Fiserv Inc (FISV) 2003 Q2 法說會逐字稿

Good morning, and welcome to the Fiserv Earnings Conference Call for Second Quarter 2003. We currently have 100 participants on this call. All participants will be able to listen only until the question and answer session begins following the presentation. At the request of Fiserv, today's call is being recorded, and also it is being broadcast live over the Internet. The call is expected to last 25 to 35 minutes, and you may disconnect from the call at any time. Now I would like to introduce the Fiserv management team in attendance on today's call: Mr. Leslie Muma, President and CEO; Norm Balthasar, Senior EVP and COO; Mr. Ken Jensen, Senior EVP and CFO; and Mr. Tom Hirsch, SVP and Controller. At this time, I would like to turn it over to Mr. Muma.

Good morning, and welcome to Fiserv's Second Quarter Earnings Conference Call. We appreciate your participation and look forward to presenting our second quarter results and answering your questions. Fiserv would like to state that the company may make forward-looking statements regarding 2003 earnings targets, sales pipelines and acquisition prospects during the course of this conference call.

Such statements are covered by the Safe Harbor included in the Private Securities Litigation Reform Act of 1995. These statements may differ from actual results and are subject to a number of factors. Please refer to the last paragraph of our second quarter earnings press release for a discussion of these factors.

Fiserv continued 2003 with record earnings for the second quarter. Our business model, which includes approximately 85% recurring revenue and associated cash flows, continues to fuel Fiserv's growth. Most of our business units performed at or above our expectations in terms of revenue and profit growth through continued strength in both new client sales and cross sales along with our ongoing initiatives in the area of operational efficiencies. We are also off to a great acquisition year, with six acquisitions closed so far in 2003 totalling combined annualized processing and services revenues of approximately $270 million. Our overall acquisition pipeline continues to be strong.

In our second quarter, we reported a new operating segment called our health plan management services segment. That will house our growing health benefits management business. This segment includes our five national health plan management service brands, benefit planners, (inaudible), Harrington benefit services, Fiserv Health Kansas and Tennessee, and Wausau Benefits. This segment also includes Avodine, a unit that offers claim injury pricing services, data management, utilization review and case management services.

Fiserv is the nation's fifth largest provider of self-insured health plan administration services. We will now begin our review of the quarter with Ken Jensen, who will present our financial performance. I will follow with a brief discussion, a brief business overview and then open the lines for questions. Ken?

Thanks, Les. As already stated, Fiserv continued 2003 with record earnings for the second quarter. Diluted earnings per share were 40 cents, compared to 34 cents in 2002. The 40 cents in diluted earnings per share for the second quarter of 2003 was within the range of consensus analyst estimates and our estimate made in the last conference call. Our estimate of full year diluted earnings per share for 2003 continues to be $1.58 to $1.62, and our EPS estimate for the third quarter of 2003 is 40 cents to 41 cents. Our second quarter processing and services revenues of $659 million increased $96 million, or 17% over the second quarter of last year. And on a year-to-date basis, increased $160 million or 14% over last year. Year-to-date revenue growth was positively impacted in 2003 by continued strong revenue growth of $112 million or 13% in our financial institution services segment, and $47 million or 45% growth from our expanding health plan management services segment.

We are currently estimating 2003 third quarter processing and services revenue for Fiserv to be approximately $700 million to $715 million., which is an increase of 24 to 27% over the prior year period. Year-to-date cash flow provided by operating activities before the decrease in securities processing receivables/payables of $79 million, was $260 million increasing $15 million or 6% over the prior year.

Fiserv's operating cash flow was negatively impacted in 2003 by a decrease in working capital changes due to a number of factors, including the timing of vendor payments related to hardware shipments, higher 401(k) profit-sharing payments, and a lower income tax benefit from the exercise of stock options.

Fiserv's year-to-date capital expenditures including capitalized software were $81 million, an increase of only 3% compared to the prior year. During the second quarter, the company also issued $250 million of five-year notes due in 2008. The first note offering was for $150 million at a 4% fixed interest rate. The company entered into fixed to floating interest rate swap agreements on the $150 million notes to manage its total ratio of fixed to floating rate long-term debt over the period of these notes. Second offering of five-year notes was for $100 million at a 3% fixed interest rate. The company earns the net proceeds from the offerings to primarily repay existing credit facilities and for general corporate purposes including the funding of acquisitions.

I will now summarize our performance by business segment. The second quarter of our financial institutions services segment which comprises approximately 75% of our total revenues and 90% of our operating income continued its strong performance. This segment increased second quarter revenue 15% and operational income 18% over the prior-year period and on a year-to-date basis increased revenue 13% and operating income 17%. over the prior year. Fueling this revenue in earnings growth was continued internal revenue growth, acquisitions, and operating efficiencies. Our fast-growing health plan management services segment increased second quarter revenue 57% and operating income 29% over the prior year period. On a year-to-date basis, increased revenue 45% and operating income 37 Fueling this revenue in earnings growth was continued internal revenue growth and acquisitions. We are optimistic about the continued strong growth potential of our health plan management services segment.

In our Securities and Trust services segment, 2003 second quarter operating income was $7 million and on a year-to-date basis was 14 million, reflecting flat results in comparison to the prior-year periods. Our Securities and Trusts segment operating income was adversely affected by, one, the weak but improving U.S. retail financial market trading environment, which still on net negatively impacts our securities division, and two, lower interest rates which negatively impact both our Securities and Trust divisions.

Now I'd like to turn the call over to Les, who will provide additional details and highlights from the second quarter.

Thanks, Ken. As Ken indicated, our second quarter earnings performance met the street's expectation and management's forecasts. Our second quarter processing and services revenues increased 17% over last year and on a year-to-date basis, increased 14%, resulting from a combination of acquisition and organic revenue growth. Our acquisition revenue growth in 2003 was derived from our 2002 acquisitions and four acquisitions that we closed in the first six months of 2003. In the first quarter, we closed Avodyne Inc. and Precision computer systems acquisitions.

In the second quarter, we closed two additional acquisitions, first, ReliaQuote, Inc., located in Falls Church, Virginia, which specializes in the marketing and sale of fully underwritten term life insurance policies primarily through the Internet, and Wausau Benefits, a third party employee benefits administrator located in Wausau, Wisconsin. Wausau benefits provide the full range of health-related employee health plan administration services nationwide. We also announced an agreement to acquire Insurance Management Solutions Group, Inc. of St. Petersburg, Florida, which services the flood insurance market with a complete range of policy and claims administration services. We expect to close this acquisition in the third quarter. Subsequent to quarter-end, we closed two additional acquisitions.

First, the EDS Credit Union Industry Group based in play know, Texas. They specialize in core processing and provide a variety of other products and services including debit card and transaction processing, electronic banking and lending, and online bill payment and presentment services. The business supports about 1,000 credit unions. With this acquisition, we continue to enhance our servicing capabilities and processing expertise within the credit union industry. We also completed the acquisition of Chase Credit Research and Chase Credit Systems based in North Hollywood, California. Together, these companies provide credit information from the three major repositories in a consolidated report to lenders and lease software that allows lenders and credit reporting companies to perform their own analysis. This acquisition continues to broaden our expanding product line in our lending systems and services group and provides another strategic component in completing our end-to-end mortgage processing solution.

Our year-to-date internal revenue growth rate was 3%. This rate was negatively impacted by approximately 1% due to weak but improving U.S. retail trading environment, which impacts our securities division, and the lower interest rate environment which negatively impacts both our securities and trust services division. We believe our overall internal revenue growth rate will continue to improve in the second half of 2003. Our ability to deliver a full suite of automated services and products as well as our broad offering of business process outsourcing services continues to provide a fertile sales environment.

Significant new clients signed in the second quarter include the following: First Federal Savings & Loan Association, a $1 billion financial institution in Lakewood, Ohio, has contracted for an enhanced solution set that includes the Fiserv vision core processing system, data warehouse and an Internet banking platform. Marriott Vacation International, the vacation ownership division of Marriott International, agreed to use Fiserv mortgage serve mortgage loan servicing system for its loan portfolio. Pacific Capital Bancorp, a $4.4 billion multi-bank holding company in Santa Barbara, California will use software from precision computer systems, a unit of Fiserv, to replace its current core banking system. The benefit planners unit of Fiserv Health will handle health plan management for Station Casinos, Inc. under a multi-year contract. Porsche financial services, Inc. has substantially increased its relationship with Fiserv Le Mans for automotive financing solutions. Romania's fifth largest bank, Raiffeisen Bank Romania, has expanded its relationship with Fiserv CBS worldwide to include an upgrade and maintenance of its existing Fiserv core systems and improve service offering for the bank's 650,000 customers. These selected major client wins highlight the breadth of our product offering and the ability to successfully attract new clients away from our competitors and to cross-sell additional products and services into our existing 14,000 clients.

During the second quarter, we also announced the addition of Thomas C. Wertheimer to Fiserv Board of Directors. Thomas elected on May 20th at board meeting and brings a solid auditing and accounting background to our board. He is a retired senior audit partner from Price Waterhouse Coopers where he most recently served as a lead audit partner for large public companies. He served as a worldwide audit partner for Ford Motor Company and as a lead audit partner for several other companies including Bank One Corporation, the Kroger company, Limited Brands Inc., and Wendy's international. Fiserv's Board of Directors now encompasses seven external Directors and two internal Directors.

In closing, our business continues to grow within management's expectations. Our sales and acquisition pipelines remain strong, and we anticipate continued growth both organically and through acquisitions. We are confident we'll be able to attain our 2003 earnings per share target, which continues to be $1.58 to $1.62 per share. We will now open the line for questions.

Thank you, Mr. Muma. At this time, we're ready to begin the question and answer session. If you would like to ask a question, please press "*1". You will be announced prior to asking your question. To withdraw your question, you may press "*2." Once again, to ask your question, please press "*1".

Our first question comes from David Togut of Morgan Stanley.

Thanks, Les. Could you elaborate a bit on the size of the new business pipeline, some of the trends you're seeing in terms of the length of the sales cycles, and any comments on pricing of new contracts?

I was talking with our Group President of Sales and he says the sales pipelines across all of our businesses right now are as strong as he can remember in the past. So they are very strong across all businesses. As far as close cycles, sales cycles, they do not seem to be any longer than normal. I would expect our deals to close at the normal rate, and general sales cycles are 60 to 90 days to close. In addition to your question, I would say that in our pipelines, typically we'll close 50 to 60% of what's in there, so we're very optimistic about sales going forward into the third and fourth quarters.

And any final comments with respect to pricing of new contracts?

I don't think we've seen any significant pricing competition. We've had a few isolated cases in the past, but they don't seem to be repeating themselves at all, David.

Ok. Thank you.

You bet.

Ms. Carla Cooper of Robert W. Baird, you may ask your question.

Good morning. I wondered if you could talk to the new information that you're giving out on Fiserv Health and talk to just expected growth in margins in that division, and I guess importantly any changes that you might see quarter to quarter based on recent acquisitions.

ken, you want to touch on the growth rates or the margins?

Yeah, we expect that that segment will grow quite well in the future, not only from internal growth but also from other acquisitions that we expect to add in there. As you can tell, the margins will bounce around substantially from quarter to quarter. For example, the first quarter of this year, we had new customers that had what's called run-end business, which increases the amount of revenues and the profits, and then we had some customers terminated, so we have run-out business that also increased the revenues in the profit margins. That's why the first quarter was stronger.

I would say overall the margins of that business will continue to be slightly above our target range for margins for the company, as well as the growth rates which should be at slightly -

Actually lower.

Are they? I'm sorry. the growth rate should be slightly higher, but the margin should be slightly lower than the company's margins. That makes sense. Just on the securities and trusts, could you separate out or give us some sense of the impact from interest rates versus trading and, you know, with the idea that to what degree could, you know, increased trading actually have on that unit for the rest of the year?

I would say there that the trading volumes, retail trading volumes and margin balances are increasing slightly. We are positive and optimistic about that, and obviously that could have a positive impact. Conversely, the low interest rates are negatively impacting pretty significantly both securities and trust business, because they're both interest-rate-sensitive, so that's having a negative impact on it. Obviously we'd like to see the volumes continue to grow, and we don't see any indication they won't at the interest rates that are problematic at this point.

Thanks.

Mr. Franco Turrinelli of William Blair & Company .You may ask your question.

(inaudible) To pick up on Carla's question though, can we expect to see the health segment margins head up into the 20's or is this going to be a mid to high teens era for you, do you think?

I would say in the foreseeable future, look for them to be in the mid teens on an annual basis. And they will fluctuate quarter-over-quarter, as Ken indicated. Over the long haul, they should increase but in the near term (inaudible) be right in that range

Great. Maybe one clarification regarding the internal growth, obviously saw a nice pickup there. There are a number of things that may factor into the second half this year including some of your acquisitions, and I think we know of particularly some of the EDS units were not growing as fast as or not growing at all, and then we got -- bank, and I just want to confirm that your comment that internal growth should improve in the back half of this year includes factors such as those.

Yes, they do. We've got sovereign factored into it as their check processing business is expected to go away in the third and fourth quarters of the year. None of that has taken place yet, but it's still anticipated. And we expect to see internal growth continue to accelerate in the second half. However, I would caution you that we don't expect it at this stage to hit that 8 to 10% rate by the end of the year. And then I would also add to it, what we talk about publicly is the rate -- annual growth rate, and as we hit these quarters, the quarterly growth rate could go up and the annual growth rate, because of rounding, could stay flat, and not that I'm anticipating that, but just remember the law of rounding and big numbers as we move forward through the quarter. However, I would come back and say that from the sales pipeline standpoint with the two negatives you mentioned baked into that, we still expect quarter-over-quarter improvement of organic growth rate as we saw in the second quarter.

Much is referenced to the annual growth rate as the year-to-date growth rate.

Right.

Thanks, Les. Thanks, Ken. Great quarter.

Thanks, Franco.

Jennifer Dugan of Merrill Lynch, you may ask your question.

Thanks. I was wondering if you could give us any update on any results from your sales cross-training and singular Fiserv branding efforts. Has that played out in any kind of increased cross sales that you guys can see this quarter?

I don't think on a quarter-over-quarter basis it's measurable. However, I would say that all of those initiatives continue, and I think over the long haul, we will see the dividends from that, but on a quarter-over-quarter basis, there's nothing measurable at this point, Jenny.

Ok. Not necessarily related to that, how have the new signings looked lately? Is it more broad signings or more core signings, more cross sales? Where are you guys seeing the most kind of strength in your new deal signings?

I would say probably across the board in new client signings is where the pipelines are strong. Cross sales continue to move along, and in the new deal signings, we're having some optimism in software licensing as well as our normal outsourcing business, but remember when we talk about new deal signings now, that also includes insurance, it also includes new health plan customers, so it's across the whole gamut. But overall, I would say those pipelines are strong as well as broad across all products.

Great. Thanks.

Kartik Mehta from Midwest Research, you may ask your question.

Good morning, Kartik.

Good morning, Les. I wanted to follow up on an answer you just gave. On the new client signings for financial institutions, are these new outsourcing clients that you're seeing or is it more of a market share gain at this point in time?

Well, it's new clients that we are signing away from competitors, new software that we're licensing replacing competitors' software, and it results in market share gains obviously, as we pull customers away from competitors.

The EDS acquisition, the credit union acquisition, is that an acquisition where we might see revenue flat or decline for, let's say, six months to a year as you kind of fix up the business and then you should see the growth rate, or is this a business that you should at least see modest growth rate even during the next 12 months?

The way we've pro formatted is flat on the revenue for the first 6 to 12 months as we do a number of things, Kartik. One is pour some R&D money into it to add capability to the product. And number two is just a step back up and improve on their whole customer service structure as we move towards taking care of these clients, and then over time, we would hope to see that stabilize and be able to grow on top of it.

This is now that you have this credit union acquisition from EDS, you have your own offerings, is this an opportunity to maybe consolidate some of the credit union offerings and improve margins in that area, or will you keep all your offerings that you currently have plus the EDS ones?

At this juncture, we intend to keep all of the offerings that we have, add the EDS offerings to our product list and continue to sell all of them. The only time that would change, within any of our products, if the customers out there start to indicate to us that they've got favored products and move towards favored products. So we have no near-term or long-term plans right now to do any kind of consolidation of products in the credit union business.

And the last question, Les, check 21 getting closer to passage, looks like it might pass by October, are you seeing any financial institutions you might call on the kusp (ph) that is not outsourced check processing - you are showing great interest now than they did six months ago because of the potential change in the law?

We've clearly seen a step-up in interest in all size financial institutions, in particular, medium to large ones who are looking to either outsource or join a con consortium and outsource check and image processing. There is definitely a pickup there. I would also say at the same time that we continue to see a rapid move of community banks and super community banks towards image technology as we continue to convert about one a day to image. So that whole check 21 area, along with the decrease in volumes of checks written, which we continue and the industry continues to anticipate decreases in check volumes, we believe are going to continue to drive improved interest in outsourcing.

Thank you very much.

You're quite welcome.

Mr. Craig Peckham of Jeffries & Company.

Good morning, Les. I wondered with the breakout here of the health benefits revenues, could you comment a bit about what the recurring revenue attributes are in that business compared to the EDS FI outsourcing segment? And just a follow-on as well, as it relates to the EDS acquisition, what kind of incremental products come with that acquisition, and how do you think about cross-selling what you might have seen added to the plate of products here?

As far as the first one goes, the characteristics of the health business is very similar to the rest of Fiserv's businesses, and that is that these are long-term agreements and contracts with companies to outsource the back office of their self-insured operation, so the characteristics and the way it fits into our business model is very nice and very similar to everything else that we do, which is one of the reasons obviously we were attracted.

Would it be fair to call that an 85%-type rate of recurring revenue?

Absolutely. Sure would and your second question had to do, I'm sorry?

What kind of increment products --?

No. EDS, I think. They brought in some additional products. Some compete with products that we have. We will have to rationalize and say we can sell both or decide which is better and then some additional products. We also have products in the Fiserv family such as check processing and image and a lot of other things that we feel very strong we can cross-sell into the credit unions that are joining us from the EDS group, so there is great cross-sell potential. I would add that the EDS group on their own, over the past, I'd say, 18 to 24 months have done a very nice job of cross-selling because new sales were not going all that well. And they build a great cross-selling engine, and one quite honestly that I think Fiserv can learn from on how that there were been able -- because I think on a percentage basis, they've done much better on cross-selling than we do, so I think there's plenty of cross-selling to do both ways and plenty to learn.

Thank you.

Nikolai Fisken of Stephens, Inc., you may ask your question.

Good morning, everyone, and congrats on the quarter. If you look at the bank technology spending today, can you give us your commentary on what it's looked like today versus, say, three, six months ago, and what specific products you're seeing acceleration in terms of spending on?

I would say as far as the outsourcing part, bank spending on outsourcing, that's been pretty smooth, and really hasn't changed positively or negative and continues to be very strong. On bank purchasing of software, licensing of software and licensing of -- maybe you'd call it non-necessary items, frill items has started to pick up again a little bit. We've seen some positive trends in that. So trends not only in new sales but in filling of the pipeline, which is encouraging to us. Now whether that's enough to really say that there is a change in attitude, I'd leave that up to brighter people than us. We just watch our pipelines and that's relatively encouraging.

How about the in-house core processing sale environment?

It's as good as it's been. I look to norm, and the pipelines in that area are -

Improved.

You know, looking back, it certainly has improved over the last year, and it's encouraging in all of our products, ITI and precision and CBS and all of our bank products.

Ok. Did I hear you right that none of the Sovereign business has moved yet?

That's correct.

Ok. Then lastly, as specific to EDS, I'm wondering, you just guided to revenues staying flat for the next six months, and I'm wondering what you are banking on to get an increase from in light of the fact that they've lost three of their big five customers.

I think one of the things that we're banking on is being able to stabilize the run-off, and I think that Fiserv has got a great track record, I've been able to do that when we do an acquisition in a situation like this. I would also tell you that the management team that's joining us from EDS has seen very positive feedback from their customer base on the fact that they're now owned by Fiserv and that Fiserv believes very strongly in the credit union business and is going to invest in the products. So that is one of the things. If we stabilize that base, then we can grow on top of it, and that's what they've struggled with over the past couple years, is attrition. Another thing they've struggled with, and I don't think you'll get any argument from the customer base or them, they have not invested in the products like they should have. And if you invest in products, then you can obviously charge more. You can obviously cross-sell more, and all of those things, we believe, will add to our ability to grow that over time.

Great. Thanks.

Thank you.

Glen Greene of ThinkEquity Partners, you may ask your question.

Thanks. A couple of questions. The first one on the securities processing segment, the revenue was sort of flattish this quarter which was surprising given that the retail activity has picked up. Were there any client losses that might explain that, or help me understand why it remained flat

I'm going to ask Ken to answer that.

You've got part of the impact is in the Trust division, where you have the negative impact of the interest rates. You get a lower spread between our customer deposits and our investments. So that reduces the revenue. And then we didn't get as much of a pickup from the increase in the margin balances because we again are having a lower spread on our margin balances than we had historically, again because of the lower interest rates. So even though our revenue in the securities group went up from trades, overall, it was minor.

Ok. And then if you could just give us a little color on the progress integrating CNS, where you are at this point and what sort of the next steps are.

That continues to move on schedule. We obviously have integrated from a management standpoint and operations standpoint both of those units, and continue at this stage to work on the software product that we're going to come out with as a common software product. Meetings are ongoing in that area. As a matter of fact, a series meetings took place here last week, and as those decisions are made, then the big push will be to bring the clients over the next 18 months, 24 months, on to a common product. But everything we've done there to date has been on schedule from what we anticipated in our original performance, not only from a technology standpoint, but from a financial standpoint.

Ok. And one final question, just an update on the outlook for sort of your European business, which has been weak for a while now?

I don't think any of us right now anticipate any pickup in the European market in the foreseeable future. Anything picking up over there would be a positive surprise to everybody around this table.

But certainly not baked into your internal growth expectations for the back half?

Absolutely not.

Ok. Great. Thanks.

Julio Quinteros of Goldman Sachs, you may ask your question.

Good morning guys. One quick question on the projected revenue growth for the third quarter, I think it suggests about an increase of 49 to $34 million, depending on the range there. And looking at the models, acquisition contributions alone from 2002 and what you've announced in 2003 to date should add about $111 million. Can you help me reconcile the differences in the numbers there, the magnitude of the differences there?

We've probably got a little different numbers, Julio. I would suggest that you give a call to Tom Hirsch (ph) and then maybe we can help you figure those out.

Ok. I'm just looking at the acquisitions contributions of loan from 2002 that are still contributing to the numbers this year and all the acquisitions you've announced the date. I am just looking at basically (inaudible) from $111 million just from those acquisitions alone.

I think the thing to do is give Tom Hirsch a call, Julio, and give the numbers you're using for those acquisitions are what we're using for those acquisitions. That may be where your problem is. Because we're growing organically on top of those acquisitions.

Right, which would suggest actually a higher number or just a higher sequential growth rate then. I'll follow up with Tom. That's not a problem. Then on the cash balance that you guys reported, that cash balance, I'm assuming, is going to go -- part of it, at least, will go to paying the $218 million for the EDS business and then some other portion would have to be used to pay out the Chase acquisition, correct?

That's correct, and then the cash and cash equivalents, we probably have about $100 million there that will go toward the acquisition.

Ok. Great. And then finally, just trying to reconcile, the CAPEX components for the last two quarters have been about $24 million in the first quarter and about $31 million in the second quarter. I'm looking at the PP&E balance for the end of the June quarter, and still only see that rising about $2 million from the end of the second quarter. What's happening in that number there?

Julio, why don't you give me a call on that. You're saying the CAPEX number, is that correct?

Right. You guys have reported CAPEX number of about $55 million for the first two quarters of the year.

Ok.

And the PP&E balance on the balance sheet is only up by about $2 million. So I'm just wondering if there are some things that have been written off, ruled off or what happened.

depreciation against it. You have depreciation and also you have acquisitions that go through there that affect that balance, so again, I mean, if you want to give me a call on that directly, I can walk you through that.

Ok. And the acquisitions, I'm assuming, would have been additive to the PP&E balances?

Yes.

Ok. I'll go ahead and follow up. Great. Thanks.

Thank you, Julio.

Our last question comes from Pat Burton of Smith Barney.

Good morning. I guess I'll ask for the potential for a dividend given the new tax laws and what your guys thought process is there. Thanks.

I would say there's always potential, but there's no conversation about it at this point. It is something that we discuss from time to time at the Board. We continue to feel that the best use of our cash is to pour back into the company and make the company grow through acquisitions and building on what we've got already. However, that's not totally out of the question. It will be discussed at future board meetings.

Thanks, Les.

You bet. Have a good day. Is our conference leader still around?

This concludes the Fiserv Conference Call.

We appreciate your interest and your questions and look forward to talking to all of you in the future. Thank you very much.