Fidelity National Information Services Inc. (FIS) reported second quarter 2011 earnings of 55 cents, beating the Zacks Consensus Estimate by a penny. The better-than-expected result was driven by strong top-line growth in the quarter.
Operating Performance
Non-GAAP earnings per share (EPS) from continuing operations increased 17.0% year over year, the net effect of a lower share count, higher revenue and lower tax rate.
Adjusted net earnings from continuing operations totaled $165.9 million compared with $176.2 million in the year-ago quarter. The year-over-year decline was due to higher interest expense in the quarter.
Gross profit increased 10.6% year over year to $496.6 million. Gross margin was 34.4% compared with 35.2% reported in the prior-year quarter, impacted by unfavorable mix of revenue.
In the reported quarter, EBITDA on an adjusted basis spiked 5.9% year over year to $415 million. EBITDA margin, however, plunged 190 basis points (bps) from the prior-year quarter to 28.8%. The year-over-year decline was attributable to a higher mix of low margin professional service revenue, lower license revenue and increasing costs.
Operating income was $321.3 million, up from $307.1 million in the prior-year quarter. Operating margin contracted 180 bps from the prior-year quarter to 22.3%. Higher selling, general and administrative expense (SG&A) (up 23.4% year over year) led to the decline in operating margin.
Revenues
Revenues on a non-GAAP basis in the second quarter increased 13% year over year to $1.44 billion. Revenues rose 5.8% organically, driven by strong results from Financial Solutions and International Solutions.
Segment Results
Financial Solutions revenues rose 12.7% year over year (5.2% organically) to $516.5 million, boosted by growth in account processing, higher services revenue, and the addition of Capco’s North American operations.
EBITDA was $208.3 million, up 3.5% year over year, but margin declined 360 bps to 38.7%, reflecting a higher proportion of low-margin professional services, including Capco.
Payment Solutions revenues of $632.0 million in the second quarter remained flat year over year. The consolidation of Fidelity’s merchant processing platforms resulted in the utilization of net method to account for certain merchant interchange fees, which negatively impacted year-over-year comparisons by $17.8 million. Further, declining check usage negatively impacted revenue growth by $1.2 million.
EBITDA increased 2.9% year over year to $238.9 million, and EBITDA margin improved 100 bps to 37.8%.
International Solutions revenues totaled $293.0 million, up 57.8% year over year (25.2% organically). The strong results were driven by higher volumes from its Brazil card processing operation, growth in professional services, higher license revenue and the addition of Capco’s international operations.
EBITDA increased 44.3% year over year to $61.2 million. However, EBITDA margin decreased 190 bps to 20.9% in the quarter, reflecting a higher proportion of low-margin professional services, including Capco.
Liquidity
As of June 30, 2011, cash and cash equivalents were $427.3 million compared with $384.1 million, as of March 31, 2011.
Fidelity’s balance sheet is highly levered. Total debt (including the current potion) at the end of the quarter was $4.88 billion compared with $5.00 billion in the previous quarter.
Capital expenditures in the second quarter totaled $68.0 million versus $71.6 million in the previous quarter.
The company generated $263.0 million in adjusted cash from operations versus $260.2 million in the previous quarter. Free cash flow (on an adjusted basis) increased to $195.3 million from $107.5 million in the previous quarter.
Guidance
Fidelity projects adjusted earnings per share from continuing operations between $2.24 and $2.34 for fiscal 2011, up 11.0% to 16.0%, compared with $2.02 in fiscal 2010. Currently, the Zacks Consensus Estimate is pegged at $2.32, roughly in line with the high end of the guidance.
Revenue is expected to grow in the range of 9.0% to 11.0% (4.0% to 6.0% organically) for fiscal 2011.
We believe Fidelity’s expansion into emerging markets such as Brazil, India and China will drive organic revenue growth over the long term.
EBITDA is projected to increase 7.0% to 9.0% and free cash flow is expected to approximate the adjusted net earnings in 2011.
Regulatory Activities
On June 29, 2011, the Board of Governors of the Federal Reserve System issued a final rule to implement the Durbin Amendment to the Dodd-Frank Act, which primarily restricts interchange fees for certain debit card issuers and limits the ability of networks and issuers to restrict debit card transaction routing, including through exclusivity arrangements.
Fidelity believes that the clarity around the Durbin Amendment will be positive for its overall business. The company believes that the exclusivity provision, which requires all issuers to have at least 2 unaffiliated networks on their cards, is a favorable outcome for the NYCE (New York Currency Exchange) network. NYCE Payments Network, LLC, is a leading U.S. electronic payments network and a subsidiary of Fidelity.
Recently, Fidelity hosted a number of webinars on the Durbin Amendment, where more than 1000 clients participated. Fidelity has also signed a record number of new NYCE participants in the first half of 2011.
Recommendation
We believe Fidelity’s commanding position in the financial services market, increasing international exposure, recurring revenue model, diversified product portfolio, cost synergies from acquisitions and a loyal customer base will drive growth over the long term.
We believe Fidelity is well positioned to grab growth opportunities in the recovering global economy. As pointed out by the company, the improved spending environment is expected to boost Fidelity’s top-line growth going forward.
However, increasing consolidation in the banking sector, a challenging environment for the Payments Solutions business and an uncertain regulatory environment are the primary headwinds, in our view.
We maintain our Neutral rating on a long-term basis (for the next 6 to 12 months), primarily due to increasing debt and intense competition from Fiserv Inc. (FISV), International Business Machines Corp. (IBM), Accenture Plc (ACN), Alliance Data Systems (ADS), MasterCard Incorporated (MA) and Visa Inc. (V).
Currently, Fidelity has a Zacks #4 Rank, which implies a short-term Sell rating (for the next 1-3 months).
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