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Fidelity National Information Services Inc. (FIS - Analyst Report) reported second quarter 2012 earnings (including stock-based compensation) of 66 cents per share, exceeding the Zacks Consensus Estimate by 9 cents. Earnings surged 23.1% from 54 cents reported in year-ago quarter. The quarterly result was primarily driven by strong margin expansion.

Quarter Details

Revenues in the second quarter increased 3.1% year over year to $1.46 billion, but fell marginally short of the Zacks Consensus Estimate of $1.48 billion. Revenues increased 5.1% on an organic basis, primarily driven by strong performance of the Financial Solutions segment, which fully offset lackluster revenue growth in the Payment Solutions segment and a decline in the International Solutions segment.

Financial Solutions revenue climbed 9.1% year over year to $563.4 million (7.8% organically), on the back of growth in account processing and higher services revenue. Payment Solutions revenue increased marginally to $630.6 million. Excluding the check-related business, Payment Solutions revenue was up 2.7% year over year, driven by continues increase in electronic transactions.

International Solutions revenue decreased 1.9% year over year to $287.3 million, primarily due to unfavorable foreign exchange. Organically, the segment grew 10.0% year over year in the quarter based on strong performance from European processing and consulting businesses, higher card issuance and usage in Brazil and continued expansion in Asia.

Fidelity’s second quarter was primarily driven better-than-expected margin expansion, which fully offset the sluggish revenue growth. Gross profit increased 10.7% year over year to $535.8 million. Gross margin expanded 250 basis points (bps) to 36.8% on the back of favorable business mix.

Selling, general & administrative expense (SG&A) surged 14.2% year over year to $193.4 million in the quarter. However, operating income (including stock-based compensation) jumped 8.7% year over year to $292.7 million, based on strong gross profit base. Operating margin expanded 120 bps to 23.5% in the quarter.

Further, interest expense decreased 14.0% year over year to $56.6 million in the second quarter. As a result, net income was up 18.1% year over year to $198.1 million in the quarter.

Fidelity’s balance sheet continued to remain highly leveraged at the end of second quarter of 2012. As of June 30, 2012, cash and cash equivalents were $533.8 million compared with $481.7 million in the previous quarter. Total debt (including the current potion) at the end of the quarter was $4.86 billion compared with $4.84 billion in the previous quarter.

Fidelity generated $258.9 million in adjusted cash from operations versus $203.8 million in the previous quarter. Free cash flow (on an adjusted basis) increased to $178.4 million from $136.4 million in the previous quarter.

During the quarter, Fidelity paid $59.0 million in dividends and repurchased 1.5 million shares for $50.0 million. Fidelity has $950.0 million remaining for future share repurchase, and expects to buy approximately 50 million shares every quarter for the remainder of 2012.

Guidance

For fiscal 2012, Fidelity continues to expect organic revenue growth to range between 3% and 5%. EBITDA is expected to grow in the range of 5%-7%, while margins are expected to expand by 40-80 bps.

The company expects the second half of 2012 to be much more challenging in terms of margin expansion due to planned client deconversion, tough year-over-year comparisons and lack of visibility around Visa pricing plans.

Fidelity revised its earnings forecast for full year 2012. The company now expects earnings in the range of $2.45-$2.55 (down from previous guidance of $2.47-$2.57) for fiscal 2012. This includes a charge of 7 cents related to the divestiture of the Healthcare business during the quarter and 5 cents benefit related to lower-than-anticipated effective tax rate.

Recommendation

We believe that 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 also believe that Fidelity’s expansion into emerging markets such as Brazil, India and Asia-Pacific will drive organic revenue growth going forward.

However, increasing consolidation in the banking sector, challenging environment for the Payments Solutions business and uncertain regulatory environment are the primary headwinds, in our view.

We maintain our Neutral recommendation on a long-term basis (for the next 6 to 12 months), primarily due to a highly leveraged balance sheet and intense competition from other major players such as Fiserv Inc. (FISV - Analyst Report).

Currently, Fidelity has a Zacks #3 Rank, which implies a short-term Hold rating (for the next 1-3 months).

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