ACI Worldwide, Inc.

Ladies and gentlemen, thank you for standing by, and welcome to the ACI Second Quarter Earnings Conference Call. At this time, all participants' lines are in a listen-only mode. After this figure's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone keypad. I would now like to hand the conference over to your speaker, Mr. John Kraft, Vice President of Investor Relations and Strategy. Thank you. Please go ahead, sir.

deck today, a copy of which is available on our website, as well as with the SEC. On this morning's call is Ojelon Almeida, our CEO, and Scott Behrens, our CFO. Before I turn it over, I'd like to share that company management will be attending the Wells Fargo Virtual Fifth Annual Technology Services Forum on August 11th, the Canaccord 40th Annual Growth Conference August 12th, and the Second Annual Needham Virtual FinTech and Digital Transformation one-on-one conference on August 19th. With that, I'd like to turn the call over to Ocalan.

Thank you, John, and good morning, everyone. Thank you for joining us for our second quarter 2020 earnings conference call. On our last earnings call in May, COVID-19 and its unprecedented global impact on people and economies was top of mind and a central focus of our discussion. Now in August, we find ourselves in slightly different circumstances, but with many of the same challenges. I hope you and your families are staying safe and well, and we at ACI remain committed to doing everything we can to ensure the health, safety, and well-being of our employees as we seamlessly support our customers. On today's call, I will begin with our second quarter financial results. Importantly, I'd also like to share in more detail my vision for profitable revenue growth and long-term value creation. We are living in a different world compared to even three or four months ago. While different parts of the globe are experiencing different stages and levels of severity of the pandemic, undoubtedly, there are ways in which our world has changed permanently. As it relates to ACI, the pandemic has heightened awareness and accelerated widespread acceptance of the essential role digital payment systems play in our modern economy. Starting with the second quarter, new sales bookings were $136 million, up 6% from Q2 last year. We saw particular strength in our merchant business, signing two larger BSP contracts, RS2 in Europe and HyperPay in Middle East, that will allow these partners to offer merchant acquiring and e-commerce services to their customers in new geographies. Another area of continued strength in the quarter was real-time. We signed a long-time support agreement with our customer, Rabobank, who was looking to extend its existing real-time payment offering by supporting batch payments. Another existing customer, one of the largest interbank switches in Indonesia, has selected ACI to orchestrate all their alternative payments, including QR, Alipay, and other real-time offers. Despite our revenues being impacted by COVID-19, our EBITDA increased by 42% compared to Q2 2019, with margin expansion increasing to 35%, up from 25% last year. Our efforts to improve operational discipline are working, and we continue to focus on maximizing profitability while advancing our pipeline of deals to position ACI for future continuous profitable growth. As I mentioned last quarter, we are fortunate to have a resilient business model with significant recurring revenue, reliable cash flows, and high customer retention, all of which are helping us weather the COVID-19-related uncertainty. On our first quarter call, I shared with you my background and experience in realigning operations toward revenue growth, margin expansion, and value creation. I also spoke about time I devoted to speaking with ACI's customers, employees, and leaders. Since that time, I have also been getting feedback from our investors. These conversations have made clear to me that ACI has a strong portfolio of customers and software-led payment solutions, and importantly, the human capital and talent to succeed. On the last earnings call, I have also communicated my initial and high-level perspectives on HCI's growth potential and the three pillars of our strategy, which will position the company for continuous profitable growth. Today, I'm pleased to share additional details on our growth. Over the last few months, we have engaged our best internal experts and industry-leading consultants, to help us review our business and identify opportunities for efficiency gains and growth optimization. These small consultant teams have worked with me on several similar efforts over many years. We have a playbook with a proven track record. Although our work is not complete, we have identified key initiatives to support the three pillars of our strategy that will drive value creation opportunities for ACI. Our first pillar, Fit for Growth is a refining and realignment of our organizational structure and operating model to better position the company for organic growth. This involves reviewing the organization model and geographic footprint and designing an agile and nimble organization that is better at creating and sustaining continuous profitable organic growth. We are also designing a best-in-class global sales organization and culture. This initiative focuses on execution and will strengthen accountability, enhance transparency, and reduce the duplicative costs throughout the company. We are very close to hiring a chief revenue officer and a chief human resources officer to complete the leadership team. Our second pillar is called Focus on Growth. We will design an organic growth strategy that puts a disciplined focus on areas where we can optimize growth. We are reviewing our current solutions to identify the best opportunities to invest operating and capital expenditures going forward. We'll focus on a smaller set of growth-rich software-led solutions supported by differentiated innovation in specific geographies and market segments. We will ensure all of our priority solutions are cloud-first in terms of architecture, deployment, and operations. We prioritize investments that have the best market opportunities, generate the highest revenue growth and cash flows, and would yield the highest ROI. This will become a core discipline here at HCI. Importantly, this investment will come from cost discipline and reallocation, not incremental spending. Our third pillar is step change value creation through M&A. We will also continue to pursue accurate M&A to drive step change value creation for our shareholders and further expedite our growth. Executing our three pillar strategy, we will encompass cost rationalization, which is already well underway. As we previously discussed, we action approximately $20 million in annual cash cost reductions in early 2020. During Q2, we further increased this amount by approximately $30 million in cost reductions related to COVID-19 by reducing the use of contractors, T&E expenses, and other known HR expenses for the rest of 2020. In addition, as part of our new strategy work, we're identifying additional cash cost savings by flattening our organizational structure, eliminating duplicative costs across our new organization, and reducing our global facilities footprint. A good part of this savings will be reinvested behind growth, and we assure value maximization to our shareholders. Additionally, we're reviewing our capital allocation. Our short-term priority is to continue to leverage the business. In Q2, we paid down $40 million, and our net debt ratio has declined to 3.3 times as of Q2 2020. In the medium term, we will also reallocate free cash flow to invest in our business, return capital to our shareholders through share buybacks, and undertake accretive M&A. We plan to provide an update on our progress implementing these initiatives on our Q3 earnings call. We also expect a fulsome discussion during an investor day we are targeting for November 2020. A new ACI is underway and will be fully launched by January 2021. We understand there is much work to do, but I have said before, I strongly believe we have the right team to succeed. There is a sense of urgency. as well as optimism throughout the management team as we execute our new strategy of repositioning the business for long-term value creation. To conclude, driving revenue growth is in my DNA and will be in the new HCI DNA too. We have a clear vision. HCI is well positioned to capitalize on the emerging trends in digital payments and specifically real-time payments. But we have plenty of room to improve in operational and go-to-market discipline and execution. I have no doubt that by executing on our three-pillar strategy, leveraging our go-to-market experience and benefiting from a new cutting-edge sales process and culture, we will generate continuous profitable growth and significant value creation. I will now hand the call to Scott to discuss the company's Q2 results. Scott?

Thanks, Ojalon, and good morning, everyone. I first plan to go through our results for the second quarter and then provide some high-level commentary regarding our expense reduction initiatives and outlook for the rest of 2020. We'll then open the line for questions. I'll be starting my comments on slide seven with key takeaways from the quarter. New bookings were $136 million, up 6% from Q2 last year, as we continue to see strong growth in real-time payments as well as our bill pay solution. We ended the quarter with a 12-month backlog of $1.1 billion and a 60-month backlog of $5.8 billion. Q2 revenue came in at $300 million, up 2% from Q2 last year on a constant currency basis. The growth was driven primarily by having a full quarter of speed pay revenue in 2020 versus a partial quarter in 2019. Excluding the impact of the incremental speed pay revenue, revenue declined on a constant currency basis by roughly 10%, primarily driven by the impact of COVID-19. Looking at our on-demand business, which saw a 15% decline excluding speed pay, the largest portion of the decline is related to the shift in tax payments from Q2 to Q3 as a result of the IRS and many of the state tax deadlines moving out 90 days this year. Aside from the government tax payments, we have seen year-over-year declines in other biller segments as a result of COVID-19, but those transaction declines have been offset by higher transactions from our secure e-commerce solution. We saw less of an impact from COVID-19 in Q2 in our on-premise business, which declined 2% compared to Q2 last year. Declines in non-recurring license and service revenues were partially offset by higher recurring maintenance revenues. We saw total recurring revenue growth 4% compared to Q2 last year and now comprises 78% of total revenue versus 75% of total revenue in Q2 last year. And despite the challenges related to COVID-19, we continue to focus on maximizing profitability. Our efforts to improve our operational discipline helped generate significant profitability growth in the quarter with adjusted EBITDA of $78 million, up 42% from Q2 last year. Consolidated Net Adjust EBITDA margin expanded to 35%, up from 25% last year, which represents nearly 1,000 basis points of improvement. It's important to note that this growth is not just a result of the incremental SpeedPay contribution, as EBITDA also grew on an organic basis, improving 25% compared to Q2 last year. We saw profitability improvement in both our on-demand and our on-premise businesses on an organic basis. Turning next to slide 8, starting with debt and liquidity, the solid growth in EBITDA delivered strong cash flow from operating activities of $68 million in the quarter, up more than 370% from Q2 last year. And we had significant liquidity as we ended the quarter with $129 million in cash and $300 million available on our revolver. We also paid down $40 million of debt during the quarter. Our current debt balance is $1.3 billion, which represents a net debt leverage ratio of 3.3 times. Turning next to our outlook for the rest of 2020, as previously announced, given the uncertainties around COVID-19, we've temporarily suspended our financial guidance for the rest of the year. So I won't give you full financial ranges, but I will say again that while revenues have been impacted by COVID-19, we are very focused on maximizing profitability and cash flows. As Ocalan mentioned, we've actioned approximately $30 million in cost reductions in response to COVID-19 by reducing the use of contractors, T&E expenses, and other non-HR expenses for the rest of 2020. This is in addition to the approximately $20 million in annual and ongoing cash cost reductions that we implemented as we entered 2020 pre-COVID. Further, as a part of our new strategy work, the team here is identifying additional cash cost savings by flattening our organizational structure eliminating duplicative costs across our new organization, and reducing our global facilities footprint. We anticipate that a good portion of the savings will be reinvested behind growth initiatives. Ojalon and I and the rest of the management team are heavily engaged in this review, and we plan to provide more details at our November Investor Day. That concludes my prepared remarks. Operator, we are ready to open the line to questions at this time.

Thank you. At this time, to ask an audio question, please press star 1 on your telephone keypad. Again, that is star 1 to ask an audio question. Your first question comes from the line of Peter Heckman of Davidson.

Peter Heckman of Davidson. Scott, could you give us a little bit more color on the bill pay? I think I missed a comment there. Did you actually talk about how BillPay did and take your estimate of what type of volume might have pushed into the third quarter.

Yeah, what I mentioned was that we had the biggest driver of ultimately the decrease in BillPay year over year was the shift in the tax payments. And so they didn't necessarily mention transaction volume, but the year over year Q2 decline related to government tax payments was about $16 million.

And that's helpful. And have you seen that volume then in July?

A good portion of that came back in in July, but not all of it. I mean, obviously, we're going to have to see how the rest of the quarter goes and all the way through the extension timing to see if we get that all back. But a good portion came back in July.

Great, great. And then just one question on, I know it's capitalized software. It looks like it's up about 40% year-to-date. How are you thinking about that for the full year, and what are some of the projects that are included that you're capitalizing on?

Really, the only place we do that in is in parts of our on-demand business, so it would be the platforms. So we're going through right now platform consolidation. we're going through, especially in the bill pay side of the business, and the front end under, you know, what we bought under speed pay was the next-gen front end, and we're continuing to develop that. So I wouldn't look at Q2 as, you know, a trend by quarter going forward. Obviously, there was certain work that could certainly be progressed more in the last 90 days than others because that's more internal-facing work. Got it. Thank you.

Your next question comes from the line of Mayank Tandem of Needham.

Hey, good morning, guys. This is actually Kyle Peterson from Mayank. Thanks for taking our questions. Just wanted to start out on gross margins. It looks like they were definitely one of the big drivers of the profitability upset this quarter. Just wanted to see how much of that was. organic improvement versus BPAY fully lapping and then try to get any flavor as to how much of that might be sustainable to keep expanding on the gross margin side in the back half of the year.

Yeah, well, if we just looked at the pure organic business, we had a 25% increase in EBITDA year over year. And that contribution came across pretty much all of our cost lines, so it would have benefited at the gross margin line. And we saw a margin improvement in both the on-premise business and the AOD business. So again, it gets into the scale of the business and the scale of the cost structure. Really, I would say there was two major cost reductions we did this year. If you recall, when we came into the year, we took out about $20 million annually in terms of operational efficiencies. Those are what I'd call more permanent in nature. Those are permanent parts of our cost structure. So they survived this year. They'll survive COVID. What we actioned really in late first quarter, early second quarter, was an additional $30 million of cost. really specifically in reaction to COVID. I would generally consider those more temporary in nature, things like travel expenses, some of our trade shows and things that didn't happen. We reduced contractors. And obviously, those costs, as things normalize and things come back, obviously, we'll get to traveling again. We'll get to the trade shows. And the contractor cost will come back as the growth comes back as well. But there is an element of, again, if I look at just purely the organic business, there's an element of improved profitability there, again, 25% in the quarter. And part of that's coming from the $20 million we took out early in the year.

Okay, that's helpful. And I guess just continuing on the $30 million in costs, in extra kind of COVID-related cost savings, how much of that was in the run rate in the 2Q numbers, and how much of that will kind of start to flip through into 3Q? Is it about 50-50, or is it mostly kind of baked in the run rate right now?

I think Q2 is probably a pretty good indicator. Again, it has the full amount that we took out early in the year, and we actioned the $30 million pretty quickly. And if we look at, you know, the course of the year, Q2 probably had the biggest impact because a lot of things really kind of, I don't want to say they came to a halt, but certainly things like travel and a lot of the trade shows and things just really stopped. So the benefit of that in our P&L, you know, we saw a lot of that benefit in Q2. Obviously, in Q3 and Q4, when we start to see travel pick up, those costs will start to come back a bit. But I think Q2 is a good indicator of the full amount of cost benefits. for a 90-day period. And the only other thing I'd go back to on, you'd mentioned you were focused more on the gross margin in your question. Remember, on the biller side of the business, there's interchange costs with that revenue. So when I said the revenue declined in Q2 on the tax side of $16 million, There's a pretty sizable interchange cost that goes with that, and so that's in the cost of goods sold. So we really have less of an impact as a company at the net revenue level and the EBITDA level as a result of those tax payments moving out.

Okay, that's helpful. And then I guess last one for me, and then I'll step back from the queue. But just wanted to get the services revenue came in a bit later today. than our expectation. Is there anything noisy going along there, or is it just a little less demand during COVID? Just want to try to get the sense of, you know, when we might see some signs of stabilization there.

I wouldn't say anything in particular noisy. I mean, we were able to continue projects during the last 90 days. You know, if you look at our Our new bookings, we had more new bookings in the quarter in on-demand, and we actually saw a decline in on-premise. On-premise is where we would see the sales related to services work, so there was obviously a drop-off in on-demand. in the on-premise business in terms of services sales, and that'll impact you too. It may impact us a little more in the second half, but nothing other than that. There's been a change in terms of what we're doing in terms of our services portfolio. I would say part of it's COVID, and part of it's just the lower sales quarter.

All right. Thanks for the color. Nice quarter. Thanks, guys.

As a reminder, to ask a question, you will need to press star 1 on your telephone keypad. To withdraw your question, press the pound key. In the interest of time, we ask that you please limit yourself to one question and one follow-up question. Your next question comes from the line of George Sutton of Craig Hallam.

Morning, Ogilon and Scott. So we attended an interesting webinar you guys hosted about real-time payments, but one of the key themes really being that real-time has been accelerated. When does this become a revenue driver in your view in the U.S., or does it remain sort of a European-centric factor? And how would you quantify the near-term addressable market?

Maybe I'd take that, and then Ojalon can add some color. Obviously, the biggest growth we've seen in real time is outside the U.S. But, you know, that's both on, you know, new logos as well as, you know, add-ons. So selling our real-time capability to our existing customer base. We mentioned an Asian customer that purchased real-time this quarter. That was revenue in quarter. That was an on-premise sale. So that converts pretty quickly. But most of the growth has come from overseas. Obviously, our U.S. banks, we're selling that in addition, especially when we go in with renewals. But in terms of a real tipping point in the U.S., I'm not sure when that will be, but certainly a lot of our growth and the 20-plus percent growth that we've seen over the last few years, a lot of that's really coming from overseas.

I think just to complement that, I think also we saw bookings are growing 60 percent plus, right? So that shows you the trend. We are very much focused behind that. real-time payments, and that will be one of our pillars. It will continue to be one of our pillars of growth. It already represents more than 10% of our revenue, so it's significant. And also, the other place that you can expect a lot of growth is emerging markets outside of the U.S. and Europe. So I think very much real-time is around the globe, and specifically emerging markets.

Just to clarify, did you say bookings for real-time are 60%?

Are you saying in the quarter?

Yeah. And then quick follow-up. So we picked up on Visa, MasterCard, and some others expanding click-to-pay to 18 new countries. Can you talk about that a bit? Sort of how are you involved, and could that be a meaningful volume and revenue opportunity?

We wouldn't speak to anything in particular with any – um, you know, any of our customers or any of our partners in terms of, um, you know, obviously we're, we're heavily involved, um, both going direct in, in real time initiatives and also, um, working via our partnership with, uh, with master call already on the vocal link partnership that we have.

Yeah, I think you, you can expect a lot of activity of a guy behind real time payments and that we will encompass alliances that we will encompass us going by ourselves. but it will be a clear area of focus for us.

Great. Thanks, guys. Congrats on the quarter. Thanks.

Thank you.

Again, to ask an audio question, please press star 1. Your next question comes from Brett Huff of Stevens, Inc.

Good afternoon, guys. Good morning, guys. Hope you're doing well. Thanks, Brett. Thank you, Brett. Two questions for me. I'll ask them both and then I'll get off. One is really good bookings quarter, surprisingly to us, just given that we've seen some banks kind of pause spending. I think you said you had a couple of merchant deals in there, but wondering if you could give us an update on what banks are looking at buying and kind of their tenor of how they're thinking about spending. And then number two, I think you highlighted a little bit some of your initiatives that you're going to start working on. I think sales execution and maybe sales reorganization was one of them. Can you just tell us a little bit more about that and kind of when we should maybe start seeing some of the fruits of that labor? Thanks.

Maybe I'll take the first one. The new bookings growth in the quarter up 6% year over year. In a COVID quarter, that's probably pretty good. Q2 is not typically our strongest bookings quarter, in fairness. But like I said, we had a lot more growth. We had a high growth in the on-demand business. We actually saw a decline in the on-premise business. But The growth we saw was actually most of it really wasn't from banks. Our two biggest net new logos, one was a biller customer, and the other was our security commerce solution, so merchant solution. And then our biggest add-on was in real time. So a lot of the growth we saw in the quarter was from billers, merchants, and then, as Ocalan mentioned, the real time up 65%. And I wouldn't necessarily say that's an indicator that banks aren't spending, but I'm just saying for the quarter, that's where we really saw our growth.

Yeah, I think, Brad, we did see, as Scott said, some impact on on-premise, on no bookings. So clearly there are some clients that are delaying the decision yet, so that's consistent to what you heard before. Just our on-demand business did wonderfully. And that's what offset on the total bookings part. And we would expect that that trend on the on-premise will continue, whereas it's a timing issue only because our products are, as you know, mission critical. So it's a question of time when we're going to be able to sign those clients. But, yes, there is some impact on that. That's consistent to what you have been seeing. So I think that's the first question. The second one on execution, I'm just going to give you some data. that we are working with our consultants and internal team today. In sales, for example, in the sales organization, we are going to centralize the sales organization. We are hiring a chief revenue officer. I think we are going to have an announcement as soon as next week about the name of that chief revenue officer. And by centralizing that, just to give an idea how agile and nimble we're going to be, you can expect three levels of management between the CEO and the sales rep around the globe. So that gives us an idea about the kind of change that we're going to be doing and how agile we're going to be. And together with that, you're revising everything. We're revising how we build compensation, how we manage the pipeline, how we evaluate the pipeline, detail by detail on that. So you can expect, again, a very nimble, agile organization with decision power, you know, real in the field and with a strong process behind it. Great. Thank you.

Your next question is a follow-up from the line of Peter Hegman of Davidson.

Hi. Thanks for taking the follow-up. I just wanted to see if you could provide us any insight into the ongoing process of some of the larger contract expansions in the pipeline if you have any thoughts on timing there.

Yeah, I mean, we, you know, I think we said earlier this year that we were, just to be clear, we weren't expecting any of those or had forecasted any of those in this year's guidance. But obviously, we continue to have conversations with our customers and even net new logos on a large new opportunity. So, Nothing that I would say we're expecting here before the end of the year.

Okay. I guess one of my understandings was that when a customer goes through a large merger, they need to renegotiate the contract with ACI before they can consolidate their payment operations. Is that not the case?

Well, no. I would say it's generally the case because the license is very specific and to the contracting user, and it's very specific to the uses. So if they were to actually expand that use to other parts of their operation, acquired operation, then, yeah, it would have to be recontracted. I will point out that, and we mentioned this earlier in the year, too, one of the large mergers, they actually executed their contract their renewal early. If you recall, it was a renewal from next year. They actually renewed it, uh, uh, back in, uh, the first half of this year. So they've recommitted to the next five years. Now that is with specifically what they're, what they're using today. Uh, so it's not an expanded, um, deal, but it's, uh, but it's a recommitment to our technology for the next five years. And that's, uh, that was supposed to renew next year.

Okay. All right. Thank you. And then, uh, Ojalan, just a question for you. I mean, do you see kind of the mix, the customer mix shifting at all in your outlook in terms of where you see opportunities from U.S. banks, global banks, emerging markets, increasing importance of the merchant channel? Can you talk a little bit about how you see this, maybe relatively more of the sales coming from which of those verticals over the next three years?

Yeah, no, thanks for the question. You can expect a much more focused organization going forward. So we will have some pillars that will accelerate significantly. One of the pillars will be real-time payments, and that will continue to be accelerated. Part of it is already the 60% plus growth in bookings that we have referred to. And we are going to continue to push that big time. I think the other area of focus definitely that we're going to be seeing is emerging markets. We are defining a concept called fighting unit, which is the intersection between geography, product, and segment. And we're going to have around 20 fighting units around the globe that we're going to be investing heavily behind it. If you put all of that together, I can anticipate to you that real-time payments, overall, it's going to be a narrow focus. And emerging markets, specifically, will be also a narrow focus.

Helpful. Thank you.

Your next question comes from Joseph Baffi of Canaccord.

Hey, guys. Good morning. Just a follow-up on the real-time deals in the court of the Indonesian Bank and Rabo, just to get a feel for how competitive are these types of situations for, I guess, for new customers, I guess, especially on the real-time front. And then secondly, do you think we see M&A before or during or, I guess, I know you're going through some organizational changes. Does M&A come after the organizational changes are done, or could we see M&A while things are still being optimized here? Thanks a lot.

I will start with the last one, and then I'll give the first one to Scott. I think we are always looking at M&A, right? We're always like, I have bills on my table that comes all the time, and we are always looking into that. Mike, My focus now is really organic growth. I think we need to start and show this organic growth. And I mean, it could happen, you know, while we are doing this, if we get like a spectacular, accurate option. But at this point, my focus and the organization's focus is to assure that we position the company for continuous profitable growth. Scott?

Yeah, I think when it comes to the real-time, we have the relationships with the largest banks in the world and have for a long time with our retail payment engine. So in a lot of cases, we're a natural to provide the real-time capability. So a lot of our success is coming from just selling into that existing base, whether it's a new application or expanding on some of the some of the real-time capabilities that they already have. So on the net new logo, you know, that's probably going to be more in what I'd call more the central infrastructure. where, you know, they can either procure it as a licensed software, which is really our model, or if they want somebody to operate it, that's typically going to be provided by, you know, somebody else. And so I would say probably more competitive in the central infrastructures, but in terms of the connectivity to those central infrastructures, we're just a natural fit with our existing large bank customer base throughout the world. Right.

Thanks. Very helpful.

If there are no further questions at this time, I will now turn the floor back over to John for any closing or additional comments.

Well, thanks, everybody, for dialing in and your interest. We look forward to catching up in the following weeks. Have a good day.

Thank you. That does conclude today's conference call. You may now disconnect.