the cost savings we've been implementing in preparation for anticipated price compression. We remain confident about our ability to achieve 4% to 6% revenue and profit growth for the year.

Margins, excluding reimbursables, showed continued health at 31%. This margin benefited in the quarter by approximately 1 percentage point related to termination fees. Domestic card accounts on file and domestic debit issuer transaction growth were both strong in the first quarter.

Now let's look at our non-U.S. business on slide 24. The FDI strategy is to grow both organically and by acquisition. In the first quarter we succeeded on both accounts. FDI achieved reported revenue growth of 39% and revenue growth on a constant currency basis, excluding acquisitions and divestitures, was 9% in the quarter. Due to the mix and timing of our revenue stream, revenue growth varies quarter to quarter. However, we remain on track to deliver organic constant currency revenue growth of 11% to 13% for the full year.

During the quarter, operating profit grew 20%, margin was 9.5%, which included $7 million of incremental investments in data center consolidation, platform initiatives and the strategic business development related to Merchant Solutions' acquiring partnership. These incremental investments negatively impacted margin by approximately 2 percentage points during the quarter.

Looking at the FDI key performance indicators, again, a very strong first quarter with great performance across the board. We closed the quarter with 1.2 billion transactions, up 26% over the same period in the prior year, and 91 million accounts on file, up 95% and point of sale locations increased by 31% to approximately 1.6 million.

In 2006 we closed two key acquisitions, Argencard and [GZS], and the aggregate purchase price was approximately $200 million. The operating profit excluding depreciation and amortization for these two acquisitions was $21.2 million in the first quarter of 2007.

With that I'll turn it back over to Ric for closing comments.

Ric Duques

Thanks, Kim. In closing, I want to mention that we have received enthusiastic support from our clients, employees and investors regarding the proposed private equity transaction with KKR. While we appreciate that support, for us it remains largely business as usual as we continue to focus intently on delivering the 2007 financial targets we shared with you in January.

This concludes our call and thanks again for joining us today.

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