ACI Worldwide Inc (ACIW) 2010 Q3 法說會逐字稿

Good morning. My name is Steve, and I will be your conference operator today. At this time, I would like to welcome everyone to the ACI Worldwide Third Quarter Results Conference Call. (Operator instructions.)

Thank you. I'll now turn the call over to Tamar Gerber, Vice President of Investor Relations. You may begin.

Thanks, Steve. Good morning, everybody, and thanks for joining our earnings call. The substance of today's call, like every earnings event, is subject to both Safe Harbor and forward-looking cautionary statements. You can find the full text of both those statements on the first and final pages of our presentation deck today, a copy of which is available on both our website, as well as filed with the SEC this morning.

Our management speakers today will be Phil Heasley, our CEO; Louis Blatt, our Chief Product Officer; Ralph Dangelmaier, our President of Global Markets; and Scott Behrens, our CFO. All the management members will be available for Q&A following our prepared remarks, and we'll be joined by Tony Scotto, who's responsible for applications development.

I'm now going to hand the call over to Phil to open up the remarks.

Good morning, and thanks for joining our third quarter call. We are delighted with our third quarter results. On the upside, we had a superlative sales quarter, certainly a record third quarter performance and in our top three quarters ever.

With the signing of the First Data global account deal, the FDC deal is a great benchmark for the marketplace in terms of what an integrated solution set with BASE24 core can do for high-volume, multi-country customers, and we expect to see more of these transactions in the future. The rise in recurring revenue, deferred revenue and growth in 60-month backlog are metrics that I use to assess the health and growth in the business, and these three metrics provided me confidence that the long-term economic value of the business continues to be extremely strong.

We generated tremendous improvement in recurring revenues, which represented 78% of the quarter's total revenue as compared to 60% of last quarter. On a sequential basis, deferred revenues grew $17 million over the second quarter, and 60-month backlog grew by $82 million over the second quarter.

Cash is another method of assessing the health of both new customer installations as well as our ongoing customer account management. We generated very strong cash this quarter, partially due to our disciplined and continued expense management around the globe, but also due to the efficacy of our cash collections team.

Finally, we have very good visibility into our quarter four revenue attainment, and indeed expect most of the revenue to be booked, and our GAAP financials will be delivered from our queued and contracted three-month backlog. Coming into the year, we always expect to have some variation or lumpiness quarter to quarter, and our third quarter came in pretty much as expected, albeit a bit of FX impact on the top line.

However, as I've told you in the past, FX depreciation at the top line also impacts our expense line as well, and we came in nicely, just shy of $90 million in expense. We anticipate that quarter four performance will enable us to achieve our full-year guidance, which we affirmed today and which we originally shared with you on a full-year call this past February.

I will let Scott address our preliminary 2011 outlook, but I'd like to leave you with summary conclusion. Our business grows in a more ratable recurring 60-month fashion. We can forecast and anticipate revenues relatively predictable within a given 12-month timeframe, and there are interesting opportunities internationally, both in Greenfield markets as well as potential to create more global account management with significant banks and processors who operate around the world.

I am now going to turn over the call to my team to discuss the quarter. Louis will begin.

Good morning, everyone. As Phil mentioned, it was a great sales quarter. In light of this, I thought I'd turn over some of my slides to Ralph to discuss the significant sales quarter that the team closed. As I know, there were many investor conversations over the past few months about the First Data deal in particular, so Ralph will go ahead and then turn it back to me for a general product and market update.

Ralph, please go ahead.

Thanks, Louis and Phil, and good morning, everyone. I'm pleased to join you. I'm in Amsterdam at a Sibos Global Payments Conference, seeing lots of customers, and there's great excitement about our products over here. And I wanted to start on page six and provide some commentary around our strong sales quarter in Q3.

During the quarter, we issued a press release announcing a global accounts deal with First Data. This represents a significant expansion and a multi-year extension, and it also sets the stage for First Data to leverage ACI to replace legacy platforms, consolidate multiple payment platforms, and expand into new markets. The deal includes BASE24, BASE24-eps, Proactive Risk Manager, and many of our infrastructure tools products. First Data will continue to invest in ACI's platforms to drive efficiencies and expand their offerings globally. We're pleased with our partnership and expect many new opportunities to come with FDC.

So the newly formed ACI Global Accounts team is working. We plan to use a similar deal structure to expand our presence with other global clients who are in multiple geographies across multiple solutions.

So moving to slide seven, as Phil said, it was a record quarter for us, $161 million in sales. One way we measure how we're growing our business is through monitoring what we call sales net of term extensions. This means any new customers, new applications or add-on product sales. The chart below illustrates sales net of term, which was over $100 million, up over 35% from last quarter. We had strong results from around the world.

To give you some examples, within Asia-PAC, sales doubled. Our Australia and New Zealand banks, some of the healthiest in the world, we saw major expansion and renewals. We expect large demand in 2011. Within ASEAN, the economies are bouncing back. Thailand has normalized its political turmoil in Q2, and we saw extended commitments from leading banks in Malaysia, Indonesia, as well as an increase in professional services business.

Within northern part of Asia, the Japanese payment market is starting its long-term nationalization program that will continue to represent an opportunity for us, and the Chinese banks are now looking to ACI to help advise them on some of the best practices as their payments markets grows rapidly.

In EMEA, our sales tripled. We had wins across the geography. In the retail side, we had add-on and capacity deals in the United Kingdom, the Middle East, Spain-Italy. Some of this was propelled by bank consolidation projects where ACI was the chosen platform. We also had success in Wholesale. We sold many services throughout the region, and we're thrilled about signing of our first MTS deal with one of the largest banks in the Middle East.

Now in the Americas, the total sales increased by 19%. This was driven by a combination of term extensions, significant add-on business, as well as a brand-new customer for our enterprise banking product. We also spent more time with our merchant retail customers, and that market seems to be picking up.

If you move to slide eight, it cuts the quarter sales by both product and revenue type. I'm going to address the sales revenue type and leave it to Louis to expand upon the product segmentations.

The 67% increase in sales and 35% increase in [SNAT] was driven by add-on sales to customers, which is up over 40% year-over-year. Much of this increase came from EMEA customers trying to invest in efficiencies that arise out of the bank consolidations during an active regulatory environment. And of course, our terminal business is strong, and people and customers committed to multi-year agreements.

So overall, we had a great quarter. Even though there's a lot of talk of the lending market being constrained, the payments business offers a growing opportunity. And this opportunity is customers being interested in consolidating and upgrading their payment environments to drive efficiencies and offer new services. As a result, we continue to see healthy sales opportunities in our geos and many solutions for us for the rest of the year. So I've said before on this call, our pipeline is very strong.

So I'm going to turn this back to Louis, who will add his thoughts on the product segmentation of sales as well as to discuss the recent regulatory changes in the US and what they think it -- how it applies to our business. I'll remain on for Q&A. Thanks, Louis.

Thanks, Ralph. I'll add just a few product-oriented comments. In looking at our business by product, clearly our largest growth segment remained our retail payment segment as customers continue their march for efficiency, which drives consolidation. The growth of our managed category was further bolstered by the fact that some of our competitors have turned their backs on the high-value payments market, and our customers have come to us for product to migrate to our proven technology.

There was also a healthy increase in the operator application and tools category as well, which was propelled by the tools element of the FDC deal as well as by tools being included in a significant contract renewal at a consortium switch in Canada. There were other tool sales across the geographies to both banks, as well as to major retailers, in the United States.

If you'll join me on the next slide, I'd just like to share a few thoughts with you regarding recent market trends, including regulatory change. In terms of the payments market, we believe that customers are still seeing a need for efficiencies, and I think that the First Data deal is emblematic of this focus. Our unique agile payment strategy focuses us as a company on the delivery of the most unified payment system in the marketplace.

The resulting integrated breadth of the strategies exploited by our customers to consolidate their systems and reap the benefits of reducing costs associated with the installing and deploying, configuring, running, and migrating of the payment systems. Each one of these stages in the lifecycle of payment systems provides an opportunity for our customers to deliver their products at a lower cost to their customers, freeing up their resources to invest in getting new payment services to market. And that's really what we're experiencing in the market.

In terms of regulatory trends, most of you know that the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 became law in July. Although the bill is extensive, the part of the legislation changes that are most relevant to our business concerns a provision added to the Dodd-Frank bill that focuses on interchange fees for debit card transactions and increasing competition in the payments processing, known as the Durbin amendment. This legislation applies to card issuers with over $10 billion in assets, which is approximately the top 80 banks in the US.

The legislation states that the issuers would have to charge debit card swipe fees that are reasonable and proportional to the actual cost of processing the transaction. And almost everyone, observers and experts alike, agree that reasonable and proportional means less. So additionally, and I think important, the legislation empowers the Federal Reserve to intervene in the establishment of these interchange fee rates through -- although they have no authority to actually set the ongoing rates. The Fed has not established any of the new rates yet. Research is still being done, and final results are anticipated in Q2 of 2011.

Interchange fees in the US will be set on a cost basis, and most experts agree that, as they set that on a cost basis, and since it means less, revenues and margins will decline as it relates to this revenue stream. As I mentioned, the fees will be set based on this cost model, and the legislation disallows fraud prevention and resolution to be included in the cost structure, although detection is allowed in the cost structure. This may result in a more aggressive increase of PIN debit transactions in an attempt to decrease the financial crimes prevention costs in their cost calculations.

As in all cases of significant change, there is an opportunity for those that react ahead of the competition. We expect the possibility of the following effects on our product line. This should accelerate plans for banks to become more efficient and invest in projects that will enable them to keep their payment processing capabilities under their own control. If they want to protect the profitability of their debit card platforms, they'll need to consolidate redundant platforms, move to newer, more open platforms, invest to reduce fraud, and maybe even seek to bring their portfolios in-house to create a better cost per transaction structure.

Since we support the processors, as well as those financial service customers that are unable to gain the efficiencies to remain competitive, we'll outsource to our other customers, set the processors, resulting in the same or increased business for ACI. ACI does enjoy a disproportionate percentage of PIN debit transactions. Thus, if the decline in signature transaction volumes drives a higher than forecasted volume of PIN transactions, we could receive increased capacity fees over current forecasts.

Additionally, in order to get higher margins on safer PIN debit product, banks may begin to mandate the adoption of EMV technologies and introduce a chip-and-PIN model much like that which was introduced in the UK. ACI understood the growing importance of EMV, and we would be well positioned to sell the end-to-end infrastructure required by banks to implement EMV because we recently introduced a product for this purpose called ACI Token Management.

In summary, we do have exposure to signature debit as our solutions sit in the authorization path for most of the big signature debit card issuers. However, any drop there should be offset by the cost pressure upon banks, who in turn will need to drive further cost efficiencies in their retail payment infrastructures as well as by new product opportunities and PIN debit increases.

While we're exposed to US regulatory changes, more than 60% of our business revenue is derived internationally and in faster growing markets, so we feel pretty good about both the upgrades that will be necessary in the US, the new product opportunities that should result, as well as the general growth in a less regulated card market abroad.

At this point, I'd like to -- that concludes my prepared remarks, and I'd like to turn it over to Scott to address the financial performance in the quarter. Scott, please go ahead.

Great. Thanks, Louis, and good morning, everyone. I'll be starting my comments on slide 11 with key takeaways from the quarter, starting first with revenues. We are very pleased with our growth in recurring revenue of more than $12 million, or about 20% compared to the prior year quarter. Overall revenues declined, impacted primarily by lower capacity revenue and fewer go-live events compared to the prior year quarter. However, this is really more of a timing issue between quarters.

On sales, Ralph's already done a pretty good job of covering our sales performance for the quarter, so I won't spend too much time on it here. But just to reiterate, we did have strong growth in sales compared to last year, led by the global accounts deal signed with FDC, as well as the more than doubling of new sales, net of term extensions, in our EMEA and Asia-Pacific regions.

We saw strong growth in backlog. This quarter's growth in new sales contributed to a surge of more than $80 million in our 60-month backlog during the quarter. Also of particular note is a $23 million increase in our 12-month backlog. This as we begin to see larger and larger contract values move into our 12-month view.

Turning to slide 12, we saw strong operating free cash flow in the quarter of nearly $27 million, surging $37 million when compared to the prior year quarter, driven on strong cash collection efforts, as well as our continued discipline around our cash expenses. The low operating income, we saw foreign currency losses of $1.5 million compared to foreign currency gains in the prior year quarter, driven obviously by volatility in the FX rates. Our interest rate swap was relatively flat this quarter, and has subsequently expired here in the month of October.

And the last highlight here, we did repurchase more shares in the third quarter, which followed repurchases we made in the first and second quarters. In total, we have purchased a million shares for a total of $19 million in the first nine months of 2010, which leaves us with about $23 million left on our original Board-authorized buyback program. So overall, we saw strong recurring revenue combined with continued cost management. We saw significant growth in sales and backlog, and significant growth in cash flow during the quarter.

Turning to slide 13, this is just our normal depiction of the ratio of revenue derived from backlog versus that portion of revenue derived from current period sales. As you can see, the mix is relatively consistent compared to last year. Obviously, with our continued growth in recurring revenue, we are seeing an uptick in the percentage of revenue that's coming from backlog. And overall, we're just very pleased with our recurring revenue coming out of backlog, which is providing us with a stable, predictable, and solid base of our revenue.

And just the last comment here, looking ahead at the next quarter, we do expect the amount of fourth quarter revenue derived from backlog to continue to be in the 90% range, so we obviously have very good visibility into the fourth quarter's anticipated revenue. And we are comfortable that we will achieve our annual revenue guidance.

Which brings me to my final two slides that look at guidance, both in what we see in the fourth quarter of 2010, as well as some preliminary views of what we're seeing for 2011. So starting on slide 14, we are tracking to be within the range of guidance we laid out in February for our full year 2010, but we are seeing a tightening of that a bit. We had expected revenue to be in a range of 3% to 5%.

From what we're seeing today, we expect revenue growth closer to 3% over last year's full year. The impact of FX fluctuations, relative to where we were when we started the year, has reduced top-line revenue by about $5 million. So really, if not for the impact of FX volatility, we'd obviously be solidly in the range originally provided.

FX also obviously helps us on the expense side, but even with that, we've continued our disciplined expense management and, therefore, anticipate operating income, as well as operating EBITDA, to be at the high end of the ranges that we provided to you in February.

The big mover has really been sales. Originally we had projected sales to be flat with 2009, or about $425 million. Given the closure of the global accounts deal with FDC here in Q3, as well as a few other items, both deals closed here in Q3 as well as the pipeline we're seeing for Q4, we now anticipate sales to be more in the $470 million to $490 million range for the full year.

And the last item here, our cash flows have also come in stronger than expected year-to-date through the third quarter. We achieved operating free cash flow of nearly $35 million, which is really at the -- it's at the low end of what we were expecting for the full year. Our original implied guidance was in the $35 million to $38 million range. So obviously, with one quarter to go, we are expecting to exceed our earlier projections for cash flow.

And so finally, on slide 15, it's still alluded to, is some of our visibility into 2011. As our business grows in a more stable and recurring fashion, our revenue growth has become more predictable. That coupled with our continued stable expenses, we have a pretty good visibility into what we're expecting for the full year 2011.

So following up on what we expect to be a record sales year for us here in 2010, we are expecting 2011 sales to also come in in the high $400 million range. We expect revenue growth to be in the mid-single digits over our expected full year 2010. We expect backlog growth in the high single digits, which represents our continued focus on selling new and in building our long-term economic value.

We expect operating income to grow in the 20% range for 2011, which follows on top of the 20% operating income growth that we're expecting here in 2010. Operating EBITDA should grow in the mid-teens, and cash growth we expect to trend in line with our growth in operating income. This really continues our trend of layering on incremental revenue from new customer go-live events and the incremental benefit of renewing existing customer contracts really with better economics, and our cross-selling opportunities, all while maintaining our strong expense discipline.

So with that, we'll obviously provide a more detailed guidance with specific ranges when we talk in February during the fourth quarter call, but this should give you pretty good visibility into what we're seeing for the coming year.

So with that, that concludes my prepared remarks. Operator, we are ready to open the line to questions at this time.

(Operator instructions.) George Sutton with Craig-Hallum.

Good morning, everybody. One question for Phil, and then one question for Ralph, if I could.

Phil, you had mentioned, with respect to the FDC deal, that those kinds of transactions are out there to be had. And I wanted to make sure I understood kind of the relevance of that statement. And as we look into 2011, are you assuming another size transaction like that in that high $400 million sales range?

And then for Ralph, would be very interested in your thoughts coming out of Sibos. I've heard that there's quite a bit of activity this year relative to last year, or two years ago. But I want to get a sense of what you're seeing there in a little more detail. Thanks.

My answer is straightforward, George - no. We will continue to not forecast mega. To the extent there are mega-deals, we are not going to commit to mega-deals in our forecast.

John Kraft with D.A. Davidson.

Go ahead, guys, finish that thought.

Ralph?

Yes?

Did -- you heard the Sibos question?

Yes. So, George, we've been really, really busy here at Sibos. I actually had lunch with one of the Board members at Sibos, and said it's - their attendance is at an all-time high, almost 9,000 bankers here attending this global conference. And we've had over 100 meetings with customers.

So the themes are really consistent, as what I was mentioning earlier, just around the consolidation of different payment systems, because there's a lot of inefficiencies out there that they'd like to take advantage of. And our experience, our depth of products, really makes us a real strong candidate for a lot of these large global banks. So I just feel really good about the position we've put ourselves in with a lot of the customers right now.

So John's on.

I think I'm on, yes. It's John Kraft from Davidson. Congrats on the monster bookings quarter, guys.

Thanks, John.

Thanks.

I guess the first question is some of the visibility. Can you talk a bit about what causes a go-live event to get delayed and why and where this confidence is coming in that those events are going to occur in Q4?

Well -- this is Scott. It's not just -- I wouldn't say that the ramp-up between Q3 and Q4 is not just go-live events. There's a number of events, including the annual license fees. Some of our hosting revenue, for example, I think earlier in the year we'd indicated was being deferred for a period of time while we installed some incremental functionality and delivered some more services. So we'd had a revenue stream that had really been abated for a period of time. That's coming back online, and a bit of a catch-up, as well.

But in terms of any time in any quarter when we are projecting go-live events, it's really based on the stage of the project. And so that is just one element of what's driving fourth quarter revenues. But again, as I said in my prepared remarks, that we're looking at -- if we were to put out a three-month backlog, we are essentially starting the fourth quarter with 90% of what we're expected to recognize here in the fourth quarter. The remaining 10% will come from sales, and that's -- that conversion of sales to revenue is pretty consistent in line with what our recent experience has been.

Okay, that helps. Thanks, guys. How about the implementation timeline for First Data? How long is that going to take?

Well, right now this is not a -- this is a -- it's a renewal and it's expanded contract, so right now there aren't any implementations associated with the FDC deal. It is a renewal with increased value. So there isn't anything currently contracted in terms of implementations. So there is no revenue deferral, for example, on the contract we signed.

Yes. So to the extent we do service work for them, that service work is not in this contract. And that would be discussed and contracted later in the contract -- later in the relationship cycle.

Gil Luria with Wedbush Securities.

Morning, guys.

Morning, Gil.

In your -- so by reiterating your annual guidance and tightening it, you've given us fourth quarter guidance, and I wanted to go through that a little bit. So I think what's implied by 3% revenue growth year-over-year is $140 million of revenue in Q4. And I wanted to get a sense, kind of to follow up on a previous question, how much of that do you have visibility into? How much of that could slip -- as go-lives, slip into Q1? How much of that $140 million could get into - could slip into Q1 of next year?

Well, I think you've got issues going both ways. I mean, they could be projects that are in this year that could slip, or projects we could pull forward. There's some on the bubble. But we're pretty comfortable with the amount that we have included in three-month backlog that will be recognized in the fourth quarter. So I would say we have visibility into the full amount of backlog, and we have pretty strong visibility into the 10% that we're expected to close in new sales deals and convert to revenue before the end of the year.

And then, on the operating expense front, was the commission on the First Data deal paid in the third quarter?

Yes.

Yes.

And yet operating expenses were less than $90 million even with the very large bookings quarter. So then, why would we think that operating expenses would be higher than $90 million in the fourth quarter?

I'm going to let Scott answer this after me, but we said that our revenues are lower because of FX, and our expenses are lower as a result of FX. Part of this answer is that, if our FX had been higher, right, the expenses would have been more prominent. So we lose on both sides of the -- we lose on both sides of the equation.

But yes, the single -- I would say the single biggest driver of expense change from Q3 to what we're expecting for Q4 is going to be the cost that we've deferred on the projects that will go live in the fourth quarter. So it's going from a quarter in which we've had a net deferral of project cost to a quarter in which we'll have a net recognition of project cost. And that really goes in line with the go-live revenue. So it's not an indication of a higher level of spend. It's really -- it's costs that are really tied to that go-live revenue.

Brett Huff with Stephens.

Good morning.

Morning, Brett.

Just a couple follow-up questions. Do you have any sense for -- you mentioned sort of the 10% sales that isn't going to come from backlog in 4Q. Now that we're almost a month into 4Q, has any of that 10% already closed that you expect to see?

Well, we've had deals close here in October, so yes. But, I mean, we're talking about if you -- as you recall, our sales cycle is fairly lengthy. So, you know, when we project sales for the fourth quarter, it's based on really late-stage contracting of deals.

Okay. And then, when you think about your revenue growth for '11 in sort of mid-single digits, and I'll take that to be 5%, what kind of assumptions does that make in terms of capacity renewals and sort of the trends that you've seen over time? Is there any changes in assumptions versus what you've seen in the past? And I know, Phil, you said that's excluding the big global deals, which is great, but is there anything else that we need to know about on that 5% as you're thinking about '11?

Well, I'll let Scott, again, answer it, but it'll be the fifth year of going through five years of hell of restructuring our business from pay up front to an annuity structure, which is showing up in our recurring revenue. So we do have one last year of that. But that says it's the same as the last four years, not different than the last four years. So again, we're assuming very low conversion of sales to revenue from the current year and strong sales and strong build of backlog, and continued efficiency in the business which allows us to still produce the 20% growth in earnings and book future value into backlog at the same time.

Yes. And just to add to that, I mean, it's just -- really, it's layering on -- it's another year of layering on incremental revenue that we're getting from projects that will go live this year, so new customers. And it's also the effects of the existing customer renewals at better economics and cross-selling opportunities. So it's really layering that incremental revenue stream on top of a relatively fixed cost base, and that's where we're getting a margin improvement that's a multiple of the revenue growth.

Tom McCrohan with Janney.

Thanks. Just a question on phasing, and then a follow-up. The phasing of cash flow, should we expect that to be consistent with the phasing of revenues, i.e. a strong fourth quarter?

Are you talking about 2011?

No, I'm talking about the upcoming quarter.

No. I mean, we're expecting incremental cash, but we did have -- we've had a strong Q3, and so we've already essentially hit where we thought we'd be for the full year. And so I'm expecting incremental cash in the fourth quarter, but not to the magnitude, obviously, of what we saw here in the third quarter.

The two main drivers -- the two main drivers of why we're doing better in cash are we're doing better in sales, right? And then you're seeing the -- on a year-to-year basis, we're up $35 million in deferred revenue. Deferred revenue still drives -- deferred revenue drives cash even though it doesn't put cash -- doesn't put current [period] revenue on the table. And then, expense efficiencies is the other piece.

Okay. and there was a -- one of the prepared comments in Scott's presentation was that cash flow should kind of grow, should be consistent with operating income growth, so that's the only reason I asked.

Oh, yes. That's in reference to 2011. Yes, we are expecting cash flow to grow consistent with our expectations for operating income, yes.

Okay, so the phasing this year is a little off? Is that the way to think about it?

No. I mean, phasing -- this year -- on a year-to-year basis, that's why we don't guide to cash necessarily, because cash -- you can have a customer pay a significant -- whether it's annual maintenance or annual license fees at the end of a month or beginning of the next, and it really -- it can really change the dynamics of the cash flow, but it really doesn't change the underlying economics or the quality of, say, our AR or cash flow.

So I would say that we really haven't projected any sort of phasing of that cash next year. It's really driven off kind of the bottoms-up view of the growth, whether the drivers of cash, both cash received as well as cash outflow. So really, the only thing is that, on an annual view, seeing it grow next year consistent with the growth in operating income, or really following operating income growth.

So I think we're actually saying the same -- I think we're all saying the same thing. It relates more to sales performance and operating income performance than it does to revenue performance -- than just pure revenue performance.

(Operator instructions.) And there appears to be no further questions. I'll turn the call back over to Ms. Tamar Gerber.

Thanks, Steve. Thank you, everybody, for joining us. And if you have any follow-up questions, please call me directly. And we look forward to speaking with you at our year-end call. Bye.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.