ACI Worldwide, Inc. (ACIW) Q2 2018 Earnings Report, Transcript and Summary

Good day. My name is Karnesia, and I will be your conference operator today. At this time, I would like to welcome everyone to the ACI Worldwide Reports Q2 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. Please limit your question to one question and one follow-up question. [Operator Instructions]. Thank you. I would now like to turn the conference over to Mr. John Kraft. Sir, you may begin.

Thank you, 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 Web site 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 Q2. I’ll focus my comments on customer and market trends by sharing key customer wins that highlight our global traction. I will then turn the call over to Scott for the financial review. So, jumping right in, ACI’s fiscal year is on track. Q2 revenues were in line with guidance and above street consensus. We saw continued strong demand for our UP solutions across all four of our targeted segments of banks, financial intermediaries, merchants and corporations. Around the globe, we signed marquee new contracts as well as renewed strategic relationships. Our implementation book continues to grow. Propelled by a strong first half and robust pipeline, we remain confident in achieving our full year guidance. New bookings in the first half of the year were up 52% over the first half of 2017. Demand for multitenant platform solutions in our ACI On Demand business contributed significantly to this growth. In our ACI On Premise P&L, we continued our 100% adoption rate for customers renewing into the UP Retail Payments Solutions, or RPS, which bridges customers to our powerful UP technology. Additionally, we saw increased demand for real-time payments. In Q2, we signed 14 immediate payment contracts in Southeast Asia, where banks are moving quickly to real-time. I will now share some of the significant contracts signed in Q2. These examples span the globe and are also representative of types of strategic payment opportunities in the second half of 2018 pipeline and across our four customer segments. I’ll start with the merchant segment, which continues to see increased global adoption of cloud-based omni-channel solutions. Merchants are driven to meet customer expectations for anytime, anywhere, any channel payments. Included in the key wins are one of the 10 largest grocery retailers in the U.S., which has more than 350 stores, and which processes 500 million transactions annually. Selected UP Merchant Payments for a leading global health and wellness company is leveraging up eCommerce payments for their gateway and fraud reduction services. They wanted to integrate their current acquired solutions and add additional payments internationally as well as add their U.S. business. At the same time, they acquired ACI’s world-class tools to combat significant customer fraud taking place in Europe. A leading French-based international retail group selected ACI as the strategic partner for all their payments. We are replacing the concentration routing to acquirers and the token part of their business. The largest travel conglomerate in China, representing 22 airline companies, 440 hotels and several online travel agencies, has selected UP eCommerce payments to consolidate all its payment activities together to provide a personalized travel and seamless payment experience for their customers. Moving to the corporate segment, we’re seeing a growing trend among corporates that are increasingly planning to move more of their bill payment infrastructure to the cloud. A study from an independent research firm highlights that 70% of corporations plan to move there bill payments to the cloud. A key trend, which is driving increased interest in ACI’s UP Bill Payment solutions. Key wins include; one of the largest privately held finance companies in the U.S. selected UP Bill Payment solutions to facilitate customer loan payments, as well as continued support of its expansion. A leading U.S.-based software company that provides over a dozen Web and mobile applications for tax filing and related fraud functions is migrating all its divisions to the UP Bill Payment solutions. In the bank and finance intermediaries segments, we closed several major international contracts. Rabobank, a large European bank has selected ACI issuer to modernize the management of its card portfolio business. The solution will allow Rabobank to quickly issue new payment products, including all card types as well as new tokenized payment products. We also signed a contract with JCB, a leader in Japanese payment market, representing 111 million card members and accepted by 30 million merchants. As JCB expands its footprint, UP Merchant Payments will be one of its alternative connection methods to profit its online payments. One of the largest banks in South Africa with significant operations across the continent selected UP Retail Payments to innovate new payment solutions. Its growth in the merchant space was also a key driver of its selection of RPS. A large bank in Southeast Europe has selected UP Retail Payments to address its growing card transaction volumes. One of Canada’s top five banks has adopted a cloud-first strategy with its initial focus on corporate expansion. Its global financial crime management group is utilizing UP Payments Risk Manager for fraud detection in Canada initially and then replacing the other regions, including the Caribbean, Central and South America. East West Bank, a large West Coast bank that operates across 139 locations with a focus on U.S. and greater China selected ACI’s new award-winning Universal Online Banker. The digital marketing solution provides the bank with new UI, open API’s and multi-language functionality, which is key to its growth plans in China and Hong Kong. Looking forward, we continue to be very optimistic about second half of 2018. The major trends I just shared are driving key deals from the second half pipeline. In addition, the impact of open banking and PSD2 continue to be a key driver, particularly in Australia and throughout the European continent. ACI is uniquely positioned to help these customers. And lastly, our customers continue to be very interested in Linux due to the lower total cost of ownership enabled by Linux-based infrastructure. A leading independent professional service company just completed a new evaluation of UP BASE24-eps on Linux. This soon-to-be published report demonstrates that large banks would be able to process 1 billion transactions per month for a significantly lower total cost of ownership, up to 90% improvement. The study also validated that the Linux platform could easily handle the mission critical payment processing needs of very large banks with high-availability, scalability and high-transaction throughput. Further, the evaluation highlighted that the cost savings of deploying Linux could be done in the public cloud. We see this report as significant and we expect Linux to be a key driver of future pipeline growth. In summary, we continue to see momentum across all facets of our business. Our strong first half results position us well going into the second half of 2018. Our healthy pipeline and alignment with key industry trends around the globe puts us in a strong position to achieve our full year guidance targets. To reiterate, I am comfortable and personally excited and optimistic about the second half of the year based on the momentum outlined above. With that, I’ll hand it over to Scott to provide financial commentary. Thank you.

Thanks, Phil, and good morning, everyone. I first plan to go through the highlights of the second quarter and then provide an update on our outlook for the rest of 2018. We’ll then open the line for questions. I’ll be starting my comments on Slide 6 with key takeaways from the quarter. Just as a reminder, effective January 1, we adopted the new revenue recognition standard, ASC 606, which replaces ASC 605. As previously disclosed, we’ll present our key financial results on both the new and old basis for all of 2018. For all my prepared comments, I’ll be discussing our results on a constant GAAP basis. So Q2 was another solid quarter for us with Q2 new bookings of a 127 million, which brings us to year-to-date growth at 52% versus this time last year and we remain on-track to achieve our full year new bookings expectations. Our 12-month backlog grew 5 million, while our 60-month backlog declined 17 million with both figures adjusted for foreign currency fluctuations during the quarter. Q2 revenue was 241 million and within the guidance range we provided in the last quarter. And as a reminder, we expect 2018 to follow a more historical pattern of quarterly phasing of renewal events, which will provide more of our high-margin license fees revenues into the second half of this year. And for those of you modeling out of the new revenue recognition of rule ASC 606, as we get into the second half of this year, the new accounting rules become an optical tailwind versus the headwind we saw in the first half. In the second quarter, we generated 26 million in cash flows from operations or double the 13 million in Q2 last year. We ended the quarter with 59 million in cash and a debt balance of 687 million. And year-to-date, we have repurchased 2.3 million shares for $54 million or an average price of $23.21. And lastly, we have 177 million remaining on our share buyback authorization. Turning next to Slide 7 with our full year outlook. As Phil said, based on our progress for the first half of the year and our optimism about the second half, we are reiterating our 2018 guidance and are generally comfortable with how the consensus estimates are lining up for Q3 and Q4. And also based on our expected revenue profile and cost structure as we exit 2018, we are comfortable reaffirming our longer range outlook for 2019 and 2020 EBITDA. So for the full year 2018 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 on a comparable GAAP basis. Adjusted EBITDA is expected to be in a range of 270 million to 285 million, which excludes approximately 7 million of significant transaction-related expenses. We expect to generate between 235 million and 245 million of revenue in the third quarter. Under the new accounting standard, ASC 606, we continue to expect revenue in 2018 to be between 1.03 billion and 1.055 billion and adjusted EBITDA to be in a range of 255 million to 270 million, which again excludes 7 million of significant transaction-related expenses. And we expect to generate between 230 million and 240 million of revenue in the third quarter. And as a reminder, the new revenue recognition rule do not impact our bookings, which we continue to expect new bookings to grow in the low double digits for the full year 2018. Additionally, our free cash flow is not impacted by the new accounting guidance and we continue to expect our free cash flow to be in a range of 140 million to 155 million for the full year. So that concludes my prepared remarks. Operator, we are ready to open the line for questions at this time.

[Operator Instructions]. Your question comes from George Sutton with Craig-Hallum.

Good morning, guys. Phil, you’re obviously enthusiastic about the second half driven by a pipeline that you see. Obviously we don’t see that detail. Could you just frame that enthusiasm and opportunity for us?

Well, I’m comfortable with the second half for several reasons. One is we did what we said we were going to do in the second quarter. And our whole year is more like most businesses’ quarter because the shape of our delivery is an annual delivery; it’s not a quarterly delivery. So it’s hard for us in any given quarter to be overly enthusiastic by variances that are just driven by timing, by the annual sign up in that year. We’re just really confident. Most of our – we’ve made our revenue numbers this part of the year mostly by over performance in the On Demand side of the business and we’re still waiting for the annual renewals that we know are going to take place and they’re going to take place further on in the year. So a lot of our – all this good news in bookings is coming from new names and new logos and new businesses, not so much associated with the renewals that are going to come in the second part of the year. And this strange new way we’re going to look at revenue under 606, renewals are much more valued or they’re almost over valued in the 606 accounting. So the fact that we are where we are from both the 605 and 606 standpoint, we’re very comfortable. The bookings are coming in very strong and the amount of usage, now we’re a little bit different than other companies, a lot of other companies is that we book and then we implement and then we grow revenue. So one of the reasons we feel confident is that the implementation book continues to grow and we can only implement as fast as we can convert or build for our customers and as fast as they can ramp. So at this point, our revenue is an important driver of EBITDA whereas our expenses are very much constant as they work their way through the year. So yes, there’s no reason not to be very – there’s no reason not to be confident, especially since year-to-date has been largely driven by over performance on the On Demand side of the business.

Perfect. Just one other thing. A recent trade rag named real-time payments as the number one sort of major initiative in the FinTech world. You’re obviously a direct beneficiary and you mentioned 14 new contracts this quarter. Could you just give us a sense of how significant this opportunity should be for you?

Well, I don’t want to get into the forecasting how quickly adoption rates are going. If you look at countries like India, India is forecasting 1 billion transactions a day on their new – it would be the equivalent of [indiscernible] and whatnot. You have to believe in the ramp statistics in terms of getting there and whatnot, because there’s a fraction of those numbers. But I believe particularly Asia, Southwest to Southeast Asia, they are going to bypass the heavy concentration of transactions coming through the credit side and then maturing into the debit side. It’s going to be more on the debit – they’re going to go directly to the debit side of the equation. So we view – I think we view two trends. On average, we are in less than one-seventh $0.01 for transactions in terms of what we do. But we do many, many more – we do more transactions than Visa or MasterCard who tend to earn – tend to process a transaction for what they do, right? We see our volumes coming in very strongly in the next two or three years and we see the revenues, it’s kind of a CAGR gain, because we’re not going to see as big a pop as it moves up the S curve. But as it moves up, we think those numbers – put another way, we think – well, if you look at the German profile and with its low penetration of credit and its high number of transactions per individual, we think Asia is going to look like – and I’m not talking about Japan and we’re really not talking about mainly in China yet, but they’re really not open markets for the rest of – but we’re talking about the rest of Southeast and Southwest Asia. And we think the transaction – we think there’s easily a driver of – driving that 1.1 trillion, 1.2 trillion transactions a year where it’s doubled in the next five years. And we’re going to get our requisite share as long as we keep signing up the people that are adopting it. It’s not a get-rich-quick scheme, because we’re not going to get the volume day one, month one, year one, but we’re going to get the opportunity for the volume.

Perfect. Thank you, Phil. I appreciate it.

Your next question is from David Eller with Wells Fargo.

Good morning and thanks for taking the call. Phil, you called out Australia and Europe as being particularly strong in the quarter and your outlook. Could you also maybe touch on the U.S. and North America and what you’re seeing here?

I think most of – we’re doing very well on the renewal side of the business. We’re running at a 100%. People are embracing the new technology. We are the migration path. I think most of our opportunity in terms of big growth opportunity is more in front of us versus renewal opportunity, which is right on us. And the reason I say that is that it doesn’t look – we’re beginning to see the non-renewal customers. We’re beginning to see a lot of new business from FinTech and other type players that are seeing a very different cost of entry, right, especially in the Linux environment and whatnot. And we’re – the banks are still concentrated on profitability and showing you guys their revenue growth every quarter. We’re not seeing the heavy non-regulatory investment. We see dialogue on it and the Canadian banks are certainly, I would say investment is stronger in the Canadian banks than it is in the U.S. and of course at least one of those bridges both countries and whatnot, but we think most of our opportunity is in front of us on the financial segment. On merchants and corporates, Europe is moving much quicker from a merchant standpoint than the U.S. is, but we’re getting some – we’re getting a lot of e-tailing from the U.S. and a lot of interest in pure multi-channels from the start, kinds of players. So that’s very positive. And our financial intermediary business in the U.S. is doing very well, mostly based on incremental volume that they are acquiring and pushing through us.

Great. And then, Scott, on the – you kind of reiterated your 2019 and 2020 goals. I think for 2019 EBITDA, your range was like 300 to 315. That midpoint would be like 17% growth for next year and I think consensus is looking for 4% to 5% revenue growth. So can you help us maybe understand some of your assumptions around margin improvement for 2019 and maybe 2020 as well?

I think that there’s really I would say two drivers and a lot of its driven by our path to – our rule of 40 that we talked about in our AOD business. Really it’s based on the profile of combinations of two things. Its revenue growth on top of that cost structure but also lower costs as we exit 2018. We’ve talked in the past about a lot of the heavy investments we’ve made in building out that infrastructure, whether it’s physical, virtual, cyber-security. And so it’s really a combination of both, higher revenue as well as lower-cost as we exit 2018.

Great. And then last call for me, I know your bond call price drops to par in August. Can you maybe talk about your thoughts around your capital structure? And then if you could remind us maybe your target leverage and what considerations go into that leverage target?

Well, I think we’ve historically said that we’re kind of comfortable around, call it that 2.5x. And if you look historically when we’ve done acquisitions, we’ve sort of – you’d see a step up in leverage. It is part of the acquisition, but then we quickly delever from there. So we’re comfortable with 2.5. We’re also comfortable with the right cash flow structure, we would acquire something that we’d be able to – on a combination be able to bring that down. In terms of our bonds, yes, we’re aware that we’re coming up on the five year and the expiration of these call premium. The market conditions are certainly favorable for us to get in and refinance those. So we’re keeping an eye on that.

All right. Thanks for taking the questions.

Your next question is from Peter Heckmann with Davidson.

Hi, guys. This is Alexis on for Pete today. So first, I’m just hoping you can comment a little more on the year-to-date eCommerce wins within the merchant space and specifically some of the factors that are helping drive merchants to decide to take some of this payment capability in-house?

Well, I really think there is two behaviors going on in the e-retailers. I think you have one set of customers who say, my top five priorities are A through E and payments is not one of them. And they’re more than likely to go to a full solution provider like Avion or Global Payments or Paymentech and say listen, we’re not doing it as the top of the – top five priority and whatnot. Then you have other ones who deal – they have good global volume around the world. They’re thinking about it from a global standpoint. They’ve got to figure out how to do global logistics execution from a delivery standpoint. So the whole concept of managing an integrated step of [ph] logistics and managing the cash, there is a huge – there’s huge benefit for them to leverage that capability and be able to drive yield and liquidity from it. And we tend to do very well with those companies. The other ones that are a driving factor which is kind of a new one, but it’s a very nice one. We’re seeing a lot of M&A funds that are beginning to concentrate in categories and also by five different fast-food companies and whatnot. And they’ll want to put in as many payment capabilities as possible of the one modernized – they’ve been kind of in jail with their pedant merchant providers and whatnot. And so instead of owned company by owned company, these guys are managing the efficiency of that across their portfolio of businesses that you’ll end up working, one day you’re doing hamburgers and the next day you’re doing tacos or whatever in turns, but it lands up being a leverageable payment system for them. And that’s been a very nice arena of business. A lot of those are – we have several of those in the implementation phase. And then another form is we’re doing very well in transportation. And you say, well, transportation is really not an e-retailer, they are really – they’re very much physical. But the truth of the matter is, 99% of people want ticket in hand and the transportation company wants ticket in hands and kiosk is initially in concept, but kiosk is kind of the point of the last resort. So omni-channel there works very well and it’s very leverageable. And a lot of those guys who are willing to work with each other because the American railroad system or the French railroad system are not in competition with each other, they are kind of in the – they’re kind of categorized together and whatnot. So those are the ones that I would – I think we told you last time about camera-based traffic observation. It’s really clear that the lower the average ticket, right. And the other one is gaining for us, right. The lower the average ticket, you really can’t afford. If you have a $10 average ticket and a $8 average ticket, you’re not going to – you don’t want to pay $0.40 say or $1 a transaction, right, on that and you’ve got to make your forward decision very quickly, you’ve got to make your payment decision very quickly and you can’t – you’ve got to really go for a least cost routing in terms of doing it. So we’re just filling natural niches. And there are other companies in which you could argue that it isn’t in their top five priorities right now, but we’re filling a natural set of niches that eCommerce is creating by changes in behavior – how we behave differently. Domino’s, 95% of people pay for the pizza at the time they order it whether they pick it up or they don’t pick it up or whatever. So it’s following behavior and the objectives of the company is in terms of executing those behaviors.

Great. Thank you. That’s really helpful detail. And then would you be able to break down bookings over the last year on more of a dollar weighted basis by some of your focus areas of BASE24, biller direct, online banking and also by geography?

Yes, if off the top of my head, probably not. But I think a lot of the sales – as Phil said, a lot of the growth is coming from new names, new logos, predominantly at least in the first half more so in our On Demand business than in the On Prem business. So I would say at least in the first half, the growth – bookings growth has been pretty heavily weighted towards the On Demand side.

Okay. Thank you. That’s helpful. And that’s all I have.

Your next question comes from Brett Huff with Stephens.

Good morning. This is Blake on for Brett. Thanks for taking my questions. You had a nice license quarter despite the 606 headwind you’ve talked about. The growth was fairly high sequentially at least. Was this within your expectations on the license line or was there maybe any pull forward from the second half?

No, that’s what I was saying. This year it’s going to be more – kind of follow more of that historical pattern where a lot of the renewal activities sits in the second half of the year. So I’d say, yes, the first half is in line, first half second quarter in line from our renewal book perspective. And just the timing of renewals are more back half weighted this year. So that’s why I said on the call that we get normal skewed optics in our favor in the second half. 606 also turned in our favor, but just the timing of the renewal book this year versus 2017 is more favorable to Q3 and Q4.

I was actually saying as I thought we did very well in revenues, 605 and 606 in light of the fact that we have – year-to-year, we have a lighter renewal. And I think you know our objective in terms of – is going 100% to migrate them to the new technology. Until we want that, we’re still shooting for that 25%, 28%, 30% TCV and that usually requires us to renew on renewal, right. You’re not going to early renew those situations. So this year, the second half is a heavier renewal than last year’s same period.

And then on the AOD segment, the bookings were good there what you talked about. The revenue growth in the quarter, looks like that ticked down from about 6% in the first quarter to about flat in the 2Q. Were there any headwinds in there you would call out such as may be bill pay? I know that’s a larger piece of it? And then should we expect mid-single digit growth to return there in the second half?

Yes, I would – there’s probably two things on the AOD business. Number one is, there can be timing differences between calls at the end of Q1 and early part of 2Q in terms of our government protocol and in terms of cash payments. So I would look at – there is a certain seasonality element in the AOD business. But the preponderance of our growth is probably going to come in the holiday period with our merchants and you’ll see that in Q4. There is a seasonality in the business.

Got it. And then just lastly on free cash flow, I know you said it was up year-over-year. You reiterated guidance. It was a little low relative to our industry expectations. Were there any one-timers you would call out?

No, nothing in particular. We were up double last year and again, reiterating our full year. So we came in from a cash perspective where we thought we might not. Again, I think – part of that is also again the timing of renewals because the key not only is the revenue and margin, but it’s cash. And so we’ll see more of that in the second half.

Got it. Thank you very much.

Yes, but another way of answering what Scott answered is that our FCF expectations – we don’t guide on FCF and we want you to know that we very comfortably made our FCF expectations for the quarter.

That’s good to hear. I appreciate it.

At this time, there are no further questions.

Thanks everybody for joining. Look forward to catching up with everybody in the coming weeks.