ACI Worldwide, Inc. (ACIW) Q3 2014 Earnings Report, Transcript and Summary

Good morning. My name is Candace, and I will be your conference operator today. At this time, I would like to welcome everyone to the ACI Worldwide Reports Third Quarter Earnings Conference Call. [Operator Instructions] Thank you. I'd now like to turn the call over to Mr. John Kraft, Vice President of Investor Relations. You may begin.

Thank you, Candace, and good morning, everybody. Today's call, like all of our events, is subject to both Safe Harbor and forward-looking statements. You can find the full text of both statements on the first and final pages of our presentation deck today, a copy of which is available on our website, as well as with the SEC. On this morning's call is Phil Heasley, our CEO; and Scott Behrens, our CFO. But before I hand it over, I wanted to remind everybody that ACI will be hosting an Analyst Event in Naples, Florida, in the morning of November 12. With that, I'd like to turn the call over to Phil.

Thanks, John. Good morning, everybody. ACI, as a team, continues to be steadfast on our focus of positioning the company for long-term growth. Quarter 3 was another step forward in ACI's strategic evolution from a disparate and professional service-dependent vendor to a fully integrated product-based software company. Nobody now questions that the payment landscape is facing significant change, both from the regulation as well as disruptive technologies. As you may know, ACI has been preparing for these changes over the last several years, from the actual payment vision, the illumination of the economics beyond favorable paid up discounting, the conversion of sizable amount of perpetual licenses to recurring subscription-based contracts, the completion of the Universal Payments Platform that unified financial silos and technology platforms. ACI is delivering the platform our customers desire and financial models our investors demand, not dissimilar to anti-gross conversion from -- of Intel from a vendor of memory chips to a dominant player in the microprocessor industry. It takes time, and there are bumps in the road. We are nearing completion of ACI's transformation. As we emerge a high-margin, integrated product-based software company, we are convinced that the market will reward us with material higher valuation. Moving to specific quarterly results. Our sales bookings, net of term extensions, grew 6% in the quarter and were up 22% year-to-date. These strong results set up well for surpassing our guidance of net growth in the upper single digits and provide fuel for accelerated revenue growth in 2015 and beyond. Let me take a moment to highlight a few notable successes in the third quarter. In the U.S., we signed another large hosted online and mobile banking contract. We are clearly seeing a growing preference for banks and retailers to host our traditionally licensed applications in our data center. This shift, in fact, is happening much faster than anticipated, and our hosted net-to-large financial institutions and retailers is up 23% organically year-to-year. We're also seeing better-than-expected bookings in our hosted domestic EBPP segment. The contracts we've signed in the quarter included one of the largest health insurers that purchased an omni-channel billing platform, encompassing call center, Internet and mobile. Also in EBPP, we leveraged both the ORCC and OPAY assets to deepen our relationships with one of the largest counties in the country. In Asia Pacific, we expanded our online banking relationship with a large bank to now include mobile. Also in that market, we signed a large ATM contract with a payment service provider. In EMEA, we contracted with one of the world's largest retailers to provide an omni-channel centralized card payment platform to manage all electronic transactions through all channels, including store, online and mobile. We displaced the longtime incumbent and gained an important reference customer. In quarter 3, our backlog surpassed $4 billion for the first time, providing significant long-term economic value. Importantly, we're progressing with several large and strategic sales, and our pipeline remains at record levels. We expect to discuss some of these opportunities in greater detail during our upcoming Analyst Day. However, we don't think it's prudent to assume all of these deals will be closed by the end of the year. We have moved several large deals out of the year and into 2015. This combined with foreign currency fluctuations are reducing our expectations for our full year revenue. Moving to revenue. While our top line grew 16%, it was below our forecast. Our SaaS subscription and transaction revenue continues to grow, and overall recurring revenue now represents 74% of total revenue. This revenue, combined with our cost discipline, generated EBITDA growth of 7% over the -- over last year and net EBITDA margin of 29%. On August 12, we completed the acquisition of Retail Decisions, or ReD. With ReD, we gained leadership role in the fast-growing fraud prevention and e-commerce space. Together with ReD, ACI offers a truly revolutionary omni-channel retailer payment solution. We have been working hard to finalize several large implementations. 4 of our 5 major implementations projects I've spoken about last year are behind us, with the final 1 expected to be completed by the end of this year. All this will free up constrained resources beyond harvesting our backlog of new projects. In closing, we have been disciplined and focused on our long-term strategy. We remain committed to growing SNET, and we're working hard to become more of a software product company, relying less on nonrecurring low-margin customer implementation services. At mid-year, all prepayment industry dispositioning, as well as our solid sales bookings, set us up extremely well for 2015 and beyond. We believe we are at the beginning of a highly disruptive period in global electronic payment, and we are well positioned to take advantage of it. With that, I will now hand it over to Scott to discuss our financial results and updated guidance in further detail. Thank you.

Thanks, Phil, and good morning, everyone. I first plan to go through the highlights of the third quarter and then provide an update on our outlook for the full year 2014. We will then open the line for questions. I'll be starting my comments on Slide 6, with key takeaways from the quarter. Our new sales bookings were up 6% in the quarter, and our total sales bookings were up 18%. These results contribute to an already very strong year-to-date, where we have grown new sales 22% and total sales 30%. Organically, our new sales bookings have grown 8% year-to-date. And as Phil mentioned, we are seeing a faster-than-anticipated shift in our mix of hosted versus licensed software sales, with hosted new sales bookings to our large financial institutions and retailers up 23% organically over the prior year period. This is driven by high demand for cloud-based solutions. The impact of this shift results in lower nonrecurring license and software revenue streams in the near term, offset by higher recurring ratable hosted revenue streams over the next 5 years. In addition, we've also seen a shift in sales mix to higher new account and new application sales, where we've seen growth of 63% year-to-date. These sales bookings require time to install, thus, reducing near-term revenue, but contributing to our backlog and will be recognized in future periods. Moving to backlog. Our 12-month backlog grew to $898 million, and our 60-month backlog grew to $4.1 billion, both new records for us. The acquisition of ReD contributed $42 million and $205 million to 12-month and 60-month backlog, respectively. Excluding this addition and adjusting for foreign currency fluctuation, our 12-month backlog decreased $22 million from last quarter, and our 60-month backlog increased $25 million. Our non-GAAP revenue grew 16% compared to the prior year quarter. Excluding the incremental contribution from Official Payments and ReD, organic revenue was essentially flat with the prior year quarter, impacted by both foreign currency headwinds compared to the same period in 2013 and also the shift in sales mix and slower sales to revenue conversion, that I discussed previously. Overall, recurring revenue grew to $186 million in the quarter and represented 74% of total revenue. And on a year-to-date basis, recurring revenue was $562 million and represented 77% of total revenue, compared to the same period last year. We continue to see increases in our recurring revenue streams, offset by declines in nonrecurring revenue streams. And as we continue our transition, we expect these trends to continue. Turning next to Slide 7. Our operating expense growth, compared to the prior quarter, was primarily driven by the inclusion of OPAY and ReD operations. On an organic basis, operating expenses were up approximately 2%. Turning next to Slide 8. We delivered EBITDA of $66 million, up 7%, compared to the prior year quarter. Our operating free cash flow of $18 million decreased from $27 million last year, primarily due to the timing of CapEx year-over-year. And we ended the quarter with $60 million of cash and $946 million in debt. And lastly, on Slide 9, we are updating our 2014 financial guidance. We now expect our non-GAAP revenue to be in a range of $1.025 billion to $1.045 billion, which is down from a range of $1.078 billion to $1.098 billion. And I'd categorize this reduction really in the 3 buckets. $10 million of this change is directly related to unfavorable fluctuations in foreign currency exchange rates, which will impact our top line revenue but is neutral to margins, as we also see a decline in our foreign currency-denominated expenses. About $20 million of the decline is due to several deals that Phil talked about, that we have pushed out of the year and into 2015. And the remaining $20 million is a result of the faster-than-anticipated shift in our business model to a higher mix of hosted sales versus licensed software sales, whereby revenue is recognized more ratable over time versus near-term recognition, as well as a higher mix of new account and new application sales, which have an installation time lag between sales and revenue recognition, as compared to add-on sales that have a more immediate and near-term revenue recognition. Our EBITDA for 2014 is now expected to be in the range of $265 million to $275 million, down from a range of between $294 million to $304 million. And lastly, as Phil mentioned, our sales bookings growth is expected to be in the double digits, up from the prior high single-digit growth guidance, which will set us up well for 2015 and beyond. So that concludes my prepared remarks. Operator, we are ready to open up the line for questions at this time.

[Operator Instructions] And your first question comes from Brett Huff with Stephens Inc.

So 2 quick questions. One, just to dig in a little bit on the several deals, and I don't know if this is a better question for Phil or Scott. But -- so $20 million of the guide down, and it sounds like some of the rev coming in the low end of the rev range in 3Q was a result of that. Can you -- or just give us more color on those? Are these -- you mentioned in the press release that there was more complexity, because of a larger mix of a kind of getting into the deals. Can you give us just more color on that $20 million of rev decline, specific ideas and deals?

Yes, I will, and maybe Scott will follow up on it. A very, very good news is up this year. We're probably going to do twice as much sales, as we guided to you guys, too, at the beginning of the year. And it's hitting us in a couple of different ways that are great for value. They're not great for current period. One is that we're bogged down in a proof of concept. These are our biggest customers, and it's restructuring our biggest relationships with our biggest customers. We -- if we -- one of these -- if we got one of our very largest customers over the threshold by the end of the year, I think that will be a great success. I think number two will be a lot easier to get done than number one. And then I think number three will be easier than number two. But these require us -- these conversions now incorporate Classic into eps, and we have a combined environment and software accounting being what it is, the smaller deals that we have booked have actually deferred revenue that we were earning on the Classic deals to later -- to be earned later on. So our -- even though our recurring revenues have gone up, we've had to defer some of our recurring revenues to completion of these -- till the eps up projects are completed and whatnot. And they're -- so the combination of the POC and the reworking of the combined contract, they're much larger, bigger, much, much more volumes because the banks are using them for a much broader set of activities than they previously were using them for. It's creating more complexity than we thought. And we thought it was going to be in a much more orderly fashion, to tell you the truth. And I think our friends at Apple actually really helped us make up much more of a reality and get people moving a lot quicker. And a little aside, we can't give names and whatnot, but an awful lot of the functional Apple Pay that's working in the world has -- is powered by ACI Technology. And that ended up being a little bit of a diversion during the quarter and for the end of the year. So that's the big contract piece of it. And we've just basically taken out 3 of the big deals and said they're probably not going to happen this year.

Yes. The only thing I would add to that, Brett, is really, based on where we're at today, we thought it was prudent to take those out and push them into next year. Obviously, the bigger these deals are, the more time and complexity it'll be in terms of getting them closed. And we felt from where we sit today here at the end of October, it was most prudent to push those into 2015.

Okay. And the second question is sort of related, I think, just talking about the other piece of the $20 million, the shift from hosted to licensed faster. I think I understand both the mix of higher new account and new app versus -- that require installations. And therefore, delayed revenue versus just immediate sort of cross-sales, I guess, if you will. Is there -- is this a renewal problem? Or is it a more -- is it different from that or more complicated? Can you just give us -- again, dig in on that a little bit?

Well, no, I mean...

Instead of -- let's put it this way. Instead of -- if you look year-to-year, you'll actually see it in one of the pages. Instead of buying more of the same and having immediate, buying more capacity, buying more of the same, what you're seeing is that they had Classic and now they're buying eps, or they have whatever and they're buying something new. Instead of getting immediate revenue recognition, you're getting delayed revenue recognition. Or they're buying something new and they want us to host it, and there's no revenue recognition on that until it is actually hosted, including any kind of services because we have to absorb the services till we host it.

Yes. Just to add to that, it's absolutely not a renewal problem. Our term extensions are actually up, term extension bookings actually are pretty strong over the last year. And ultimately, you can be a victim of your own success when you're trying to cross-sell multiple products and trying to get net new customers. It's a very good value in those sales bookings. But the time to install, anytime you sell a new product versus more of an existing product and/or trying install a net new customer, it just takes more time. So that's really the conversion mix issue on that piece.

And your next question comes from George Sutton with Craig-Hallum.

Phil, kind of a big picture question. But as I speak with bank CIOs, I hear pretty consistent themes. We need to get mobile right, and it's shifting very quickly and I need to be able to handle payment risk. When we talk to retailers, we hear they just want a bigger piece of the payment pie, and they're obviously concerned about risk. In that context, can you talk about the acquisition of ReD? Can you talk about the deal timing that we're talking about here and how those things might be influencing that deal timing?

What we are finding out, and this is true around the world, not just in the U.S., is that we've been saying for a long time that in order to really have a highly functional mobile strategy, that they should really be funneling their mobile and through their online and not having their mobile side-by-side with their online. What's happening with a lot of our customers, and we mentioned one of them in my notes to you, was that those who I would kind of thought that -- territories in the bank and all that other kind of stuff, where they were building them side-by-side, their ability to manage the fraud and their ability to kind of manage innovation and whatnot was -- they weren't able to kind of keep up with a very, very fast-changing world. Now what a lot of them are doing is they're backing up and they're building their mobile through their online, right, so that it's the same level of service. The retailers are stuck with exactly this same conundrum in terms of the retailers need your shopping experience by phone, in person, online and mobile to be the same. And the fraudsters were being -- were beginning to figure out, you read the newspapers, that you buy it one way, you pick up another way and/or you defraud the company through the 2 different channels and whatnot. And ReD, we owned -- there's a very great technology that came out of Brown University called PRISM. And we had half of that technology, and ReD had the other half of that technology. And bringing that technology together was symbiotic. One-on-one was more than 2 in terms of that. So one of the reasons we want ReD was we wanted to bring the same technology together versus disparate technology. And they have done a lot of smart things with the technology on the retail side and not that much on the financial services side. We had done a lot of smart things on the bank side, and we hadn't done as much smart stuff on the retail side and, certainly, the card-not-present side. And the combination of the 2 really makes a powerful offering and -- in a lot of markets both ways, right? ReD has built a pretty good -- is in the process of building a good consortium business on the retailers' side and in some markets, combined retailer bank side. So that's a complex -- that's a powerful piece of our business. There's not a lot of ReD results in these numbers yet, but ReD has a very good pipeline and it has very good symbiosis for what we're doing in our PRM. And very quickly, we're not going to be able to tell the difference. Just like I said, they're even the same technology.

And as my follow-up, relative to the retailer-bank relationship, can you give us an update on your direct connection opportunity? And then if you could put it in the context of what MCX is trying to do, that would be helpful.

Well, sure. I mean, direct connections is -- we're an arms merchant. So I mean, we're willing to help anyone do whatever kind of things that they want to do. I think Apple -- I said Apple is really kind of spurred. Apple has kind of moved the point of sale from -- on the cash register, the countertop to -- it can be any place in the store you want or it can be right in the per serve or pocket of the consumer, right? So the concept of being able to directly connect is -- there's a whole new validation point in terms of how you do it because if you now have an independent point-of-sale device, the number of permutations and whatnot, which could do direct connections, becomes really huge. But now that banks -- the banks don't have proprietary -- the bank's relationship with the retailers is more through treasury management, at this point than it is through the ownership with Visa, MasterCard, whatever. They have more reasons to work together as partners, where they were kind of odd in terms of interchange rates and those kinds of things and whatnot. And there's a lot of reasons for there to be logical direct connections because on one hand, you can really lessen both sides of fraud, right? That's just -- that's kind of a low-level kind of value. But on the other side, you can do in high-share areas or in high-share situations, or you can do an awful lot that you couldn't do before. A simple way of thinking about direct connections is how well the guys like Macy's and everyone else is going back directly into the card business, right, because the -- it's a 40-memo direct connection with the consumer that we haven't seen since the hyperinflation of the '70s. And that's actually kind of a simple little model that shows -- that you can eliminate an awful lot of the intermediaries if you want to, right, in order to create a much more efficient straight forward thought. I would say that the critical mass -- and probably talk a lot more after 2020 and talk when we do the -- when we have our Analyst Meeting next week. But the critical mass or the interest in direct connections is very, very strong at this point, because it's logical. It's just logical at this point. So it's going to permeate itself and lots of -- as many ways that people can think about it, it's going to happen. And we're willing to -- we have no dog in -- we have no -- we really have no horse in the race, other than we're willing to lend our technology to whoever wants to use it.

Lend with a fee?

Yes. Well, yes, with a fee but a reasonable fee. I would say one last -- I'm sorry, before we go to the next question, another way of thinking about that, you want to think about direct connections or think about first cousins. The 21 countries are rethinking how ACH works, formally rethinking how ACH works, right? They have Faster Payments. And what they are all really thinking is how to build national debit systems that move ACH in a point-to-point basis that's much more logical and don't have all these tollbooths and gateways and whatnot, and it's a level playing field for everyone. So it's really a very, very global thing. And there's 21 countries that are actively working on it. And good -- really good-sized countries that are doing it. The U.S. being somewhat kind of a little bit behind, but involved. They're one of the 21.

And your next question comes from Wayne Johnson with Raymond James. Wayne Johnson - Raymond James & Associates, Inc., Research Division: So a couple of questions here. Could you give us an update as far as the software sales, to the extent that there are any for BASE24-eps? Can you talk about the pricing environment for those sales?

Well, we don't discuss -- let's put it -- pricing is good, right? I guess, that's all -- we don't discuss pricing. But pricing is very good. We're not in a discounting -- we provide very efficient alternatives to processing and other kinds of costs. So we don't -- we have no need to discount what we're doing with our technology. So our technology pricing is holding very nicely.

Yes, the only thing I'd add to that, Wayne, is really, the value in particular -- really, the value change was with the release of eps 2.0, and its UP capabilities. Many of our largest customers are now looking at a situation where they will -- instead of thinking of migrating from Classic to eps in some instance, they're just going to buy. They want to get to the power of UP and the power of eps 2.0. And so essentially, what they're going to do is buy eps, in addition to what they have in Classic. So we really have a lot of leverage in terms of pricing on it, because of the capabilities that eps has now that Classic doesn't have. Wayne Johnson - Raymond James & Associates, Inc., Research Division: Okay, and that's very helpful. That's -- because that begins to address what my second question was, which is the BASE24 Classic user base. At one point, this is several years ago when eps was just being released, the thought process was that 10 to 20 of these customers could migrate a year. Now with the availability of UP, would you see the uptake of 2.0, eps 2.0, to that BASE24 user base? And if you wouldn't mind adding a little color, do you think that some of these BASE24 Classic users are incentivized to sign up for more of a hosted or SaaS-based solution?

Well, that's actually a good -- that's a great question. Actually one of our -- we've actually begun to bring Classic customers into our hosted environment. So when we talk about bringing hosted customers in, Classic is one of the products that we're bringing in. So yes, that is beginning to happen. The other thing that -- we thought that our customers would convert from Classic to eps. And that was a misnomer, over the last 5 years on our part, because if you look back, we've sold well over 100 eps systems, of which less than 10 of those have been to our Classic customers who have converted over to eps. The vast majority had been to people who had competitive systems. Where we're now selling eps systems are to people who are going to conjointly run them under UP with Classic. And in some cases, we're going to get in situations where people are going to ask us to run Classic or they're going to ask us to run Classic and eps. And once it's in a more balanced situation, they've moved the transactions over to eps that need to be in an open environment, we will give them back the eps, give them back the eps side of the transaction of processing, and we would keep the Classic side of the processing. So that's a very good question.

And your next question comes from Gil Luria with Wedbush Securities.

This is Aaron Turner on for Gil. Just a quick one for me. With the reduction in EBITDA guidance, looks like leverage is now over 3x. Do you guys still feel like you have the capacity for more acquisitions and stock buybacks? What's the plan for things?

We're still generating a tremendous amount of cash. So we're not running out. I think UP is such a big opportunity to us right now, that thrust to run around and look for a big acquisition would be foolish right now. With the UP, if we keep this level of sales going, the last thing I'm going to be doing is going out and buying something. Putting the PRISM technologies together was a once-in-a-lifetime opportunity. We weren't going to let that pass us by. And we still have plenty of -- will be generating plenty of cash to both reduce our leverage and to buy back our stock. So I think that's the way I would think about it.

Yes, the only other thing I'd add to that is, yes, obviously, we have -- even with the bringing down in the guidance, we'll have a strong Q4 cash generation. We obviously have the availability on our revolver. And so we're in a tremendously flexible position, if the opportunity presented itself. And I would just add that we still have $135 million left on our share buyback authorization.

And we have no further questions at this time. I'll turn back the call to our presenters for closing remarks.

Well, thanks, everybody, for joining us. We look forward to seeing many of you November 12. Have a good day.