ACI Worldwide Inc (ACIW) 2009 Q3 法說會逐字稿

Good morning. My name is Jessica, and I will be your conference operator today. At this time I would like to welcome everyone to the ACI Worldwide financial results for Q3 ending 2009 conference call. (Operator Instruction) After the speakers' remarks there will be a question and answer session. (Operator Instructions). Thank you.

Ms. Gerber, Vice President of Investor Relations, you may begin your conference.

Thank you everybody for attending our Q3 results conference call today.

This call, like all of our calls, is subject to Safe Harbor and forward-looking statement language, and it applies to the entirety of the substance what we speak about today. The full text of the Safe Harbor and forward-looking language can be found on the first and final pages of today's presentation, a copy of which is available on our website as well as filed with the SEC this morning.

Our management speakers today will be Phil Heasley, our CEO, Ron Totaro, our COO, and Scott Behrens, our CFO. And all three management members will be available for Q&A immediately following our prepared remarks.

So I'm going to turn the call over now to Phil Heasley to kick it off.

Good morning. And thanks for joining us today. I just wanted to kick off the call with some general comments on market trends and what we are seeing among customers, before turning the call over to the team to run through the operations and finance.

It's pretty clear that we serve mega banks, processors and retailers around the globe, and those customers are changing their habits in ways that are both good for the duration, and short-term negative for ACI.

The good news is that the customers are now looking at their global operations as a single unit. In the past they used to treat each country has its own purchasing agent and did not exploit -- did not fully exploit global efficiencies in their back-office operations. Now most of the large customers want to discuss transactions with us on how to achieve major efficiencies across not only their software infrastructure but their hardware as well. We think this development is very good for us and expands our relationship and reach with our clients.

The less positive news is that this type of comprehensive deal takes a longer time to close than the average one to two product sale would take. However this sort of relationship is more aligned with our philosophy around Agile Payments Solution. So we are pleased with the development in terms of creating longer-term, more sustainable economic value for ACI.

Payment systems investments is by no means finished but speed of time to promulgate a deal has become more of a factor. Rigid approval processes are introducing us to higher management within our clients, and that's a good situation for us to gain both visibility and stronger relationships within the CIO office and the corporate offices. Yet this process is clearly more time-consuming.

And one outcome of what's happened in the banking market is we are seeing customers pay us cash, frequently towards the very end of the contractually acceptable date. For example, we received $14 million early in October in customer payments. We expected at least $8 million to $9 million of that to come in during quarter three, but customers are managing their payment dates extremely carefully.

Our anticipated sales for the year are running at their usual trajectory of being extremely quarter end -- quarter four loaded. We think we have a band of possible sales outcome. That's the main reason why we highlighted potential diminution to sales in our October presentations to investors at William Blair. We have a few projects which are very large dollar sized transactions, but calling out when exactly these will close is clearly an inexact science, and as we approach the end of the year, makes it impossible to forecast that closely.

And we won't offer unrealistic discounts to close deals in 2009 versus 2010. And I've told (inaudible) recently our priority is to grow and to grow prudently. We will maintain our focus on operating profitability. Last week we announced an alliance with Bell ID based in Rotterdam, Netherlands which provides capabilities that will expand our smart card management and token management expertise as EMD continues to expand globally. These product announcements align nicely with our Agile Payments Solutions and will enable ACI to improve its market position and customer satisfaction.

I'm going to close here and have Ron take you through business operations at this time. However, I will remain available for Q&A.

Thanks Bill, and good morning to everyone on the line. I wanted to start my comments today with a broad overview of the quarter, touching mainly upon revenues and expenses.

We had a very good quarter, and probably the calendar year-over-year revenue variation was driven by the final faster payment bank and switch revenue coming out of our EMEA segment. While EMEA looks weak at first glance, the difference was driven mainly by ILF or term extension revenue contraction year-over-year. That is basically a function of the cyclical timing of term renewals and their associated capacity and other ILF fees.

We saw a much stronger Americas channel mainly driven by the renewal of a large US bank deal in July.

Revenues under on a recurring basis continued to look very good in the quarter. We have had a consistent monthly recurring revenue, and approximately 60% of what we booked in the quarter came from recurring revenue.

On the expense side, our restructuring exercise from earlier this year and late 2008 continues to drive benefits. We saw a $5.2 million save in HR related costs over last year due to restructuring activities implemented since 2008 of September. In addition to those cost savings, we also benefited 2009 by not having the higher IT outsourcing and services contractor costs we saw in 2008. Together these items account for a $33 million year-to-date improvement in our cost structure. And we continue to institute could cost control mandates and productivity measures throughout our entire business.

The IBM alliance continues to produce interesting deals for us. We sold a System z management program to a major northern European bank this quarter, and we also have several z deals in our pipeline in Brazil, Canada and the US. We are seeing a lot of activity around our fraud product right now, which makes sense when you consider the increased fraud activity occurring with many of our customers.

Turning to slide eight, this is our standard depiction of sales by type of product. The most obvious point is that we were very successful in up-selling add-on business to clients who already use our products. These sales occurred mainly in term renewals situations. We generally had a smaller number of deals which we are hitting renewal deadlines as compared to last year, and that is reflected in both term extensions and in the growth rate of the retail payment [venture] products.

New accounts and applications continue to be a sluggish category as we continue to experience longer selling cycles.

And looking at sales from a product perspective, it is clear that the risk and retail systems continue to sell more briskly. Wholesale was flat for the most part over prior year when accounting for the fact that we have approximately $7 million in renewals last year that did not recur in the quarter. In fact, there is no corresponding renewals at all this year, as we did not approach any client expiration dates.

Application sales were lower due to the $3.1 million varied term extensions, and there was a commensurate reduction in add-on sales for term extensions in the amount of nearly $5 million.

Slide nine highlights sales segmented by geography and customer concentration. This quarter was different from last year's Q3 because of the size of some of our term renewals. While we booked fewer total terms, you can see that the top five deals clearly accounted for a lot more revenue than the top five customers did in Q3 2008. Obviously our biggest US market contributor was JPMC, although we also saw other interesting renewals in both Latin America and the US.

While America showed significant growth from large renewals, EMEA demonstrated the opposite trait. Last year's top five customers accounted for approximately $10 million more revenue than this year due to the fact that there were certain term extensions up for renewal in 2008 than in the current period.

Asia looked pretty similar to prior year, so our only major changes happened in the two large channels, with the US growing significantly and EMEA contracting on prior year quarter. This type of swing in term renewals of where we book revenues is typical as we run through the timeline of our 60-month backlog.

Slide 10 is our standard leave-behind with summarized sales mix over a two-year historical look-back. We are tracking closely to our performance last year at the same time, with the obvious exception that we have seen an annualized shortfall in new accounts and applications as the sales cycle has remained long.

I would like to take a moment to speak to channel performance on slide 11 before spending time on our recently unveiled product initiatives.

Americas continues to be our strongest performing segment. Monthly recurring revenue is growing nicely, especially when we account for the distortion of short-term monthly license fee revenue booked in Q3 2008. We had 14 deals "Go Live" in the Americas this quarter. So we are continuing to manage and adhere to implementation and install schedules with our backlog customers.

We maintained renewal schedules with Latin American deals and also signed some new and diverse US customers who are not our typical large tier bank client markets, such as a food franchise and a credit union. Both of those names are leveraging our product capabilities in our On Demand environment, so our hosted product offerings continue to give us more flexibility and provide a cost effective solution, just to a somewhat smaller customer set.

EMEA had a large variance of renewal bookings that I mentioned throughout my presentation, coming in at $14 million last year and only just under $2 million this year. However, excluding the change in renewals, we did see some interesting rises in servicing revenues related to major "Go Live" projects. We also closed sales at a major credit card provider and cooperative bank, as well as a risk management program with a large Dutch bank. In fact, we had over 41 "Go Lives" in Q3 globally, with 17 of them occurring in EMEA including an SEPA-compliant cross-border cash management system.

Our ability to move backlog into current period revenues is a function of improved product management processes at ACI, which we told you about in the beginning of this year.

Asia turned in a solid and stable quarterly performance, as we noted with Americas. Monthly returning revenue rose on a year-over-year quarterly basis, although total revenues fell slightly over the June quarter. Probably the most singular point in Asia was its heavy dependence on a handful of deals to achieve the bulk of its services revenue. That stated, we are still seeing wide and varied sales signings in North and Southeast Asia, as well as in Australia and New Zealand.

My next few slides cover some significant progress we have made on the product side of our business. Over the last few quarters we've made significant investments and progress in assessing our product strategy, realigning our solution roadmaps, and focusing on areas that lay the foundation for future innovation and growth for ACI.

Slide 12 discusses some of our recent activities in the third quarter. We have seen good take-up on our most recent ACI On Demand product that was released at the end of Q2, and Enterprise Banker install times has been significantly reduced by 50%. Both the newer iteration of product functionality as well as focus on more rapid installation aid in retention and marketing to new customers.

We also introduce our Agile Payments Solution strategy with an unveiling at the SIBOS industry conference in Hong Kong in September. Agile Payments, as shown visually on the next slide, has really jumpstarted customer conversation around holistic views of a multi-product infrastructure.

One significant feature of the APS strategy is that we are now able to better explain how to combine our products, which used to be viewed and used in separate silos, into an integrated payments solution with shared infrastructure. This integration means that products such as tools, testing, and broader financial crime detection will work together in a more seamless and robust manner and are tied together with software services.

Slide 13 is the visual depiction of Agile Payments. Put simply Agile Payments is the unified solution that initiates, manages, secures and operates payments and maximizes total economic impact for our customers. Agile is the outcome of the exercise we've undertaken over the past year to identify and focus on 11 key products which we provide to the marketplace. We are now looking at them as a software service delivery, rather than a silo of single product entities, to create the kind of flexibility our customers seek in deploying and migrating to holistic payment solutions.

My final product slide is really a recap of improvement initiatives we've made in both product and application development. We think that the improved delivery times will allow us to maintain our market leading edge in developing payment environments. Innovation has become much more important to us as we look at how common architecture can improve the rate of return for a customer who purchases our Agile systems in the overall total cost of ownership.

Finally, we have been involved in alliances activities lately, as Phil alluded to. Over the past week we announced an exclusive alliance with Bell ID where we will now be marketing and selling their smart card management solutions to customers in markets who utilize EMV type technology. This alliance enables us to offer a strong value proposition to the -- in the chip space with a best in breed offering, while enabling us to focus internally on building the core components of Agile, and we look to do more of these types of deals in the future.

So to close my section, we are excited with the new product capabilities that we have recently announced. We continue to make good progress in identifying and executing on needed areas of improvement to drive productivity throughout our global operations.

I will now turn the call over to Scott.

Thanks Ron, and good morning everyone. I'll be starting my comments on slide 16 with key takeaways from the quarter. As usual, I'm going to jump right into revenue, as Ron has done a pretty comprehensive job of covering sales, the sales performance for the quarter.

In the third quarter we achieved $104 million of revenue, which represents a slight decrease compared with the September 2008 quarter, as Ron mentioned, the variance being largely the result of the remnants of the UK government faster payments project that went live in the September 2008 quarter.

Foreign currency fluctuations compared to the third quarter period of last year reduced revenue an additional $2 million. Revenue did improve, however, on a sequential basis compared to the $87 million we achieved in the second quarter of 2009.

And finally on this slide, our recurring revenue, which again includes our monthly license fees, our maintenance fees, and our On Demand ASP portion of our services revenue did remain consistent year-over-year and represents about 60% of our total revenues this quarter.

Turning now to slide 17, overall operating expenses were down about $13 million year-over-year. Here we have provided an expense walk to highlight here graphically some of the key reasons for the decline.

If you recall, in 2008 we were transitioning our internal IT services to an outsourced relationship with IBM and incurred a little over $4 million of transition-related expenses in last year's third quarter. Those costs obviously did not recur again this year.

Our headcount reductions and other restructuring actions taken in late 2008 resulted in a little more than a $3 million reduction, primarily in personnel and related costs, and that number is a net number, that being net of our reinvestments.

We had a 2-plus million dollar reduction subcontract labor expenses compared to last year, and we saw about a $2 million reduction in T&E expenses, with the remainder of the reduction -- a little over $1 million -- coming from the lower deferred cost recognition year-over-year.

Below operating income we saw lower foreign currency gains this year, offset by a slightly lower net interest expense. But overall nonoperating expenses were less than $400,000 in this year's quarter.

Lastly on this slide, looking at operating free cash flow, similar to what was saw at the end of Q1 this year, and as Phil previously mentioned, we did experience some slippage in cash receipts right around the quarter end, which as you will see is also reflected in our higher trade receivable balance at September compared to where we were at June 30. We had a handful of invoices that we expected to get cash receipts in September, but instead, those receipts ended up rolling out into the early part of October.

So in terms of our outlook on cash for the year, we are currently negotiating some of our renewals as MLF or ratable transactions, and that will possibly impact the portion of cash we receive in Q4 as ILFs. For the long-term, this is a better deal for us, but the modification does mean that OFCF for the year will likely be closer to $20 million rather than the $25 million to $30 million range we discussed in our presentation throughout this year.

Turning to slide 18, this is our normal depiction of the ratio of revenue from backlog versus the revenue that is provided by current period sales. While we did book some significant renewal business this quarter, the total volume of renewal deals was down compared to last year, that primarily being in our EMEA region, as Ron mentioned previously.

The most interesting point here is the revenue from backlog, and that being both our recurring revenue and revenue from customer "Go Live" events, are continuing to show consistent and incremental growth in absolute dollars, and that's even in light of the foreign currency headwinds that have been affecting us on a year-over-year comparable basis.

So that leads into my final slide of prepared remarks on slide 19. We are reaffirming the guidance we provided in October. Right now it's our belief that the full risk adjustment is necessary. That being said, sales are likely to come in close to the 8% risk level, or approximately in the range of $414 million to $428 million of sales for the year. Consequently that will impact the GAAP revenues to the full 2% haircut, which equates to roughly $406 million in revenue for the full year.

However, on the positive side we feel we are very comfortable in the operating income range of $36 million to $38 million for the full year.

So that concludes my prepared remarks. Operator, we are now ready to open the lines for questions.

(Operator Instructions). George Sutton, Craig-Hallum.

Phil, once we're through the entirety of the shift away from the PUF transactions and you've moved to a larger component of global revenues -- so I am looking out a couple of years -- can you just give us a sense of how much larger do you think this business ultimately could be? And what kind of profitability dynamics would we see in that environment relative to today?

Let me see if I understand you. Probably -- maybe -- I don't know if I'm going to answer the question the right way. When we did a lot of PUF'ings and we presented ourselves -- and PUF'ings is a legitimate way -- payment up front are legitimate -- but we basically were on a largely monthly license fee basis. We were a PUF $300 million revenue company, and from a monthly license fee, we are probably much closer to a 200 -- little over a $200 million company. Today we are a 400-plus million dollar company, and there really isn't much adjustment that has to be made between PUF and -- that have to be made between PUF.

So the real thing that -- the real situation that we have is that as -- the company has stopped really doing a lot of new business, and we've got that famous pig through the python in terms of we are now harvesting as many "Go Lives" as we are putting into the front, I think. What you'll see is you'll see the margins go from where they are today to where we said they were going to go, which is the low -- we've stated low 20s.

I don't know if that answers your question, but without getting into brand-new greenfield, that's a way of explaining it.

That's helpful. Now, with regards to your Agile Payments Solution, what is the -- where is the customer's head with regard to this holistic solution? For years, vendors have pursued an integrated theme, and I'm just curious what is unique that you are bringing to the market that may not have been brought before?

Well, I don't -- I would hate to disagree -- I would never disagree with you, George. But I would --

My wife does every day.

Right. But I don't think anyone in the payments area has really been presenting integrated themes. And our theme is less an integrated theme than it is an integrating theme. And I don't want to make that sound different, but you can still buy individual capabilities, but you can then leverage those individual capabilities with common -- against common infrastructure and interoperability. And I think that's fairly new.

And most payments were, believe it or not, the manifestations of the hardware that they came from. So there was very little compatibility between -- at the software level because it was so much dominated (technical difficulty) level in terms of what your offering was or what it wasn't.

Now what we are really doing is inverting the paradigm that says that you can pick whatever hardware you want and we will give you software that will work from a payments standpoint. And then therefore the feature function of that software is interoperable. So if you like functionality that exists on the wholesale side of the business but you'd really like to present it directly to the consumer or small business, your ability to transcend that.

An example is that in our Enterprise Banker, where we sell what's called cash management product. Our product really ranges all the way from being able to fit consumer needs to very, very large corporate needs. And therefore whereas a lot of companies have three different online banking kinds of systems, you're able to employ a single structure, or at least a single image of software, and then present it to three different tiers within your company.

The whole idea of ACH being wholesale and debit card being retail has from a consumer standpoint, especially on the debit side, gone by the wayside. Consumers' use of ACH debit is actually growing faster than a lot of the debit card growth, which is the highest portion of card growth. So the need for interoperability and the need for debit card kind of functionality into the debit/ACH side of the business is getting stronger and stronger, especially in the customer management aspects of it.

So I think this is actually pretty new territory. And next year when we do our investors conference, we are going to highlight it as a product. We are actually going to go through it pretty rigorously from a product presentation. We will have our Dr. Blatt has a centerpiece. We're going to have him take actual payments as a centerpiece of that presentation.

Gil Luria, Wedbush.

First of all, in terms of your discussion of the fourth quarter, I think you made a comment at the beginning of the conference call about there being a big range of outcomes. Yet the guidance is for a couple of very specific numbers, I think $126 million on revenue and $30 million to $32 million for operating profit. Can you tell us what the maybe expanded band of outcomes is for those two numbers? What would be one standard deviation? Maybe two standard deviations of outcomes for those two numbers?

Well, I'll let Scott also answer this. But on revenue we are not giving a really expand -- sales and revenue are not very connected at all, right? Especially since we are not in the PUF -- we are not looking very much -- we are trying to bleed revenue immediately out of deals.

On the sales side it's a function of what closes and doesn't close. So another way of putting it, our pipeline is very strong and our pipeline is strong in the high percentage of close. Whether it closes in the next 60 days or whether a closes in the next 200 days, right, is a very inexact science in these sized deals.

I'll just add to that. Based on the numbers we've provided, we are probably pretty much in a pretty narrow range on those numbers. Obviously from a sales perspective we've risk-adjusted those. We are less than 60 days out from the end of the year. So we've got pretty good visibility in where we are coming out for the year. So obviously from a -- especially from a sales perspective could those risk adjustment factors change, but I think we've put in here a pretty narrow range from the numbers we have provided in terms of where we expect to land.

So the large band of outcomes, you were mostly referring to sales, not revenue or operating margins?

Absolutely.

Absolutely positively correct.

Great. And then one of your smaller competitors that competes with you in the wholesale talked about the fact that their large bank customers that include Barclays, Lloyds, Bank of America, Citi, HSBC, have recently started to increase their spending and that the trend towards global projects is actually helping facilitate them moving forward. And it sounds like you are saying that trend actually is slowing them down. Can you help us reconcile that and understand where those very large global banks are now in terms of their spending on payment systems?

Okay. I actually agree. I'm not going to say what company it is, but if it's what I read, I actually totally agree with what they said. And their statement was is that they are seeing the major banks really open up their interest investment spending in payments. And I totally agree with that.

What the phenomenon I was talking about was is where -- whereas our largest customer is about 3% of our revenue stream, sometimes we'd have to deal with those very large customers in five or seven or 15 pieces. They are now saying, well gee, I really am a global enterprise, I am not this headcheese kind of series of different businesses around the world. And what they are doing is they're consolidating their 3% relationship into a 3% relationship, right? So that is one piece of it.

The other difference between us and, quote, that company is that we are largely a product company. Our main emphasis is that we are 80%, and we aspire to be 85%-plus a product and maintenance company and a 15% to 20% services company. And their model is almost -- is somewhat inverted to our model, and we have great respect for them and whatnot. So they would actually start showing growth in services in front of us showing growth in products.

So I think both of our statements are very logical with each other.

John Kraft, D.A. Davidson.

Scott, I just wanted to have you repeat or clarify something you said about rev rec. It sounded like the renewals you're pushing to be more ratable?

Yes. What we are looking at in terms of the current negotiations on deals we expect to close for the year would be more of an MLF model versus an ILF model. And what that does is it drives your -- say for example, an annual license fee. If we contract for an ALF, you'll get that once a year. Well, if it closes in December, you'd get all that -- you'd essentially get all that revenue in the fourth quarter. If you structure it as an MLF model and that payment stretches out over the following 12 months, it's the same deal economics essentially, but you're essentially recognizing that revenue and receiving that cash over an extended period of time. So that's where you get into an issue around cutoff between the two fiscal years.

Sure. Presumably that would help your visibility a bit and just the steadiness of your results.

Correct. Anytime we do an MLF model. And that's really what's been -- over the last eight quarters we have been -- really been emphasizing and focusing is on our growth in our recurring revenue, which is obviously much more predictable, more stable, more reliable base of both revenue and cash.

How about as it applies to some of the more comprehensive deals? Phil specifically talked about moving away from the silo'ed approach. Is that -- is there a way to get into a little bit more ratable approaches to some of those bigger deals? And how long of an implementation time are those deals?

In terms of the -- it really ends up where we are at with negotiations with that particular customer. Again, it could be anywhere from an ALF model to an MLF model to some mixture of all of the above. So it kind of ends up where in some cases even how the customer wants the contract in terms of their payment period. Do they want to -- for example, we could get to the end of this fourth quarter and there may be customers who want to pay a full year's worth of cash payment before the end of the year. So that can sometimes lead to how they want to finalize the deal, versus those that are saying maybe they are not in a position to pay it all up front but they'll -- they'd rather then pay it over a period of time.

I don't think that's any different on these larger deals than it is on any other customer we have.

Wayne Johnson, Raymond James.

My question is regarding the conversion rate from BASE24 to eps. Can you just give us a little color on the rollout of that at the 200 largest users of BASE24? How many have been converted of those 200 largest users? How many have been scheduled?

And then I have a quick follow-up to that.

All right. I think we've said this publicly before, but whatever. We have 70 eps -- about 70 eps customers. Six of them are conversions from BASE24 Classic. And BASE24 Classic is going to take some -- I think it is very safe to say it's going to take multi years between now and when they actually convert over.

And in order to understand that, think about the typical American bank who may in effect have a single license with us but due to the consolidation of the US banking industry, they may have 26 to 85 images of the old Classic. And there's real efficiencies for them to move from those 26 images to 85 images to a single new eps image, but it -- by definition -- is a multi-year -- it's a multi-year kind of project. So I don't think you should expect a huge amount of quarterly conversions in these large customers.

Right. Okay, good. So I appreciate that. So just going back to kind like of the largest -- what I'm trying to get a sense of directionally is, of your largest BASE24 users, how many have already come back to you and said, okay, this is going to be -- let's talk about the scheduled time frame for conversion to BASE -- to the eps product line. So that's what I'm trying to get at. And within that, if a customer has scheduled the conversion but is not converted in two years, do they still have the big jump-up in the maintenance fees?

Two questions there. One is, we are in dialogue with a huge amount of our customers, who all -- what we do subordinates to their overall strategy as IT organizations and as market players. And we are figuring out how to fit appropriately within that subordination, right? So it's not going to be the same for anyone, and we would never discuss any of our customers. So that answers that question.

And two, we are in sun -- in the sunset phase there are higher maintenance fees because we are now forced to maintain two systems and whatnot. That's a very industry-standard practice. And yes, it will happen after 2011.

Tom McCrohan, Janney Montgomery Scott.

What needs to happen going forward to kind of minimize the seasonality you currently have in the revenues, given there's probably always going to be some predictability around deals going live and kind of year-end budget flushing?

I think if you see the trend line over the last eight quarters of more of our revenue base becoming a part of that recurring, kind of more predictable, I think that you're going to see that trend line continue. I don't think we'll ever get away from -- and we don't want to get away from large projects that "Go Live" that could have revenue built up and deferred that "Go Live" in any particular quarter. I guess we would love to have a number of faster payment type situations. So I think we are always going to get -- I think it will be less and less going forward. I think, again, the trend line is going to continue to be more recurring and less the lumpy portion of revenue.

So if there is -- if recurring revenues went from like 60% to 70%, what would be the implication as far as your expectations of second-half revenues as a percent of first-half?

I'm sorry. Second-half --?

Well, your second-half revenue -- your model right now is pretty much back-end loaded.

Yes. I would just add, a lot of this is based on budget cycles of our customers. So that's one of several sort of explanations. But I think I would just emphasize this, Scott, is that we also hope that we are getting more effective. We've had some very large implementations in the pipeline, so to speak, that we have been working on for multiple years periods. In fact one of the ones we alluded to was the SEPA-compliant implementation. That was a two-plus year implantation that we have been working on that just happened to happen in Q3. That very well could have been a Q1 or Q2 event going forward.

So I think as we get more proficient -- we are signing larger deals. Again, from a sales perspective you will still see I think some of this Q3, Q4 phenomena, out when we actually take hold of the revenue and recognize that revenue, that will smooth out I think over time as we are doing larger, healthier deals and we've gotten our processes and whatnot in place to do a better job and more efficiently executing on them.

Well, I'm going to add to that, if you look at the phasings throughout the year, the recurring is relatively consistent every quarter. One of the reasons why, and we've talked about this in the past, that the fourth quarter in particular is lumpy in terms of the ILF portion is because we have, of all of our customers that are contracted under an annual license fee model -- that's where they pay whatever they're billable and recognizable in the quarter at their anniversary date -- the disproportionate amount of that is in Q4.

And that's about a $15 million number that comes in Q4 with virtually zero incremental variable costs. So in those customers -- and that $15 million worth of ALFs represent customers that are in a five-year contracting cycle. So until they come up for renewal, fourth quarter is going to continue to be a significant quarter for ILF revenue and then specifically annual license fee revenue until those customers roll off. They may renew as ALFs, they may renew as MLFs but (multiple speakers) they have to drop off their five-year cycle.

I don't know if this is the question behind the question, but I'll answer it this way. I would totally expect next year's seasonality to be very similar to this year's seasonality and last year's. This year and last year we were the same, and I expect next year to be -- it would be great if we took that $15 million, $16 million from the fourth quarter and made it $4 million a quarter, right? But that's not going to happen immediately next year.

And the more we improve the business from margin and everything else, the more it keeps the curve -- that ends up reinforcing the prior year's curve to begin with. Because we don't get paid in the same way as we provide the service necessarily, because some of the service we get paid for, we get paid at the very end of the year. Other people pay us every month, and we're -- you know we are moving away from the ones that pay us one day and then we do it for the next four years and 364 days. We've largely gotten away from that behavior.

Brett Huff, Stephens.

A quick question -- a couple of quick questions, just some details. Can you explain -- and I might have missed this. Can you explain the $0.05 one-time add-back per the appendix in the presentation? Can you just articulate the driver of that?

That's the employee-related severance we had in the quarter.

And was that -- how many incremental -- what kind of additional forward-looking cost saves should we sort of expect from that? Can you put some other (multiple speakers) comments around that?

Yes. When we came into the year, we had expected -- we had done a restructuring late in 2008. Most of that had been completed by the end of 2008. We had expected and we -- when we put out our guidance at the beginning of the year, we had expected to have about $5 million of additional severance related costs this year. And so those actions that we took were really in contemplation of the finalization of that plan. So that's really all been factored into our current year guidance.

But I would think going forward, I would see -- I mean, in some of those cases we are going to be -- I would say probably a couple -- maybe $2 million a quarter going forward.

Franco Turrinelli, William Blair & Company.

So one question I have for you is, over the last, what, 24 months or so you made various changes in the Asia-Pacific region to control distribution and sales there more directly. I'm kind of wondering if we could kind of go over a little bit of a scorecard for that region so far and kind of look out to the future and when we might see some stronger results from that region.

I would agree with what you say, except I would change the tense that we are in the process of changing what we do directly versus -- we did take over the Malaysian and the Philippine distributorships. Some of the other direct activities that we are looking at, which I prefer not be specific about, are in process. And it's very hard to predict exactly when those things get finalized and whatnot.

But all I can say is it's sooner than later. I don't mean to be cute, but my legal counselors don't let me say anything more than that.

But do you think we need to -- beyond a change in distribution arrangements, Asia-Pac has always been one of those regions that you kind of look at and say, boy, there should be so much opportunity there, and not really kind of flowing through the numbers. And I'm kind of just wondering where you think you're at in that process.

I would just add -- by, as Phil alluded to, the Philippines and Malaysian move and some of the other moves we're looking to make to go to direct, gives us a lot more flexibility in understanding what the customer needs are, how we can price our business. And obviously as we view these efforts, we are improving sort of economics as it pertains to sharing revenue streams with other third parties in some cases, or at least improving our situation when there is a revenue share.

So it's a multifaceted thing, but I think the biggest benefit is getting feet on the street that can really bring to life Agile Payments, understand holistically what a bank's needs are, whereas a lot of our distributors tend to sort of focus on legacy offerings and the legacy mindset. As you know, we've been talking a lot about how we're trying to evolve innovation and future growth, and that's the message we are going to be better suited to deliver versus a distributor.

But Franco, to your basic "observation versus" question, you're absolutely correct. There is huge opportunity, especially in North Asia. We have not -- and I don't think anyone has of yet really harvested that. I don't think it's come to critical mass. And hopefully you'll see behaviors coming out of us that will at least validate our interest -- will validate our interest in that. You will see them sooner than later.

Gil Luria, Wedbush.

Just a couple of really quick ones. Margin target of low 20s, is that -- could you remind us if that's GAAP operating margin? And what the time frame that you've discussed for that goal?

Yes. That's -- we are talking 20% GAAP operating margins, yes (multiple speakers)

It's not a next-year -- it's a multiyear goal. But we absolutely are going to progress to that next year.

Then just finally, the taxes for the year? Do you still -- I think you said $17 million for the year. Is that still what we expect?

I think that from a cash tax perspective we are looking more in the range of $14 million now. I think we've been able to -- we've utilized some foreign tax credits and so forth to be able to -- which is a noncash -- to be able to get some noncash -- some cash relief. So we're looking at $14 million now.

Brett Huff, Stephens.

Just a couple of more quick details. Scott, can you explain a little bit more on the operating free cash flow, kind of size the dollar amount that slipped that was subsequently -- you got receipt of? If you could just sort of give us a sense of that from Q3 to Q4? And then also size the number, the amount of operating free cash flow you thought was going to come in as a one-time payment that you're contemplating now spreading out? I'm just trying to walk back from the -- I think you said $35 million to $40 million operating free cash flow originally, and correct me if that number is wrong, to now (multiple speakers) $25 million to $30 million?

Yes. We guided -- we provided earlier in the year an expectation of $25 million to $30 million. What we are saying now is we look like we're going to have $5 million slippage, and it looks like it's come in more around $20 million. And that's a function of a couple things, one being both the nature of deals -- that means more MLF structured deals versus ILF.

In terms of the timing, it gets also impacted by a deal that closes in December, and we wouldn't necessarily -- we may be able to invoice and recognize that sale, but not necessarily get (inaudible - background noise) by the customer until the earliest maybe being January, if you look at say a 30 day term, so it's a function of a contractual structure as well as the timing as we get closer to the end of the year in terms of when these deals are going to close.

The other specific numbers were, we expected $8 million to $9 million to have been paid in the third quarter, which was part of $14 million that ended up getting paid very early in the fourth quarter.

Right. If you see our receivables, if you look at June to September, we had a jump of somewhere around $12 million plus in the billed and unbilled receivables between June and September. That normalized itself back to the June levels shortly after quarter end. So that was really the difference, a handful of invoices that approximated 10-plus million that came in in the early part of October.

So basically just a -- I just want to be -- make sure I'm understanding, $10 million that you expected to get in Q3 you got early in Q4 from free cash -- from a receipt driving free cash flow?

Yes.

And then (technical difficulty)

Is there another question?

Did we lose him?

Sorry, I think I got cut off for a minute. Sorry about that. Scott, I just want to make sure I'm clear, the $25 million to $30 million sort of range that you thought before is now $20 million? Or $20 million to $25 million?

I would say we are closer to $20 million. I think it is firming up around $20 million.

And that is primarily driven by you both asking customers and customers both requesting deals that from a pipeline point of view, that hasn't changed, it's just the way that you are going to get paid the cash?

Right. The contractual structure, as well as, again, the timing. If we -- the later we close -- now we're within 60 days of year-end. The later we close, the less likely we are going to be able to bill it and collect it in this calendar year.

Is that delay in close just sort of -- just since it's so close to the cutoff, it becomes material, but beyond that it's not pushing it out three months, it's pushing it out several weeks, and it just happens we are close to the end of the year. Is it that kind of pushing out?

I would say, yes, both a mixture of deal structure -- deal structure and the MLF model. If it's deal structure, it's going -- it could say instead of having an annual license fee component, we would be getting it over the next 12 months. Deal timing is a factor just around the cutoff of the calendar year, around the calendar year-end. And that would be just a matter of being -- of the timing of billing and collection not landing in the same year.

One follow-up question I think I got cut off before is [wild], but just a -- the last question on G&A, the sequential increase in G&A ex the D&A portion, was that partially due to the severance costs that you saw? Is that part of the one-time stuff?

Yes. It was approximately $2 million in severance.

In G&A?

It would be primarily in G&A.

Then my last question is, can you just talk a little bit more again about the Q4 revenue? You've talked about it a little but previously. Phil, you mentioned your seasonality just sort of is what it is, and it's a Q4 loaded business right now. Aside from the $15 million that you've called out before on this call, Scott, can you just give us a sense of -- the pipeline remains the same? Or etc.? -- just to give us some comfort that the Q4 number, which is a meaningful sequential ramp, is achievable?

Well, if you look at our Q4 sales expectation of $167 million versus Q3 of $96 million, if you take that spread and just apply an average -- what our average sales to revenue conversion rate has been for the year, which is right around 9%, that's going to give you about a $6 million revenue increase, just sequential quarter over quarter, all else being equal. So you're going to get it from the ALFs of [15] (technical difficulty) get higher sales is going to drive higher revenue, and then just from an overall margin perspective, we won't have the severance in there in Q4. We will get some benefit on the payroll side. So the costs will go down, probably, again, at baseline of $90 million, if not a bit lower.

At this time I would like to turn the call over to Ms. Gerber for closing remarks.

Thank you everybody for participating. If there are any continuing follow-up questions, we will be happy to answer them. And we look forward to seeing you at our next conference. Thanks.

Thank you.

This concludes today's conference call. You may now disconnect.