First Data Q2 2007 Earnings Call Transcript

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First Data Corp. (FDC)
Q2 2007 Earnings Call
July 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 turn the meeting over to Silvio Tavares, Senior Vice President and Head of Investor Relations. Silvio, you may begin.

Silvio Tavares

Thank you. Good morning, everyone. This is Silvio Tavares. 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 second quarter of 2007. We had another great quarter and will be providing financial details for the company overall, as well as for each one of our main business segments. Now, if you will, please turn your attention to the agenda on Slide 3.

Ric will start us off by providing an update on our previously announced transaction with an affiliate of Kohlberg Kravis Roberts & Co., which we will refer to ask KKR. Next, Ric will review the company's second quarter highlights. Finally, we will discuss the significant progress we made against our four key strategies during the last three months.

Kim will then take us through the corporate financials. She is also going to discuss the financial performance of our three primary segments: Commercial Services, Financial Institution Services, and First Data International.

Please note that, due to the pending transaction with KKR, there will be no live question-and-answer session during today's call. Should you have any questions, however, please don't hesitate to contact me at 303-967-8276, or you can send me an e-mail at [e-mail]. Now, please go ahead with me and turn to Slide number 4.

Today's call is being recorded. Our comments today include forward-looking statements. I ask that you refer to the cautionary language in the earnings release and appendix of 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 reconcile those measures to GAAP measures in the appendix and on our web site, in the invest 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 has not authorized and disclaims responsibility for any recording, replay or distribution of any transcription of this call.

Now, I will hand it over to you, Ric.

Ric Duques

Thanks, Silvio. Good morning, everyone. Thank you for joining the call today. Before I go into the second quarter results, I would like to provide an update on the KKR transaction, which is moving ahead very smoothly in all respects. We are on track to close the transaction in the third quarter.

I would also like to mention the very exciting news for us that Michael Capellas will become First Data's Chief Executive Officer immediately following the completion of the transaction. KKR has hired Michael as an advisor until he assumes his new role with First Data. He is a former CEO of both Compaq and MCI, and I am pleased and proud that an executive of Michael's caliber will be leading First Data after I retire.

We have passed a number of significant milestones related to the transaction. The final proxy was filed with the Securities and Exchange Commission on June 26. A special shareholder meeting will take place July 31 in New York City to approve the transaction. In connection with the transaction, we will initiate a tender offer for all the existing public debt of First Data. That tender is expected to expire in conjunction with the closing.

In the weeks since our last earnings call, shareholders have been asking a few common questions related to the KKR transaction. I'd like to take a couple of minutes to address these before going to the second quarter results. Let's go to Slide 7.

The first question. What is the status of the regulatory approvals necessary to close the transaction?

Most of the necessary regulatory transactions approvals have already been secured, and many of these are described in the final proxy. The few remaining regulatory approvals are progressing smoothly, and we do not anticipate any of them will delay our closing beyond the third quarter.

Second question. Has financing been committed for the transaction?

As you may guess, we have had many such questions along this area. The simple answer is yes; committed bridge financing has been secured for both the debt and equity portions of the transaction. Furthermore, per the merger agreement, the transaction is not contingent upon debt or equity financing.

Third question. What happens in the event of a termination of First Data's largest equity alliance?

The very simple answer is that our reported revenue would increase and our reported profits would stay the same. I would encourage all of you to read the final proxy, which contains additional details and can be obtained by going to FirstData.com.

Now, let's move to First Data's financial performance in the second quarter as outlined on Slide 8. As you can see on this slide, we had another very strong quarter. Overall revenue for First Data grew 16% year over year. Commercial Services grew 11%, Financial Institution Services grew 8%, and First Data International delivered 35% growth.

Our consolidated organic revenue growth on a constant currency basis, was up 10%, further demonstrating healthy core growth. I am pleased to say that earnings per share was $0.31, excluding items, or $0.30 from continuing operations.

Now, let's go to Slide 9. This slide summarizes our key strategies, which continue to be the foundation of our success. Grow our core business. What this means is retain existing clients and gain new clients in our main businesses. Expand product offerings. Our strategy here has been to acquire and/or develop products and services that could help attract new clients and be cross-sold into existing clients. Improve our overall cost structure. We have established a culture where operating costs are continually challenged and opportunities for improvement are identified and acted upon.

Finally, expand globally. We are an industry leader in the United States, 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 second quarter.

First, let's focus on our strategy for growing our core business on Slide 10. These key performance indicators are outstanding numbers and they tell a great story. Domestic merchant transactions grew 12% to $7.1 billion, and we signed 164,000 new merchants in the quarter. This highlights strong, fundamental growth of our Commercial Services business.

Domestic debit issuer transactions grew 14%, and domestic card accounts on file grew 13%, demonstrating continued strength of our Financial Institution Services businesses.

In our International business, transactions, card accounts on file and point-of-sale locations all showed very healthy growth in the quarter. What these numbers clearly indicate is that we were very successful in expanding our core electronic payment business in this quarter.

Moving to Slide 11, we had a number of important new partnerships, contract wins, cross sells and significant conversions in the quarter. Starting with new partnerships and contracts, in our Commercial Services business, we signed five new revenue-sharing alliances and added about 400 new branch locations. We experienced further success by signing 21 new independent sales organizations, bringing our total to more than 140. Finally, in a competitive request for proposal situation where multiple vendors where evaluated, Sears-Kmart selected First Data as its prepaid card partner.

Financial Institution Services finalized two important agreements with utility companies to provide new customer information systems through First Data's Peace software. First Data International had a number of wins around the globe. Especially significant is new the merchant acquiring contract with WestJet, Canada's second-largest airline. We also signed a significant prepaid card service contract with Tim Horton’s coffee chain, also in Canada.

The second area you see on the slide is cross sales and contract renewals. In our Commercial Services business, we continue to execute on our strategy of cross-selling new products into our large client accounts. As of today, only 16 of our national and mid-market clients utilize all three of our core products. That's creditor debit card processing, TeleCheck, and PrePay. Since this is less than 2% of our basis, I'm sure you can appreciate the magnitude of the opportunity that is in front of us here.

In our Financial Institution Services segment, we continue the pattern of strong renewals. The most significant event in the quarter was the renewal of our processing agreement with PSCU Financial Services, the nation's largest credit union service organization. This contract provides a suite of services, including debit and credit card processing.

Internationally, we renewed a number of important contracts. We extended our agreement with Laurentian Bank of Canada to continue providing payment processing services for their credit card portfolios. In Asia, we renewed a strategically important deal with China Everbright Bank. We also renewed our credit-card processing contract with Dresdner Bank in Germany for another five years.

Finally, with respect to conversions, we successfully completed a very large conversion, over 15 million accounts, from Citicorp's in-house gas station card portfolio. We are excited about the growth opportunities of our core businesses, both in the United States and around the globe. In the second quarter, we also demonstrated that we are committed to innovation by developing and/or acquiring new value-added products and services.

Looking at slide 12, we have good news to report on product acquisition. We closed our previously announced FundsXpress acquisition. We also made a small strategic investment in Vivotech, which makes near-field communication point-of-sale terminals. With respect to new products, our Financial Institution Services business really led the way here. We rolled out First Data Revenue Assurance for utilities. This product is a unique web-based service that analyzes data from the utility's existing billing and metering systems to identify revenue recovery opportunities for utility companies.

In addition, we developed two improvements to our enterprise loyalty suite of products. CustomerLink Rewards enables financial institutions to reward a customer for all of their relationships within one loyalty program. Item level processing allows financial institutions to capture product-level data from cardholder purchases, thereby rewarding specific buying behavior.

Next, to our recent acquisition of intelligent results, we are rolling out sophisticated new analytic products that will help our clients improve their bottom line. First Data continues to leverage its extensive electronic commerce relationships to create new partnerships. For example, commercial services agreed to resell, repair and warrant U.S. and Canada products from Ingenico, a global leader in secured payments and point-of-sale devices. In addition, we signed an innovative stored value contract to offer the CoinStar money network pay card. It's an alternative to the paper check and broadens our product offering in this strategically important stored value area.

Another example of our innovation in the quarter is the introduction of our alliance with T-Base Communications to provide braille and large-print statements. This capability provides the blind and partially sighted full access to their private financial statements in a format of their choice. We are very pleased with the progress we made in expanding our product offerings during the second quarter.

Now, let's discuss our strategy of continuing to increase the efficiency of our infrastructure on Slide 13. We promise to keep you informed on the progress of our U.S. data center consolidation initiative. We invested $8 million on this significant initiative during the quarter, and it is moving ahead very much in accordance with our plan.

We have also been quite active internationally on our data center consolidations and platform initiatives. Here, as expected, in the quarter, we invested a total of $17 million, $12 million of which was recorded in the First Data International segment and $5 million of which was recorded in all other and corporate. By the end of July, we will have closed the second data center in Germany, which will complete our data center consolidation initiatives in that country.

Within First Data International, we continue to drive our global labor sourcing initiative. 18% of our IT application development costs are now sourced from personnel in lower-cost countries. We are well on our way towards our target of 40% exiting 2007.

Moving to Financial Institution Services segment, we have completed or identified approximately $72 million in cost savings out of the $75 million annualized savings goal by the end of 2007. We are really pleased with our progress here. As a result of these initiatives, profit margins, excluding reimbursables, showed continued strength at over 30% despite ongoing price compression.

This brings us to another key aspect of our strategy, our continued expansion into global markets outside the United States. During the first quarter, we entered into an agreement to buy POLCARD, the leading independent merchant acquirer and card issuer in Poland. It has the largest network of electronic card acceptance devices in Poland. It is a very healthy business. In 2006, its exiting revenues were $52 million on an annualized basis. We anticipate closing this transaction during the third quarter.

We expanded our client base in two countries with our partnership with Societe Generale. First, in Portugal, we signed a five-year agreement for card processing, and second in Russia, where we also signed a five-year contract for core processing and call-center services.

In summary, all of our main segments continue their momentum with strong performances in the quarter. The opportunities for continued growth and expansion of our business remains as compelling as they have ever been. This was further confirmed by a white paper that we commissioned with the intelligence unit of the Economist publication on the payment market in China. This paper was widely heralded as a groundbreaking analysis of the future of electronic commerce in China. You should get it and read it.

Now, I would like to turn it over to Kim to walk through the financials in a little more detail.

Kim Patmore

Thanks, Ric and good morning. So let's get started, and for those of you following along in the presentation, I am on Slide 16. I am pleased to tell you that our earnings per share was $0.31, excluding items, or $0.30 per share from continuing operations. Earnings per share from continuing operations includes $0.01 per share charge for KKR transaction-related costs, which include legal, accounting and other advisory fees.

Items to note, relative to the earnings per share results also include the following:

The Integrated Payment Systems segment, which includes our official check and money order business, generated approximately $17 million in net gains from the repositioning of our investment portfolio. We are extremely pleased with the progress to date, as over half of our portfolio has been transitioned to short-term securities, and we expect to complete the repositioning by the end of this year. This will substantially eliminate our interest-rate risk on these securities while freeing up approximately $300 million in cash during 2007.

The tax rate from continuing operations for the second quarter was approximately 23%. Excluding the effects of the official check and money order business wind down and the pending KKR transaction, the tax rate would have been 22%.

Finally, second quarter 2006 earnings per share from continuing operations of $0.33 included a favorable $0.07 of items comprised of a non-cash FAS 133 derivative accounting restatement and one-time investment gains related to MasterCard redemption. Excluding items, earnings per share was $0.26 in the second quarter of 2006 compared to $0.31 in the second quarter of 2007, a strong growth rate of 19%.

Let's move to cash flow on Slide 17. First Data continued delivering strong cash flow. For the quarter, our income from continuing operations was $229 million, and after adding back depreciation and amortization and subtracting both CapEx and dividends, we generated free cash flow of $302 million. Operating cash flow from continuing operations was $217 million. Operating cash flow was negatively impacted by approximately $140 million in the quarter due to certain settlement operations restructuring. We expect to recover much of this outlay in the third and fourth quarters as the restructuring is completed.

Year-to-date, free cash flow was $534 million, while operating cash flow from continuing operations was a healthy $657 million, even with the aforementioned settlement operations impact.

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 KKR transaction, as well as the effect of the wind down of the official check and money order business, which the company is not able to accurately estimate at this time. Due to the scheduled closing of the transaction with KKR in the third quarter, going forward, we will no longer update our financial guidance.

Now, let's turn our attention to the business segments, starting with our largest segment, Commercial Services. For Commercial Services, reported revenue reflects 11% year-over-year growth, or 7% excluding reimbursable debit network fees, which is in line with our expectations. We still expect our annual revenue growth, excluding debit network fees, to be in the 7% to 9% range. We expect to see some acceleration in the latter half of the year from continued product penetration, especially TeleCheck and prepaid card products.

Our reported operating profit growth was 7%. Compared to the second quarter of 2006, operating profit margin, excluding debit network fees, stayed relatively constant at 33.5% compared to 33.4%. Reported margin for the quarter was 26%. Merchant transaction growth is a good indicator of fundamental business growth and came in and a very healthy 12%, which is consistent with the overall industry.

Now, let's look at Financial Institutions Services. Financial Institution Services turned in a very solid quarter. Revenue growth was 8%. Excluding reimbursables, revenue growth was 7%. We remain extremely confident of our ability to meet or exceed our target of 4% to 6% revenue growth for the year. Operating profit growth was 4%, within the range of our forecast and on track for our full year goal of 4% to 6% growth. Profit margin, excluding reimbursables, showed continued health at 30.5%. Reported margin was 20.3%. Domestic card accounts on file and domestic debit issuer transactions, both good indicators of core underlying business performance, were up 13% and 14%, respectively.

Now, let's look at our non-U.S. business on Slide 21. FDI achieved revenue growth of 35%. Revenue growth on a constant-currency basis, excluding acquisitions and divestitures, was 9% in the quarter. Due to the mix and timing of revenue streams, we remain on track to deliver our organic constant currency revenue growth at the low end of our previously stated range of 11% to 13% for the full year.

Operating profit growth was 21% and profit margin was 10.1%. Operating profit included the impacts of continued investments in platform initiatives, data center consolidations, and business development costs related to the Merchant Solutions acquiring partnership totaling $13 million. Of these costs, $11 million were incremental as compared to the second quarter of 2006. These investments were partially offset by expected termination fees of $9 million.

Looking at the FDI key performance indicators, again a very strong quarter with great performance. We closed the quarter with transaction volume up 20% over the same period in the prior year, 94 million accounts on file, up 67% and point-of-sale locations increased by 17% to 1.6 million.

With that, I will turn it back over to Ric for some closing comments.

Ric Duques

Thanks, Kim. Well, this time, closing comments really mean closing comments, as I plan to retire at the closing of our go-private transaction with KKR. But don't worry; until closing, we will be working very hard to deliver the financial results projected for 2007.

First Data is in an industry like no other. We see billions and billions of payment transactions around the world that are still cash or checks but will turn into electronic transactions over the next decade or so. We've seen gas stations, grocery stores and now quick-service restaurants go from cash and checks to electronic payments over the recent past. We've seen the use of prepaid and gift card transactions explode over the last three or four years, and the greatest potential for exponential growth in the electronic payment transactions has barely started.

What's that? It's the 2 billion mobile phones in use around the globe that will be devices used for electronic payments in the future, and that is almost for sure.

First Data is a company squarely in the middle of a tsunami wave of electronic payments that will occur over the next few years. We are number one or a strong number two in every market in which we compete for processing of electronic transactions. Our objective is to strengthen our position in these markets, not just hold on to our leadership position.

We clearly have the technology and the high-volume processing capabilities to be successful, but our most important assets are our 29,000 people around the world that are our employees. We have the most talented and most experienced group of employees in the payment processing marketplace, without question.

Turning over the CEO position to Michael Capellas, a world-class client and employee-focused executive, gives me great confidence that both our clients and our employees will be very well served in the exciting next chapter in First Data's life.

Upon my return to First Data in late 2005, our management team said that our top priority was to add shareholder value. Actually, we said our number one, number two and number three priorities were to add shareholder value. I think we did that, and I want to publicly thank the management team that led that effort.

But equally important, I think we have positioned First Data for even greater success over the next few years. The addition of Michael Capellas, together with our existing management team, promises to extend First Data's leadership in the processing of electronic payments around the world. I will follow their progress with great interest and great pride as I sit in my rocking chair.

Finally, I want to offer my sincere thanks to our shareholders, our clients, our board of directors and our employees for their support that they've given me over the years. Thanks to all of you. I will miss you. That's all for today.

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