ACI Worldwide, Inc. (ACIW) Q1 2018 Earnings Report, Transcript and Summary

Good day. My name is Elsa, and I will be your conference operator today. At this time, I would like to welcome everyone to the ACI Worldwide Q1 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer session. [Operator Instructions] Thank you. Mr. John Kraft, you may begin your conference.

Thanks, Elsa, 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 to both statements on our 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. With that, I’d like to turn the call over to Phil.

Thanks, John. Good morning, everyone. I’ll spend the next few minutes providing deeper insight into quarter one. I’ll focus my comments on customer and market trends through the lens of ACI’s two P&Ls, six solutions and four customer segments by sharing wins that highlight our global traction. I will then turn the call over to Scott for the financial review. Jumping right in. I’m pleased to report that ACI is off to a strong start in 2018. Our total bookings increased $82 million, or 44% over quarter one 2017. Organizations across each of our four target customer segments, banks, financial intermediaries, merchants and corporates, continued to select ACI as the trusted provider to power their real-time, any-to-any payment needs. We achieved outstanding new bookings in the first quarter with $215 million, or 142% growth and our 60-month backlog hit an all-time high at $4.4 billion. The new bookings represent more than 25 new logos across our six solution areas. In addition, our pipeline continues to grow and we expect the strong bookings environment to continue throughout 2018. The $215 million in new bookings growth and the $82 million overall growth difference is totally explained by the shape of our renewals 2017 versus 2018. I’ll move now to our two P&Ls. Within our ACI On Demand P&L, we saw a continued momentum for our cloud-based payment solutions. Bookings for our UP Merchant Payments and UP Bill Payment Solutions were particularly strong, validating the investments we made over the last few years in expanding our UP Solutions portfolio, filling out four core data centers and strengthening our cybersecurity capabilities. ACI On Demand segments grew revenue 6% over last year with an 800 basis point improvement in adjusted net EBITDA margin. As I’ve mentioned on past calls, we are targeting the rule of 40 as a yardstick to show progress for the ACI On Demand business. In other words, our revenue growth rate and an EBITDA margin that when added together equates to 40% or better. At maturity, our goal for ACI On Demand business is to achieve a 40% EBITDA margin with mid to high single-digit revenue growth. Our quarter one EBITDA margin improvements were the result of many factors. We’re in the last stages of managing out inefficient revenues. In addition, the completion of our multi-year data center integration included a core focus on improving nonfunctional requirements, such as availability, scalability, capacity and security, has been rewarded by positive revenue growth and an improved customer experience. While there is still plenty of work to be done to attain our revenue and margin targets, progress to date affirms our 2019, 2020 projections. On the renewals side, within our ACI On Premise P&L, we continue our 100% adoption rate for customers renewing in the UP Retail Payments Solution program, or RPS, which bridges customers to our powerful UP technology. RPS continues to drive 25% to 30% total contract value uplift for renewals. We’re taking a similar renewal approach with UP Real-Time Payments Solution launched in quarter four. RTPS allows organizations to address their real-time gross settlement, SWIFT messaging and real-time payment needs with a single universal offering. I’ll now turn to our UP Solution portfolios and underlying R&D initiatives. In Q1, we announced that UP Merchant Payments is now available on the cloud. Based on a multi-tenant architecture, UP Merchant Payments offers the scalability required to meet the channel growth needs of merchants now and into the future. Also, in quarter one, we announced that a suite of processing on fraud monitoring capabilities within UP Retail Payments will support UBI – UPI’s transactions, that’s UnionPay International’s transactions in India. Through our decade-long R&D build, we have now delivered Linux support to five of our six solutions. This initiative reduces the switching and delivery cost for our customers by 75% to 90% per transaction through the massive hardware and middleware savings on running UP with Linux. With this same customer-centric strategy in mind, we are building support for the host versus SQL, a lower-cost, open and modern database option. Pilot projects begin this year with commercial delivery in 2019. Following the quarter four release, the Universal Online Banker, our cloud-based, multi-tenant digital banking solution, we kicked off two customer upgrades and one new customer project in quarter one. Our pipeline for UOB has more than doubled as numerous banks are evaluating ACI to transform their digital engagement strategies. I also want to spotlight continuous advancements in Titanium, our payment intelligence and analytics initiative. Early in quarter one, we completed the deployment of our next-generation streaming analytics engine to all of our fraud customers. These advancements are driving 30% faster performance, higher acceptance rate and lower false positives. We also continue to actively deploy and develop new payment endpoints supporting our any payment, every possibility commitment to the marketplace. I believe that payment providers with connections to the most endpoints and services will win and ACI’s capabilities in this area are unparalleled. ACI uniquely makes fast, simple and secure payments possible around the world by connecting more ways to pay with more payment capabilities than any other provider. Our UP Solutions continue to receive industry accolades. In quarter one, Frost & Sullivan presented ACI with the 2017 European Competitive Strategy Innovation and Leadership Award in the payment systems market. In addition, we received two industry awards for our fraud solution. ACI was named Fraud Innovation Firm of the Year by Finance Monthly and Merchant Payment Ecosystem awarded ACI as the Best ID, Security and Antifraud Solution of the Year. I will now share some of our more significant contracts signed in quarter one. These examples span the globe and a representative of strategic payment opportunities we’re seeing across our four core customer segments. I’ll begin with the Merchant segment with key wins in transportation. We signed a significant contract with one of the world’s largest transportation companies to provide a centralized omni-channel payment platform. With ACI’s UP Merchant Payments Solutions, this France-based railway will be able to move away from a proprietary payment system that is expensive to maintain and enhance. ACI’s support of the nexo standard was the key factor in this win. In another European transportation win, one of the world’s largest travel service providers to the online travel agency selected UP eCommerce payments to provide payment and fraud protection services. We also signed a deal with ATF, a leading national provider of smart transportation solutions that processes more than 50 million photo enforced traffic violations and toll transactions every year. ACI will simplify a complex process of multi-payment touch points. We also gained traction in other merchant subsections – segments, including e-commerce retailers and restaurants. One of the world’s leading sports retailers, already a customer of our UP eCommerce Payment solution selected ACI as its global payments layer to provide flexibility and choice through one integrated solution. In addition, one of the world’s top restaurant brands expanded its relationship with ACI. Our UP Merchant Payments Solution was selected to provide this global brand with data security through point-to-point encryption and tokenization for card-present and card-not-present transactions. Turning now to our bank and financial intermediary segments, we signed a strategic contract with UnionPay International, a leading China-based bank, card company with the world’s largest cardholder base of more than 7 billion cards. UnionPay International is set to grow it’s worldwide footprint significantly by enabling Chinese tourist cardholders to connect to ACI’s extensive global network of payment endpoints. We also signed a contract with OTP Bank Group, one of the largest independent financial service providers in Central and Eastern Europe. Already using UP Retail Payments and UP Payments Risk Management, OTP will now implement ACI’s API manager capabilities and UP Real-Time Payments to power its open banking digital transformation initiative. We also signed UP Retail Payments contract with a major UK bank. ACI was selected to update the bank’s instant payment gateway for UK Faster Payments, as well as create a platform for its global instant payments initiative. Real-time payment momentum is also building in Asia. Following ACI’s selection in quarter four by PayNet to build Malaysia’s real-time retail payment platform, we started signing gateway connector contracts in quarter one. I’ll also highlight one additional customer in the segment, a significant RPS renewal with one of the largest banks in the Nordics. This bank is leveraging RPS to transform its consumer payments business within a country that is well advanced on its journey to become a cashless society. In the Corporate segment, UP Bill Payment was selected to transform the consumer payment experience for several U.S. organizations, including two large insurance companies and one large mortgage provider that services more than 450,000 loans. These organizations chose ACI in order to provide their customer with a wide range of payment service options, customized bill presentation and ensure PCI compliance. In summary, ACI is off to a strong start to 2018 with momentum across our two P&Ls, six solution areas and four customer segments. Our journey of investment in R&D infrastructure had been rewarded with excellent bookings, particularly new bookings. That places us in a strong position to achieve our full-year guidance targets in the fast-evolving electronic payments industry. A sage once told me that nothing worthwhile is easy. During the last few years, we certainly stared in the face of nothing as easy. Portion of that quote, it will be good to cash in on the worthwhile portion through the coming years. With that, I’ll pass the baton to Scott to provide his financial commentary.

Thanks, Phil, and good morning, everyone. I first plan to go through the highlights of the first quarter and then provide an update on our outlook for 2018. We’ll then open the line for questions. I’ll be starting my comments on Slide 6 with key takeaways from the quarter. And just as a reminder, effective January 1, we adopted the new revenue recognition standard, ASC 606, which replaces ASC 605. And as previously disclosed, we’ve adopted the modified retrospective approach and will present our key financial results on both new and the old basis for all of 2018. And for all my prepared comments today, I’ll be discussing our results on a constant GAAP basis. So overall, Q1 was a solid start to the year for us. We had $215 million in new bookings in the first quarter, which is more than double what we booked in Q1 last year and is actually our highest first quarter ever of new bookings. These strong bookings drove a notable increase in our backlog with both our 12-month and 60-month backlog seeing strong growth. Q1 revenue was $225 million, which was above the guidance range we provided in the last quarter with our On Demand business growing 6% over Q1 of last year, offset by lower revenue in our On Premise business. The decline in the On Premise business was due to timing and size of renewal and capacity events in 2018 compared to Q1 2017. Total EBITDA was lower in the quarter compared to the prior year from our On Premise business as a result of the timing of those high-margin license fees that we get on renewal. We expect 2018 to follow a more historic pattern of quarterly phasing of renewal events. Our On Demand business delivered strong growth in EBITDA with net EBITDA margins increasing over 800 basis points, driven by a combination of both revenue growth and lower expenses compared to the same period in 2017. We continue to be very optimistic about future margin improvement opportunities in our On Demand business. We ended the first quarter with $74 million in cash on hand, up from $70 million at the end of 2017, and a debt balance of $689 million, down $7 million from the end of 2017. Our adjusted operating free cash flow for the quarter was $36 million, down from $76 million in Q1 2017, and again, due primarily from the timing and size of renewal and capacity events compared to the same time in Q1 2017. Also of note, during the quarter, S&P Global Ratings raised it’s corporate credit rating on us to a BB from a BB-. And lastly, we have a $200 million remaining on our share buyback authorization. Turning next to Slide 7 with our full-year outlook. With our solid start to the year and in our particular, our strong bookings, we are reiterating our full-year guidance. So starting with our guidance under historical accounting ASC 605, we continue to expect revenue to be in a range of $1.05 billion to $1.075 billion, which represents 3% to 5% growth over 2017. Adjusted EBITDA is expected to be in a range of $270 million to $285 million, which excludes approximately $7 million in significant transaction-related expenses. And we expect to generate between $240 million and $250 million of revenue in the second quarter. Under the new – excuse me, under the new accounting standard, ASC 606, we continue to expect revenue in 2018 to be in a range of $1.03 billion to $1.055 billion, and adjusted EBITDA to be in a range of $255 million to $270 million. And we expect to generate between $230 million and $240 million of revenue in the second quarter. And as a reminder, these accounting changes do not impact our new bookings, which we continue to expect to grow in the low double digits for the full-year 2018, and also our free cash flow is not impacted by the new accounting guidance. We continue to expect our free cash flow to be in a range of $140 million to $155 million for the full-year. That concludes my prepared remarks. Operator, we are ready to open the line for questions at this time.

Thank you. [Operator Instructions] And your first question comes from the line of Brett Huff from Stephens Inc.

Hi, this is Blake on for Brett. Thanks for taking my question. Nice to see the bookings growth. How much of the net new bookings growth, that acceleration, how much of that was maybe just catching up from the fourth quarter that got pushed out versus just a really strong 1Q?

Well, I think, I mean, obviously, at the fourth quarter earnings call, we’ve said we had deals slipped into the new year, had started off strong. I wouldn’t necessarily split our Q1 bookings out between what should be in 2017 and what should be in 2018. But obviously, I think what it shows is that deals were not lost. They were just lost at the time. And so, as I said in my prepared remarks, it’s a record first quarter for us. Obviously, some of that stuff, we wish we would have signed last year. But I think the point of starting off strong is, it doesn’t throw us off track from being able to convert those bookings to revenue this year, regardless of whether they would have been signed at the end of last year or early part of this year.

The fact that we had the GAs coming at the end of last year, the new Linux offerings and whatnot, it doesn’t surprise me that there was a bit of a hiatus in terms of the signings. But what we said was that we had a really – our – in our prepared comments, what we said was that, we had a very strong quarter and we had a – we’re very pleased with the growth in the pipeline. And that’s probably the best way of answering the question.

Great. And then how much of the really strong – the net new bookings, how much of those were BASE24 UP-driven? And we are asking, because last quarter, you noted you had a big bank UP deal you signed, but did not see that on bookings yet. Is that – did that come into the 1Q bookings and then just overall BASE24 UP-driven?

I wouldn’t – I think, we had strong bookings. As Phil said in his script, it really went through each of our solutions. We had strong bookings across all of our categories. I mean, we had a large UP renewal in the quarter. But I wouldn’t say that the UP new bookings was disproportionate to the other solutions. And we really had broad-based bookings growth across all of our six solutions.

Great. Thanks for the time.

And your next question comes from the line of Peter Heckmann from Davidson.

Hey, good morning. It seems like you’re seeing a wider range of merchants – or in that category of merchants with, I think, this is your second large deal with either a transportation or a logistics company. Can you talk about the main drivers there? And does this expand the potential TAM from what you might had been thinking about a couple of years ago?

Yes. Our real specialty is electronic payments. So if you really think about it, there are becoming more and more ways that things can be paid for before you get to the point of purchase. One of our pizza companies now does over 90% of their – of payment settlement at the point of ordering, right? And that’s kind of a good example of the way the world is going. Transportation, we actually – I actually rattled off three major transportation logistics players as signing in the quarter. And every one of them wants their main experience to be basically a card-not-present experience and that they will facilitate someone who shows up with a card. But if you think about it, if you’re going to the train or the movie theater or your car is driving from one lane to another lane, what you want is you want a real-time experience. You want a real-time experience in terms of that taking place. And it’s not only hands off, but it’s mind off what’s actually taking place. And we’ve seen that with our big gaming company partners in terms of kids are on their Game Boy or whatever they’re called and whatnot, and they need to make an immediate purchase, they need a real-time. So our offerings, I would tell you that in our six solution sets of merchants and corporates, it’s hard to differentiate sometimes between corporate and a merchant. But they – I would say that they’re actually moving faster towards real payments than the banks are trying to hold on to their traditional higher-margin pieces and whatnot. And you’re seeing certainly transportation, gaming, food merchants and whatnot thing, fine. We’ll drive the payment decisions and whatnot. And that’s where an awful lot of our signings are coming from, be it transportation, gaming, restaurants or multi-global players that really have to think about the world as the – as their potential customer base and whatnot. So we’re seeing very strong growth there.

Okay. That’s helpful. And then, can you talk a little bit about on the FinTech disruptor side, some of the new payment providers, some of the online payment providers and maybe digital wallets, can you talk about how you’re playing there either supplying technology or how maybe some of those new entrants may have changed the economic about how some of your customers think about in-house versus outsource?

Well, one of our fastest-growing businesses is – one of our fastest-growing offerings is our ability to offer a gateway to anybody who wants that gateway to a multitude of payments. And I’m talking about probably we’re somewhere between 500 and 1,000 choices that someone could come and sign up with us for. I was kind of laughing, because we even allow people to get to bitcoin, right? And of course, we get paid the same little tiny bit as this was approaching anything else. So listening to what one of our competitors was talking about, we’re probably bigger in that business than they are, but we don’t pretend to be in the business. So don’t miss okay. But we give you the ability, that’s why UnionPay International wants connectivity to us and whatnot, as they want the ability to be able to touch virtually hundreds of different endpoints. And we provide them the ability to reach out to that payment type and satisfy their – what they need to accomplish. That’s a very – that is either the fastest or second-fastest category of business that we’re selling right now. It’s one of the smaller at this point, but it’s growing very, very quickly.

Great. And then just a last question and I’ll get back in the queue. But Scott, you had given multi-year EBITDA guidance ranges last quarter. I thought that market responded very positively to that. Can you just at this point confirm or talk about any changes in those longer-term forecast?

Yes. Well, there has been no changes. Obviously, we’re tracking on the full-year 2018, and that’s really the baseline. I think a lot of the profitability improvements that we’re starting to see in our AOD business, those are going to be the ones in part to drive that growth in those outer years. So I think, we’re tracking nicely to executing on those long-term outlooks.

Great. Good to hear. Thanks.

And your next question comes from the line of George Sutton from Craig-Hallum. Mr. George, your line is open/

Yes, thank you. I love how you say my name. So relative to strong bookings that you mentioned you felt were in front of you for 2018, Phil, I wanted to get a little bit more of a sense of what you’re seeing in the pipeline. And I do want to make sure that this is the case, but I don’t believe your guidance includes any elephant. So, obviously, there are some opportunities for significant bookings growth this year?

Yes. Well, the good news on the elephants is that, we’re now on to Page 2 of potential elephants versus – working one page. But no, we can’t. We made the mistake in the past of thinking we could time these really large deals. Quite honestly, if three or four of these deals came and said they wanted to sign next quarter, we’d be in a world of hurt to be able to actually do – to do them all. But those dialogues are progressing very, very well. And we’re now at the point that we’re thinking – we’re making sure that our strategy and our strategic options align to which ones make – not only make the most sense for our potential partners, but which make the most sense for our longer-term planning.

Just to be clear, you’re saying your implementation capabilities would be stretched?

That’s correct, right.

So one other thing you said I found very interesting is 100% of your On Premise customers have adopted RPS, which, if I think about what that means, you’re basically saying you’re seeing zero churn in that part of the business. Is that effective…

Our attrition, I think, we’ve said this many times over. I mean, if any conventional way of rounding attrition would have to be the zero in terms of our RPS business. And what we’ve said is that, we’re running a 100% on renewals. We haven’t – we still have about 2.5 years of…

Yes.

Almost three years of renewals left. But we’ve got a good portion of our largest customers have renewed. And so what this says is that, they’re bridging both technologies and we – we’re continuing to grow on the projects in terms of them figuring out what they attack first or what new opportunity they use first. But no, that continues both at 100% and we’re still getting the 25% to 30% total contract value uplift for those transfers, which basically equates to 5% a year growth, right, on a 5-year contract.

All right. That’s it for me. Thanks, guys.

And your next question comes from the line of David Eller from Wells Fargo.

Good morning, and thanks for taking the questions. Scott, you mentioned that you expected 2018 to have a more similar phasing in terms of renewal that’s in terms of historicals. But in terms of the EBITDA, it looks like Q1 EBITDA looks like it’s probably a smaller proportion of your kind of the midpoint of your guidance? Could you just talk about either the timing or phasing of maybe when you might expect EBITDA earnings to hit this year compared to historical?

Yes. Really, the – yes, I mean, the whole timing there, the license fee on renewal in the On Premise business is all at 100% margin. And so it’s – that has an impact on the On Premise license fees, 100% of that is EBITDA and 100% of it is cash. And so it’s really following the timing of the renewal book this year. And so when that – when those deals renew in the later quarters and it’s typically been a second-half phenomenon, it – that – so too will the margin and cash that comes with that. So it’s really just the timing of the renewal book.

Okay. So when I look at you reiterating your guidance on sales and EBITDA for the year, I guess, what I’m saying is, will EBITDA be much more weighted to not only the back-half of the Q4 of this year than historical periods?

I would say second-half Q3 and Q4. That’s typically where we start seeing a lot of the renewal activity. I mean, again, it’s – this year, in particular, I mean, every year has a different timing of the book, but most of it’s – most of it happens in the second-half.

Gotcha. And then Phil, you say that the – or you mentioned in the script that you were kind of managing through the last stages of inefficient revenues. Could you talk about what ballpark – what inning you’re in and maybe when you expect that to phase out?

I think we’re in the very late innings of it. Couple of three years ago, it – when we were getting rid of payday lenders and subprime, we were expunging our books of those things that are regulated – no, when we are a regulated entity like our banks are, right? When we’re getting rid of that stuff and we’re burning our way through the, I call it, S1 false promises, we have virtually ate up all our growth and looked like we weren’t growing. Now it’s still a – it’s still an offset to our growth and it’s a couple – it’s maybe 1% or 2%. But it’s not like it was – it wasn’t like it was before. So this year, next, we really see it – we’re at the very – maybe, Scott, you should talk to…

No, I think….

…so I think we’re at the very end of the integration – sane integrated – we could have kept some of these businesses that, we have revenue growth, but no EBITDA. And I guess, we’re just too old fashioned. We’d rather not have – we know you’d pay us more for the revenue growth than the EBITDA. But we just don’t see the logic on just keeping businesses for revenue growth that don’t produce value.

Yes. I think, the only thing I’d add to that is, yes, we’ve been managing some attrition from acquired portfolios probably the last four, five years. And we’re – we – so it has been a headwind to our top line growth. We’re probably down to maybe 1% a year in terms of our – it’s still a top line headwind. But yes, we’re probably down to about 1% of revenue a year.

Okay. And then Scott, lastly for me. Your bonds are going to be callable at part in August. And I hope you could provide maybe some color on whether you expect to address those in the near future?

I mean, obviously, we’re aware that the call premium expires here in August, and we’re obviously exploring what our next steps are. But nothing to announce at this point.

All right. Thank you for taking the questions.

And there are no further questions at this time.

Well, thanks, everybody, for dialing in. We look forward to catching up in the coming weeks.