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Fidelity National Information Services Inc. (FIS - Analyst Report) reported third quarter 2012 earnings of 63 cents per share, beating the Zacks Consensus Estimate by 3 cents. Earnings climbed 4.1% from 60 cents reported in the year-ago quarter. The quarterly result was primarily driven by strong margin expansion.

Quarter Details

Revenue in the third quarter increased 2.8% year over year to $1.44 billion and was in line with the Zacks Consensus Estimate. Revenue increased 5.0% on an organic basis, primarily driven by strong performance of the Financial Solutions segment, which fully offset flat year over year revenues in the Payment Solutions segment and a decline in the International Solutions segment.

Financial Solutions revenue climbed 8.1% year over year to $565.7 million (7.0% organically) on the back of strong growth in processing and consulting revenue as well as higher commercial services revenue in the reported quarter.

Payment Solutions revenue remained flat on a year-over-year basis at $576.1 million. Excluding the check-related business, Payment Solutions revenue was up 1.6% year over year, driven by continuous increase in electronic transactions.

International Solutions revenue decreased 0.7% year over year to $295.5 million, primarily due to unfavorable foreign exchange. Organically, the segment grew 11.9% year over year in the quarter based on strong performance across all the regions.

Fidelity’s third quarter was primarily driven by better-than-expected margin expansion, which fully offset the sluggish revenue growth. Gross profit increased 7.1% year over year to $528.3 million. Gross margin expanded 150 basis points (“bps”) to 36.8% on the back of favorable business mix.

In the third quarter, earnings before interest, tax, depreciation and amortization (“EBITDA”) increased 2.8% year over year to $442.2 million.

As far as expenses are concerned, selling, general & administrative expense (“SG&A”) surged 12.8% year over year to $180.2 million in the reported quarter.

However, operating income was up 4.3% year over year to $348.1 million, based on strong gross profit base. Operating margin expanded 30 bps to 24.2% in the quarter.

Further, interest expense decreased 10.7% year over year to $54.0 million in the third quarter. As a result, net income was up 1.1% year over year to $187.5 million in the quarter.

Fidelity’s balance sheet continued to remain highly leveraged at the end of the third quarter of 2012. As of September 30, 2012, cash and cash equivalents were $576.6 million compared with $533.8 million in the previous quarter. Total debt (including the current potion) at the end of the quarter was $4.53 billion compared with $4.86 billion in the previous quarter.

Fidelity generated $255.4 million in cash from operations versus $258.9 million in the previous quarter. Free cash flow increased to $193.2 million from $178.4 million in the previous quarter.

During the quarter, Fidelity paid $59.0 million in dividends and repurchased 3.1 million shares for $100.0 million. Fidelity has $850.0 million remaining for future share repurchase, under the existing plan.

Acquisition & Divestiture

During the third quarter, Fidelity acquired ProNet Solutions for approximately $24.0 million in cash. The acquisition is expected to expand Fidelity’s product offerings in the outsourcing and consulting business going forward.

In August 2012, Fidelity divested its healthcare business for $335.0 million in cash, with net proceeds of approximately $220.0 million after-tax. Fidelity recognized after tax loss of $56.0 million related to the divestiture.

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 margin is expected to expand by 40–80 bps.

Fidelity reiterated its earnings forecast for full year 2012. The company continues to expect earnings in the range of $2.45–$2.55 per share for fiscal 2012.

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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