First Data Corp. (FDC)
Q3 2007 Earnings Call
November 14, 20079:00 am ET
Executives
Silvio Tavares - IR
Kim Patmore - CFO
Michael Capellas – Chairman, CEO
David Yates - President, First Data International
Ed Labry - President, First Data USA
Analysts
Manish Somaiya - Citigroup
Guy Baron - Credit Suisse
Sundar Varadarajan - Deutsche Bank
Jeff Harlib - Lehman Brothers
Ryder Campbell - Barclays
Operator
Welcome to the FirstData 2007 third quarter financial results conference call. (OperatorInstructions) I am pleased to turn the conference over to Silvio Tavares, SVPand Head of Investor Relations. Silvio, you may begin.
Silvio Tavares
Thank you, Jim. Good morning, everyone. This is SilvioTavares and I'd like to thank you for joining us. Speaking on the call today isMichael Capellas, Chairman and Chief Executive Officer. He actually becameChief Executive on September 24, 2007when the company was acquired by an affiliate of Kohlberg Kravis Roberts &Co. Also on the call are Ed Labry, President of First Data USA; David Yates,President of First Data International, and Kim Patmore, Executive VicePresident and Chief Financial Officer.
We're very pleased to host this teleconference and webcast.We had another great quarter, and we'll be providing the details of ourperformance on the call. Now if you will, please turn your attention to theagenda on page 3.
Kim will start by covering the consolidated financial highlightsfor the company. She will then present the financial performance of our threeprimary segments: Commercial Services, Financial Institution Services and FirstData International.
Next, Michael will discuss the key aspects of First Data'sstrategy going forward. The remainder of the call will be devoted to answeringyour questions. The operator will provide you with instructions on how to askyour questions at that time.
After the call is concluded, should you have any furtherquestions, please don't hesitate to contact me at 303-967-8276 or you can justsend me an email at Silvio.Tavares@FirstData.com.
Now go ahead and turn with me to slide number 4 for someimportant information about this call. Today's call is being recorded. Ourcomments today include forward-looking statements and I ask that you refer tothe cautionary language in the quarterly report on Form 10-Q that we filed thismorning with the SEC, as well as the appendix of today's slide presentation foradditional information concerning factors that could cause actual results todiffer materially from those in the forward-looking statements.
During the call, we will discuss items that do not conform GAAP,and we reconcile those measures to GAAP measures in the appendix and on our websitein the investor relations section.
All statements made by First Data officers on this call arethe property of First Data and subject to copyright protection. Other than thereplay, First Data has not authorized and disclaims responsibility for any recording,replay or distribution of any transcription of this call.
Before I hand it over to Kim, I just want to mention animportant presentation point. You will recall that our going privatetransaction with an affiliate of Kohlberg Kravis Roberts & Co. closed on September 24, 2007. The quarterly andyear-to-date financial information that we will discuss today is presented on acombined basis. The combined quarterly results represent the predecessorperiod, July 1, 2007 throughSeptember 24, 2007 combinedwith the results of the successor period, September 25, 2007 through September 30, 2007.
The combined year-to-date results represent the predecessorperiod, January 1, 2007through September 24, 2007combined with the results of the successor period, September 25, 2007 through September 30, 2007.
With that, I'm going to now hand it over to Kim Patmore.
Kim Patmore
Thanks, Silvio. Good morning, everyone. Thank you forjoining the call today. Let's move to First Data's financial performance asoutlined on slide 6. As you can see on this slide, we had another very strongquarter. Overall revenue for First Data grew 16% year over year; CommercialServices grew 11%; Financial Institution Services grew 10% and First DataInternational delivered 28% growth. For the year-to-date, I am pleased to saythat revenue was $5.9 billion, up 15%. Reimbursables contributed 4% to thisgrowth. Excluding projected near-term cost savings, our year-to-date adjustedEBITDA was $1.8 billion, up 7%.
Year-to-date income from continuing operations was $436million, down 28% but included $221 million of after-tax merger-related costs,and other costs directly attributable to our going private transaction, whichare detailed in footnote 3 on this page. I will collectively refer to thesecosts as “merger impacts”. Excluding these merger impacts, year-to-date incomefrom continuing operations grew 8%.
I will walk you through the detail behind these adjustedEBITDA figures shortly, but first, let's turn our attention to the businesssegments, starting with our largest segment, Commercial Services.
Remember, the quarterly growth rates are presented using thecombined results for 2007 and are reflected in the column labeled “combined”.The column labeled “combined adjusted” reflects the combined results excludingpurchase accounting adjustments and accelerated stock-based compensationexpense related to the transaction. The adjusted information is more comparableto how we have reported our financials historically, so those are the resultswe will discuss today.
Now looking at the results for Commercial Services, adjustedrevenue reflects 11% year-over-year growth, or 7% growth excluding reimbursabledebit network fees. This quarter's adjusted revenue and adjusted operatingprofit included incremental contract termination fees of $7.5 million relatedto our debit business. Our adjusted operating profit growth was 7%.
Compared to the third quarter of 2006, adjusted profitmargin, excluding reimbursable debit network fees, stayed relatively constantat 34.6%, compared to 34.5% for the third quarter of 2006. Adjusted profitmargin for the quarter was 27%. Merchant transaction growth is a good indicatorof our fundamental business growth and came in at very healthy 12%. We continuedto see strong transaction growth throughout the quarter.
Now let's turn our attention to Financial InstitutionServices. Adjusted revenue growth was 10% and excluding reimbursables, growthwas 7%. Adjusted operating profit declined 3%, primarily due to anticipatedprice compression resulting from contract renewals and lost business, partiallyoffset by growth from existing clients and incremental contract terminationfees of $7.5 million.
For the quarter, adjusted operating margin excludingreimbursables was 28.5% compared to 31.4% in the third quarter of 2006.Adjusted profit margin for the quarter was 18.6%.
Domestic card accounts on file and domestic debit issuertransactions were up 15% and 9% respectively. Debit issuer transaction growthwas negatively impacted by approximately 2 percentage points as a result ofthree customer deconversions which occurred in the quarter.
Now let's look at our non-U.S. business on slide 9. FirstData International achieved adjusted revenue growth of 28%. Adjusted revenue growthon a constant currency basis, excluding acquisitions and divestitures, was 8%in the quarter. This 8% growth was slightly lower compared to previousquarters, due primarily to the deconversion of the Goldfish portfolio in the UK,as well as price compression.
Adjusted operating profit growth was 25% and adjusted profitmargin was 9.5%, compared to 9.7% in the third quarter of 2006. Adjustedoperating profit included approximately $9 million of incremental investmentsin platform initiatives, data center consolidation and strategic businessdevelopment costs related to the Merchant Solutions acquiring partnership.These incremental investments negatively impacted adjusted profit margin byapproximately 2 percentage points during the quarter.
Looking at the FDI key performance indicators, we closed thequarter with transaction volume up 15% over the same period in the prior yearand card accounts on file up 72%. Point-of-sale locations increased by 19%.
Finally, I would like to walk you through our adjustedEBITDA results on page 10. Adjusted EBITDA is defined as EBITDA adjusted toexclude certain items and other costs. We believe that the inclusion ofsupplementary adjustments to EBITDA are appropriate to provide additionalinformation to you about certain material non-cash items, nonrecurring itemsthat we do not expect to continue at the same level in the future, and certainitems we believe will materially impact future operating results.
Please note that the adjusted EBITDA presented here differsfrom the consolidated EBITDA defined for covenant compliance purposes in oursenior secured credit facilities agreement. Please refer to our quarterlyreport on Form 10-Q which was filed this morning for a reconciliation to theconsolidated EBITDA, pursuant to our senior secured credit facilitiesagreement.
We will focus on the column labeled “combined nine monthsended September 30, 2007”.Please note that the appendix to this presentation contains the adjusted EBITDAreconciliation for the quarter.
Starting on the top line on page 10, income from continuingoperations was $436 million. Income from continuing operations includedapproximately $48 million related to pre-tax royalty; $34 million of thoseroyalties were recognized in the third quarter.
Year-to-date EBITDA was $1.2 billion. The adjusted EBITDAreconciliation presented here is consistent with the description presented inconnection with our going private transaction. I will briefly walk you throughthe significant adjustments on this page.
The adjustment for stock-based compensation was $267 million;$215 million of this was incurred in the third quarter, the majority of whichwas due to accelerated vesting of all outstanding First Data and Western Union stock options, restricted stock awards and restricted stockunits held by First Data employees as well as the related payroll taxes.
Due to our wind down of the Official Check and Money Orderbusiness, which comprises most of our IPS segment operations, we have excludedIPS segment EBITDA of $29 million, including the associated pre-tax equivalencyof $180 million.
Moving to the next line, we have approximately $51 millionin costs related to the data center and technology initiative. Approximately $36million of these costs are associated with platform and data centerconsolidation initiatives in the First Data International segment, andapproximately $16 million is associated with domestic data center consolidationinitiatives. Both are considered one-time projects.
Skipping down four lines, adjusted EBITDA, excludingprojected near-term cost savings, is $1.8 billion, up 7% year-over-year. Webelieve this number better approximates the underlying liquidity of thebusiness, and shows our clear ability to meet our obligations and invest in thebusiness for the future.
Finally, moving to the next line, you see projectednear-term cost savings of $150 million. The annualized figure of near-term costsavings is approximately $200 million, which we are on track to complete in2008. This represents an acceleration of our original plan of $150 million innear-term savings.
Before I hand it over to Michael, there are two quick pointswhich I would like to briefly mention. With respect to our IPS Official Checkand Money Order business, in October we completed the repositioning of theinvestment portfolio from long-term municipal bonds to short-term municipalbonds. We expect to transition our short-term municipal bonds to short-termtaxable securities beginning in the first quarter of 2008.
Finally, I did want to update you on our capitalexpenditures during the quarter. Our CapEx was $213 million for the quarter and$399 million year-to-date. Our capital expenditures this quarter included $98million related to the buyout of synthetic leases, as required by the change incontrol. So excluding synthetic lease buyout costs, our year-to-date CapEx wasapproximately $300 million.
Now let me hand it over to Michael Capellas.
Michael Capellas
Thanks, Kim. Icertainly would also like to express my thanks to all of you for joining thecall as well. My comments will be brief because as Silvio mentioned, I've only beenofficially on the job since September 24, but associated with the company sinceearly July. I do want to spend just a few minutes discussing some of mythoughts on the company and on our strategic positioning.
First, our position in the fast-growing electronic paymentsindustry is second to none. For example, together with our alliance partners,we are the largest merchant acquirer in the U.S.,acquiring approximately half of all U.S.credit and debit card purchase volumes. In the third quarter, we saw 12% growthin our domestic merchant transactions, despite the downturn in other parts ofthe economy.
We maintain a highly diversified, predictable and stablebusiness. Over half of our domestic merchant transactions come from what Iwould call commodity purchases. These are transactions from merchants in thegrocery, gas station and quick service restaurant industries, which tend togrow predictably even through difficult economic cycles.
Our card businesses are healthy. In the quarter, adjustedconsolidated organic growth on a constant currency basis was 11%, or 8%excluding reimbursables. In addition to our core business, we have significantopportunity in new adjacent markets such as mobile commerce, prepaid cards,security, loyalty and analytics. These are all very attractive multi-billiondollar markets.
The company clearly has significant potential for structuralcost savings. We are already executing initiatives to capture thoseopportunities.
Finally, we continue to generate strong cash flow. Over thepast several years, our P&L has reflected about $1 billion in annualexpense on information technology, which demonstrates our commitment totechnology leadership. However, we have low capital expenditures and modestworking capital requirements, resulting in significant cash flows.
In order to build on First Data's inherent strengths, we'velaid out a five-point strategy for the company going forward. First, our focuswill be on generating continued organic growth through improved saleseffectiveness. Substantially all of our U.S.sales operations are now under the leadership of Ed Labry. We have heightenedour focus on cross-selling First Data's portfolio of services.
Secondly, accelerating new product innovations will generatesubstantial incremental revenue. Our product development organization is underthe leadership of Tom Bell, our new Chief Strategy Officer. We are establishingcenters of excellence to execute against the opportunities in the areas ofmobile commerce, risk and fraud solutions, loyalty and analytics.
Next, internationally we have the opportunity to expand thebusiness in a more targeted fashion. This means consolidating our number one ornumber two positions in key international markets as we build scale, increaseorganic revenues and improve margins. Acquisitions will be deemphasized. DavidYates is the new President of First Data International. He manages the majorityof our international business with responsibilities for all of our Europeanoperations.
Fourth, we will continue to reduce structural costs. We'vesimplified the structure of our U.S.operations by combining Commercial Services and Financial Institution Servicesunder Ed Labry. We now have one face to the customer and as a result, we aremuch easier to do business with. We are on track to achieve approximately $200million in annual savings in 2008. Most of these near-term savings will comefrom the reduction of corporate and business unit overhead spending, includingheadcount reductions of approximately 6%.
Finally, we will focus on significantly improving ourtechnology delivery. First Data is fundamentally a technology company. Thereare a number of areas we have identified that will increase the impact of ourtechnology through product innovation and the efficiency of consolidating ourplatforms.
So in summary, we have a clear path and are alreadyexecuting it. As I've been meeting with the First Data team around the world, Isense a real excitement and an enthusiasm about the future.
I'll now hand it back to the operator for questions. With metoday on the call is the entire management team. I've already mentioned EdLabry, President of First Data USA; David Yates, President of First DataInternational; Tom Bell, Chief Strategy Officer; and Kim Patmore, ChiefFinancial Officer.
There are other members of the core senior team: DavidMoney, General Counsel; Peter Boucher, EVP of Human Resources; and Grace Chen,EVP of Communications. I'm quite proud of the senior team we've assembled. Wehave a rich and diverse set of skills and certainly, continuity of experience.As we move forward, we'll add new talent as appropriate.
Once again, thanks for joining us and I would now like toopen it up for questions.
Question-and-AnswerSession
Operator
Your next question comes from Manish Somaiya - Citigroup.
Manish Somaiya - Citigroup
I'm sure this is going to come up as we go through theQ&A, but let me just ask this anyway: do you have any updates on ChasePaymentech?
Michael Capellas
Certainly, that was a question we anticipated. Obviously,just to put the facts on the table here, everybody knows that this is a jointventure with JP Morgan. JP Morgan has 51%; we have 49%. Obviously, the merchantacquiring business has been in place since the late '90s.
Under the clause and terms of the merger agreement, they hadthe right to, after 30 days of the transaction being closed, to terminate.There are some specific provisions relative to how the dissolutionment of thatJV would go about. So those are the facts.
As probably many of you heard me say when we were out on theroad, that agreement to continue negotiations can be extended at any time bythe two parties. Relationships with JP Morgan are quite good. We are incontinued and active constructive dialogue with them about the go-forwardposition. I don't have anything new to report today, other than we continue totalk at the highest level of this company. They are constructive dialogues, andneither side feels any terrible pressure to force to a conclusion that is notin the best interest of both parties and our customers.
Bottom line here to net that out is we continue to talk,they're constructive talks, we can extend it at any time we like. We're justgoing to make sure that we go through something that's really helps us win inthe marketplace.
Manish Somaiya - Citigroup
Essentially, Michael, you're saying that there is nodeadline in terms of getting a final resolution?
Michael Capellas
The way it works invery, very practical terms is that we can extend at any time between the twocompanies. That extension can be as simple as we both say “let's take another90 days”. We agree to take another 90 days; the lawyers paper it, and we goforward. It's very practical. At a very practical level, there is no realdeadline -- at a practical level.
Manish Somaiya - Citigroup
The second question I had was on the international business.I think you commented in the press release that the growth rate on theinternational side had slowed down a bit. I think it was about 8% compared tothe target rate of around 11% to 12%. Can you just give more details on thepricing pressure that you're facing on the international side? Is it more, lessthan domestic or what you have seen in the international marketplace before?
Secondly, the lost business in the UK,what was it? Why did you lose it? If you can just provide some clarity on that.
Michael Capellas
I would be happy to.I think you have to segment the market into a couple of places and not look atit -- because you actually have different characteristics. I actually am goingto answer this question quite specifically.
If we take the UKand Germany,this has the characteristics of what we have seen in the U.S.issuing business. This is a smaller number of very large accounts, and therewas pricing pressure in the traditional long-standing issuing business, sort oflike we saw with the issuing business a few years ago in the U.S..So there's a very similar parallel.
The pricing pressure is in the UKand Germany inthe traditional issuing business, and that's with the large customers, as youwould expect. In many cases, we have extended our relationships with those keycustomers, but at the cost of some price pressure. That's pretty similar towhat we've seen elsewhere.
The second piece of the market would be where we're startingto expand into new markets, which would be by and large, either the smallercountries or into emerging markets. Naturally, that is more of a blend of theissuing and the acquiring business, and the pricing pressure is much less. Butobviously, it's a smaller piece of the business at this point.
In terms of lost business in the UK,this primarily relates to one particular contract, which I think we've alreadyannounced. Did you want to comment?
Kim Patmore
Yes, that was one that we had announced probably about ayear ago, and it took them about a year to deconvert. It was the Goldfish Portfolioprimarily; again, related to the issuing business.
David Yates
To be specific, thiswas a portfolio that used to belong to Lloyds TSB that was sold to MorganStanley, and Morgan Stanley decided to convert this onto their own platforms.
Michael Capellas
Thank you, David.
Operator
Your next question comes from Guy Baron - Credit Suisse.
Guy Baron - Credit Suisse
Now that we're halfway through Q4 here and as we head intothe holiday season, can you talk about what you're seeing in terms of volumes? Howmuch of a spike would you typically witness towards the end of Q4?
Ed Labry
Overall, we have not seen any volume declines associatedwith the economy, as some people anticipated. Of course, we're just nowbeginning to see gasoline back over $3 a gallon so we'll see how that impactsus. We believe that everybody is anticipating a great Christmas season so it'snot any additional anticipated revenues for the Christmas season, it's just thenature of the business is your fourth quarter is primarily your largestquarter.
Michael Capellas
Just to add to that, thereality is in the third quarter we anticipated to see some slowdown, and wedidn't see it. So we're all doing exactly the same thing as you are doing,which is trying to triangulate all this data whether it's same-stores comingout of Wal-Mart yesterday or some of the indices that came out this morning.
We cautiously continue to have believed through time thatthe pattern was that the secular growth towards electronic transactions hasoverlaid any slowdown on particular elements, and the fact that the businesseswe are in tend not to slowdown. All we can say at this point without trying topredict this economy, which I'm not sure anybody can, is we just haven't seenit yet.
Operator
Your next question comes from Sundar Varadarajan - DeutscheBank.
SundarVaradarajan - Deutsche Bank
A couple of housekeeping questions if I may. Your cash onthe balance sheet was a little stronger than what we had seen as pro forma atthe end of the transaction. Is there any stuff that you need in terms ofrefinancings that didn't get done in the quarter? Could you give us some morecolor as to what we should look for? What should we take away as a morenormalized cash balance here?
Kim Patmore
If you look into the 10-Q in the liquidity section, we dospeak a little bit about that, because about $700 million of those cashbalances were really just still cash on our balance sheet at the end but it wasjust the payout of the stock options, primarily to employees. So it was justcash in transit, but still cash on our books at that time. I think in general you can think about between$500 million and $550 million or so of cash on the balance sheet going forward.
Operator
Your next question comes from Jeff Harlib - Lehman Brothers.
Jeff Harlib - Lehman Brothers
Good morning. In Financial Institution Services, I'mwondering if you can address a couple of things? One, on the customerdeconversions, is that pretty much behind you, and is there some more falloutfrom that?
Second, Wells Fargo, it sounds like it's unclear whetherthat business will be going in-house or staying with you; if you can justaddress that.
Lastly, the margin pressures in that business in the quarterand just going forward, can you talk a little bit about that?
Ed Labry
I think that the deconversions were relatively small andanticipated in the first part of the quarter. I think that we've seen greatsuccess over the last six to eight weeks in renewing customers, three or four specifically.Just for competitive reasons, I'm not going to talk about specific names of othercustomers on the deconversion list.
As it relates to the margins, of course when you renew theselonger-term agreements, which are typically in this business five to sevenyears, you're seeing price compression associated on card, and a little bit higher than that on signature-baseddebit processing.
Michael Capellas
Ed, do you want to go back on the Wells question?
Ed Labry
On Wells, I think that we had previously announced thatWells was bringing their signature debit processing in-house. I believe we announced as part of thisrelease, or in the Q, that that business has not yet deconverted. Asanticipated, that it would by the end of this year. We are working with WellsFargo for a longer-term renewal of that business.
Operator
Your next question comes from Ryder Campbell - Barclays.
Ryder Campbell -Barclays
First, just a little more clarity perhaps on the cashbalance -- actually, the $720 million that's earmarked for the formershareholders. Is there anything else that might have happened between September30 and today, perhaps related to transaction fees that might bring that cashbalance down to below $1.1 billion or $1 billion that it would be, minus the $720million?
Secondarily, it looked like your revenues from product saleshad a pretty good boost in the quarter. I was wondering if you could just talka little about that and maybe give us some color whether that's a new kind oflevel that we should be looking at going forward, or if there are some kind ofone-time sales in that quarter that you don't expect to really continue, atleast on that level.
Kim Patmore
On the cash balances, keep in mind also that we had adrawdown on the debt on the short-term revolver piece which was about $200million, which you will see in the fourth quarter; we will repay that. Soagain, we probably had a little excess cash at the time that we closed and notknowing exactly all of our cash needs, we did have that draw on September 24thso you'll see that as also a large piece of the paydown.
And then we did have some of the transaction fees that wereactually paid post September 30th. So I think with thosecombinations in general, again you'll see us closer to that $500 million or so.
In the product sales and other, the largest piece there wasthat patent royalty piece that I referred to earlier, which was $38 million. Youcan see the patent income, that is something that we think over time is windingdown because the patents are coming to a close. That was the primary largerpiece in there, along with those contract termination fees that I mentionedearlier.
Operator
This does conclude today's Q&A session. I'll turn itback to Mr. Tavares for any additional or closing remarks.
Silvio Tavares
Thank you all for joining the call. You know where to reachme if you have any follow-up questions. 303-967-8276 is the number to reach me.Thank you very much. Have a great day.
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