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Online Resources Corporation (NASDAQ:ORCC)

Q3 2008 Earnings Call Transcript

October 29, 2008, 5:00 pm ET

Executives

Beth Halloran – Senior Director, Corporate Communications

Matt Lawlor – Chairman and CEO

Cathy Graham – EVP, CFO and Treasurer

Ray Crosier – President and COO

Analysts

Glenn Greene – Oppenheimer

Bob Napoli – Piper Jaffray

Wayne Johnson – Raymond James

Brett Huff – Stephens Inc.

Doug Campbell – Spirit Capital

David Parker – Merrill Lynch

Operator

Good evening, my name is Trishana and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Online Resources third quarter 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. Ms. Beth Halloran, Deputy Director of Corporate Communications, you may begin your conference.

Beth Halloran

Thank you to everyone who has joined us today on our conference call for third quarter 2008 results. Shortly, Matt Lawlor, Chairman and CEO; Ray Crosier, President and COO; and Cathy Graham, Executive Vice President and CFO, will present Online Resources’ financial and operating performance.

Before we get started, I want to invite you to view our press release and some exhibits that we will refer to during the call labeled “Third Quarter 2008 Earnings Call Slides.” You can see these in the Press Room and in the Investors section of our web site at orcc.com. But first, as is our practice, I would like to preface our remarks today by taking full advantage of the Safe Harbor provisions of the Securities Litigation Reform Act. The following conference call contains statements about future events and expectations of Online Resources that are forward-looking and involve risks and uncertainties detailed in filings made by the company with the Securities and Exchange Commission. I’ll provide a more detailed review of the Safe Harbor provisions at the end of this call.

Now to you, Matt.

Matt Lawlor

Welcome everyone. Our call today will cover three topics. First, we delivered results in the range of our financial products for the third quarter. Despite still lower interest rates and prior year client losses, revenue grew at double digits. Earnings were slightly down, as expected, but would have been increased very substantially if normalized to reflect an apples-to-apples comparison to the prior year.

Second, our operating fundamentals continue to trend up nicely on a seasonal basis. Billpay transaction growth was strong, particularly for our eCommerce business line. We also signed a number of major new clients and renewed our largest client to a multi-year contract. The lift from these signings and new product sales further validates the strategic benefit of the acquisitions made over the past four years.

Finally, we will report on steps taken to preserve our financial and operating standing in a weakened economy. Our first line of defense rests with a durable, well-diversified client base, which appreciates the advantages of an expanding online and electronic payment channel. At the same time, we have taken the initiative to further control our costs in order to drive higher earnings and cash flow.

With that, I’d like to turn the call over to Cathy to report on our financial results.

Cathy Graham

Good afternoon everyone. Today I’d like to take you through our third quarter financial results, review our guidance for the remainder of the year, and make a few comments regarding our current expectations for 2009.

For the third quarter, all of our revenue and earnings metrics were within the guidance ranges we provided. Revenue grew 11% over the same quarter of the prior year. A full quarter of revenue from our ITS acquisition offset most, but not all, of the revenue lost to steep interest rate declines and previously announced large client departures. Fundamentally, however, seasonally-appropriate transaction growth was the key driver of continuing client revenue.

EBITDA showed a slight increase, and core net income showed a slight decrease, compared to the third quarter of 2007. These trends were due almost entirely to interest rate and client departure impacts. If the only change to third quarter 2008 had been that interest rates remained consistent with the prior year period, EBITDA would have shown 20% year-over-year growth. If you then adjusted the 2007 period for client departures, year-over-year EBITDA growth would have been 50%.

These same factors impacted core net income per share for the quarter. With constant interest rates, core EPS would have increased 13% year-over-year. And without departed clients, that growth rate would have increased to 80%. We reported a net loss available to common stockholders in the third quarter compared to the net income we reported in the 2007 period. In addition to absorbing interest rate and departed client impacts, this quarter’s comparison suffered from the fact that the comparable period contained approximately $2.2 million in non-cash accounting and valuation benefits that offset interest expense.

Looking at the balance sheet, we maintained unrestricted cash, equivalents and short term investments totaling $17.6 million at September 30. During the quarter, we generated $4.1 million in cash flow available for debt reduction, and used this to repay $3.2 million in principal on our senior secured debt, reducing its balance to $78 million. We will continue to make quarterly payments on this debt on an accelerating schedule, through its maturity in early 2012.

Turning to guidance for the remainder of the year, we have provided you with our expectations for the fourth quarter and full year 2008. Given year-to-date results and interest rates that continue to decline, we have narrowed our guidance to the low end of our current range for the full year. For fourth quarter, the midpoint of our revenue guidance represents only slight growth, both year-over-year and sequentially. Though we anticipate continuing transaction increases, including a normal seasonal uptick, we are planning for further interest rate cuts and continuing longer sales cycles.

Year-over-year EBITDA growth is forecasted to be modest for the fourth quarter. While we are still experiencing the factors that impacted us in third quarter, we have been able to take additional measures to reduce our cost base. Ray will describe these more for you momentarily. This allows us to expect both sequential midpoint EBITDA growth of 28% and that we will meet our goal of exiting 2008 at a 26% or better EBITDA margin.

As with EBITDA, fourth quarter core earnings per share growth will not likely be significant year-over-year, but sequential growth is expected to be high – over 80% at the midpoint – due both to seasonality and cost saving initiatives. For full year 2008, the midpoints of our narrowed revenue and core earnings guidance represent mid-teens annual growth rates. We expect earnings growth to accelerate as we move into 2009 and get past the impacts that interest rate declines and large client departures have on our period-to-period comparisons.

As is our practice, we will provide 2009 guidance in early December, after we complete our budget cycle. Though we anticipate continued growth from our key business drivers, we also expect to confront the continuing effects of a weak, volatile and unpredictable economy. Investors should therefore expect our guidance to be appropriately conservative, particularly with regard to top-line growth. We will focus on continued cost control to achieve increased earnings and cash flow, and we are willing to trade-off less certain revenue opportunities to deliver a more certain bottom line.

So in summary, this was a quarter in which the impact of economic conditions and past client departures masked solid earnings growth driven by strong operating fundamentals. We were in line with our expectations, but continuing interest rate declines caused us to come in at the mid-to-low end of our range. We expect to see a similar pattern for the remainder of the year, with our operating drivers experiencing their normal seasonal uptick in the fourth quarter, offset by continuing rate compression.

Now, let me turn you over to Ray for his operating update.

Ray Crosier

Thanks Cathy. Today I’ll comment on third quarter highlights for each of the markets we serve and talk more specifically about some actions we took in the quarter to position us for higher earnings and cash flow next year.

Let’s begin with eCommerce, where we serve billers, card issuers, and other credit providers. We sold two more top 10 credit card issuers for our web based collections. We now serve 6 of the top 10 and 14 of the top 20 for card presentment, payment, or collection services. Additionally, several of those clients are expanding their use of the web collections beyond delinquent card portfolios and into other loans they service such as mortgage, auto, home equity, and consumer. Still in eCommerce, equally good sales progress was made with billers. We signed two sizable contracts worth $0.5 million each per year, in addition to the usual handful of smaller deals. In addition, two of our large asset receivable management clients expanded their relationship beyond payment services and opted to add web collections. As for 3Q transaction growth in eCommerce, we experienced steady bill payment increases of 7% sequential and 41% year over year.

We continue to expect that our eCommerce business will particularly benefit from increased scale, as we layer more volume over relatively fixed costs. In my opinion, the combination of the three acquisitions that make up the eCommerce business is starting to really click. We continue to cross-sell new products into the existing customer bases in each of the vertical markets we serve. In addition, the breadth of services we now offer has become a real differentiator for us. No one delivers the complete suite of services we do, where account presentment, payment processing, and recovery of delinquencies can all be integrated into one seamless consumer experience.

I’d like to turn now to Banking, which also had a solid quarter. In the community banking and credit union market, we signed a $2.7 billion credit union with 30,000 existing billers to a four year bill payment contract. We also completed our mobile beta for nine clients, and we launched the downloadable mobile application for banking and bill payment into full production. And, we had a record quarter selling additional products to existing community banking clients. In the national banking market, where we serve regional and large financial institutions over $6 billion in assets, we renewed our largest client, TD Bank. TD Bank was formed by the combination of TD Banknorth and Commerce Bank, where we had previous relationships. And I’m pleased to report that this multi-year renewal came with significant volume commitments. By virtue of this contract extension and the other renewals in the quarter, we achieved one of our most important goals for the year in the big bank market; to renew 100% of our national banking clients whose contracts were expiring in 2008. We’re really proud of the team for this accomplishment.

Looking at user and transaction growth across Banking Services, the numbers were seasonally typical and pretty much what we expected. Users from continuing banking clients, which factors out large departing clients from prior year quarters, grew 3% sequentially and 20% year over year. Bill payment transactions grew a similar 2% sequentially and 18% year over year.

Now I’d like to address some steps we recently took for earnings expansion in periods ahead. If you recall from my remarks last quarter, I talked about the challenge we faced having to manage the business to the bottom line in a pretty tough economic environment. On one hand, we needed to pare back expenses, and on the other we needed to be careful in making those trade-offs so as not to jeopardize existing business or future opportunities. One move we just made was to right size our business. We made the decision to basically hold total headcount constant through 2009, and only allow staff increases in those areas that are growth related. In order to fund those additional resources, we took the step of eliminating approximately 5% of our current staff positions.

The second step we took was to moderate non-critical capital expenditures. Obviously, we will continue to invest in areas necessary to support existing business and planned growth, but outside of that, we’re slowing CapEx spending.

The third action was a renewed focus on a program we call Optimus, which is designed to reduce costs and improve efficiencies across the enterprise. This includes the usual belt tightening, but also finding better ways to streamline processes, improve throughput, and more effectively operate our business. A number of initiatives were completed in third quarter under the Optimus umbrella. I believe these actions, while some painful, were necessary to position the company for continued EBITDA and cash flow expansion, and deliver on our promise of doing the right thing for shareholders and employees alike.

Matt?

Matt Lawlor

Thanks Ray. So, with the obvious exception of our stock price, I believe we are in good shape fundamentally. First, we are performing in line with our financial expectations and our operating fundamentals continue to trend up nicely. In addition, there are some very significant upsides, including the eventual rebound of the very low interest rates that have recently been a drag on our earnings. Second, our acquisitions are starting to contribute materially to growth. The former Integrated Data Systems has provided significant differentiation in the internet banking market, which is winning us deals. The former Incurrent provides the backbone of our expanding web collections service. Last year's ITS acquisition adds distribution for web collections. And the former Princeton eCom is now the anchor for our fast growing ecommerce business, with 41% transaction growth this last quarter.

Third, I believe our risk-reward profile is quite favorable. We have an attractive business model, with over 90% recurring revenue. And most of the acquisition risks and uncertainties are now behind us. We have further trimmed expenses to make sure we have ample cash flow to service acquisition debt, and we have right-sized our staff to support our key growth opportunities. I also believe our diversified client base and low level of revenue concentration mitigates our risk, and I'd like to spend a couple of minutes talking about that.

I will be referring to some slides posted on our website. As Beth mentioned earlier, go to the Press Room or the Investors section of orcc.com, and posted with the press release is a link called “Third Quarter 2008 Earnings Call Slides.”

Recognizing that there are some daunting challenges ahead for our clients, we believe that our client base is still a source of strength for the company. Looking at the chart on Slide 1 of the presentation, you will see our client mix based on 2008 year-to-date revenue. First note that no single industry segment exceeds 33%. This gives us a balanced portfolio of clients, and limits our exposure to any industry-specific problems.

Also note the balance between banking and ecommerce. Banking industry segments now comprise 63% of our business. eCommerce contributes 37%. This reflects a fundamental shift in our client mix over the past four years, where we enjoy synergies between banks and billers, as well as a more diversified client mix.

A portion of our commercial clients are credit card issuers. Though technically banks, we treat them as commercial enterprises, because the business drivers and regulations are very different from depository institutions. Moreover, most of our credit card issuers use us primarily for web-based collections, like our ARM clients. As we’ve previously outlined, this is a high growth area of our business that is counter-cyclical to the economy.

The chart also shows that credit unions comprise 33% of our business. This exceeds the banks. Our credit unions have limited commercial real-estate exposure and securitized mortgages. These clients have consumer loan exposure, but as reported by Callahan & Associates, credit unions typically have lower loan loss ratios than other credit providers. Also note that while 12% of our revenue is tied to large banks with over $6 billion in assets, these clients tend to be strong regional banks who have stuck to the traditional core businesses.

Finally, you can see that about 18% of our revenue is from community banks. Our community banks are strong and tend to have better asset quality than average. I’d like to turn your attention to Slide 2. Here we examine the concentration of our revenues to ascertain our exposure to industry consolidation and buyer-leverage. By depending less on any single client or group of clients, we reduce this exposure. First, no single client exceeds 3% of revenue. Second, our top ten clients represent just 16% of our business, a high level of diversification by any measure.

In sum, we believe our portfolio of clients diversifies us more than most. It is diversified by size, industry segment and percentage of revenue. Further, our largest segments are expected to be the durable ones. Finally, I know that banking industry consolidation is on the minds of a lot of investors, particularly with the recent TARP capital funding, relaxed mark-to-market rules and tax loss changes. But I would not be so quick to assume that there's going to be a rush by the banks to consolidate. TARP funds are designed to re-liquefy the banks, not simply to provide investment funds. I believe that TARP was primarily about rolling up weak banks; Treasury would not have approved recent funding to a number of regional banks that are widely considered good candidates for consolidation. Furthermore, we now have cheap government money and an extremely accommodative Fed policy. That supports strong bank earnings and continued independence – not the other way around.

So while I appreciate that there are sound arguments for consolidation, I'm more in the camp that there will be a period of balance sheet healing, followed by perhaps modest consolidation, more typical of periods of economic weakness. But to be perfectly honest, who can say? Anyone who claims to have a crystal ball in this rapidly changing environment should be prepared to be humbled, even if they get lucky. This brings me back to the fundamental tenant of my earlier remarks – even if there is banking consolidation, he who wins is he who is best diversified.

That’s why I believe we are in good shape – with a healthy balance between banking and ecommerce, which is diversified by industry segment, size and revenue. But beyond all the macro-economics, it’s really all about the individual circumstances of our clients. We keep a watch list and it’s rather small. And at the end of the day, I believe the vast majority of our clients are well-managed, resilient, savvy operators who will be the survivors of whatever the economy throws at them.

Thanks for listening. We’d be happy to answer your questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Glenn Greene of Oppenheimer.

Glenn Greene – Oppenheimer

This is the first question. I just wanted to get an update on ITS and how that’s progressing; obviously, the second quarter wasn’t great, so I was wondering how the third quarter looked?

Ray Crosier

Glenn, this is Ray. It’s coming along just great. The ARM clients out there are doing well. That’s a cyclical business that typically is very high in the first quarter, drops down a bit in the second, and then picks back up in three and four. So that seems to be doing great. It is but a piece of what makes up the eCommerce division, and accountably, most of those clients are targets for web-based collection and other payments. So we’re real pleased with that.

Glenn Greene – Oppenheimer

Good. Is there anyway you could give me a number, the revenue number, what it was this quarter relative to last quarter?

Matt Lawlor

We don’t segment out, we’re now fully integrated, Glenn.

Glenn Greene – Oppenheimer

The revenue was an issue last quarter and I’m just trying to know what happened?

Matt Lawlor

Yes, I wanted to address that. And this isn’t your fault, it is our fault. We didn’t do as good of a job as we could have done. If you’ll recall, we were trying to explain last quarter some unexpected lower revenue. And in our forecasting model, we had a forecast for ITS, which overstated the seasonality, deposit seasonality that they would have in their expedited payments. And this is only one of the areas that we had mis-forecast yesterday; the payments are also in our traditional (inaudible) business. So it was a forecasting seasonal expectation that we had that we were warm on. We haven’t seen a repeat of that this quarter at all. It was never that it was underperforming or that revenue was falling short of our expectations. So I know we confused some of the market in the second quarter; that was certainly not the case this quarter. And to the best of our measures, again we don’t account in that (inaudible) subsidiary. With ITS being part of our eCommerce business, we now have web collections going down that channel, we have got some expedited payments and other kind of one-time debits that they do that are accounted for in different ways. We’re happy with the acquisition’s performance.

Glenn Greene – Oppenheimer

Okay. Cathy, in the last quarter, you had very clearly delineated the revenue EBITDA and EPS impact from the client departures, do you have the comparable figures for this quarter?

Cathy Graham

They are the same, – Matt, you have them in front of you.

Matt Lawlor

This is year-over-year, we are still expecting, Glenn, in terms of the total year, again lower float, we think it is versus the original forecast for EBITDA is about $2.5 million. So, in other words, lower earnings on our payment float, caused us to be $4.5 million less than the original $40 million guidance that we had given for this last year. And then slower implementations and sales accounted for another $2 million. So there have really been no changes. Cathy, I believe described how interest rates are going down in the fourth quarter and that does affect us.

Glenn Greene – Oppenheimer

How much of the client departures hurt you year-over-year in terms of revenue?

Cathy Graham

Let me give you – Matt, I’m sorry. I threw it to him because he had the information on relative to our regional forecast. On a year-over-year basis, Glenn, if you looked at 3Q of 2008 versus 3Q of 2007, we were down on float revenue by about $1.6 million, and the lost clients were about $2.9 million.

Glenn Greene – Oppenheimer

Okay. And do you have an EBITDA number related to that $2.9 million?

Cathy Graham

I’d call it at a 60%, say $1.7 million to $1.8 million, something like that, because we share so many common platforms, it’s a little bit difficult to say, but something in that range. And obviously the float is 100%.

Glenn Greene – Oppenheimer

Okay. And then just as it relates to this whole bank consolidation and of late, the bank failures that we’ve seen, which generally haven’t been that big yet – have you been impacted at all or any of your clients within that mix, have you had any clients that have failed or been consolidated at this point?

Matt Lawlor

We have had two. First we are the web-collections provider for WaMu. As you know Chase is taking over WaMu, and it’s too soon to tell, but I would expect that we would carry on with our web collections with WaMu. The second client was National City. NatCity, we are their web-based card provider and includes account presentation on the web, the collections and so forth. NatCity is a much larger card provider than PNC, the acquirer. Again it’s too soon to really opine on this, but I would expect that our system would be the adopted one, given how much larger NatCity is, and how embedded we are into their services.

Ray Crosier

Matt, if I could, there is really some silver lining in a couple of those as well. We’re a processor of payments for JPMorgan Chase, and we’re not for WaMu. So if they consolidate onto a platform; maybe that would be a good thing for us. And as Matt mentioned, NatCity is a larger card provider than PNC, which bodes well. But at the moment, NatCity has less than 0.5% of our revenues. So even if something terrible happens to us, it is going to be de minimus.

Glenn Greene – Oppenheimer

And you don’t have any exposure on the billpay side, the banking side?

Ray Crosier

No.

Glenn Greene – Oppenheimer

Okay. Great, I’ll jump back in the queue. Thank you.

Operator

Your next question comes from the line of Bob Napoli of Piper Jaffray.

Bob Napoli – Piper Jaffray

Good afternoon. A question on cost cuts – you said you had reduced the staffing by 5%, is there additional cost cuts slated, or have you made the adjustments that you wanted to make?

Ray Crosier

Bob, we’re done, as best as we can tell. In the second quarter, if you went back and listened to my remarks, we were already starting to tighten up already. Candidly, we had frozen open reqs, and we were waiting to see some things there. As we progressed, we made the decision how we’re going to run the business into 2009, and in order to fund growth areas next year, we needed to take those extra steps. So between the number of positions that we eliminated, and the handful of open reqs that we canceled, that’s it as best we can tell. Now, you caveat everything, this was a wild environment, so if something really drastic happens, we’ll do what we need to do. But as we’ve told our own staff, we’ve done what we think is necessary.

Matt Lawlor

Bob, that’s not to say that we don’t have more to go in terms of non-staff expense reduction, because that is a continuing matter. We think we can do a lot more next year and we’ll be talking about that a little bit more with our 2009 guidance in December.

Bob Napoli – Piper Jaffray

Well, I predict that you can’t lose more than another 100 basis points on the interest rate side.

Ray Crosier

It’s nice to see somebody that always finds the silver lining.

Bob Napoli – Piper Jaffray

As far as your EBITDA growth outlook for 2009 – I know you’re going to give that in December – I was hoping you would give – I think Cathy, you had given a little bit of color around what to expect when you give your guidance. So, I was hoping you could go back over that and talk about what your goals might be, without preempting your December call.

Cathy Graham

Well, I think I said pretty much all that we’re sort of willing to put out there at this point, because we certainly have not finished our budget cycle yet. But I think that you can expect us to continue to control costs to make sure that we deliver EBITDA and core earnings, and we will sacrifice less certain revenue opportunities to do so. And so I think you should expect that we will be conservative, particularly with regard to top-line growth relative to the long-term targets that we’ve given you.

Bob Napoli – Piper Jaffray

Can you do double-digit top-line growth in this kind of an environment organically?

Matt Lawlor

Potentially. But we can’t comment on that, Bob. A lot of this has to do with how conservative we want to end up being with you and the investment community and with ourselves. I will say on the upside, there are a ton of new products that you know about. You’re seeing some of the successes of those new products already with the web-collections. We’re getting success with our Command product in the internet banking side. Our feeling is let us not bet on those upsides. Let us bet on the uncertainty of strong EBITDA cash flow growth next year, and be conservative on the revenue side when we set expectations.

Bob Napoli – Piper Jaffray

And you would expect EBITDA margin expansion next year regardless?

Cathy Graham

Yes, absolutely.

Bob Napoli – Piper Jaffray

Okay. And last question. What have you seen out of your client base? What has changed over the last several months and into October, given the certainly worsening economic environment?

Matt Lawlor

We have to echo what some of our industry comrades have talked about. We’ve been here reading the papers, watching the television, hearing about the Armageddon that exists in the industry and we haven’t seen it. We clearly see disciplined cost control by our clients as well as you’d expect, but not in the extreme. We continue to see strong demand for our services, particularly web-based services, which are cost effective. But we haven’t seen a wholesale abandonment of the channel or non-rational extreme cost cutting.

Ray Crosier

I’ll remind you of one of my comments – we sold more products to our existing clients in Q3 than this company ever has since I’ve been here.

Matt Lawlor

And we know others in their earnings calls are saying the same thing. So again, all of us have to expect that there may be – and we should plan for a tough year ahead. There could be a tsunami of losses out there and it could be a very changed and very dramatic environment. But again, we don’t see it that way. Our clients aren’t exposed the way some of the largest banks are to the securitized mortgage-backed assets. They are expecting a recession. They are planning for it. They are raising their loan loss reserves, but at the same time, they’re enjoying a very positive yield curve. And they are buttoning down their hatches, and we don’t see it really affecting our business so far.

Bob Napoli – Piper Jaffray

Okay, thank you very much.

Operator

Your next question comes from the line of Wayne Johnson of Raymond James.

Wayne Johnson – Raymond James

Good afternoon. Can you talk a little bit about the pipeline? Can you give us any kind of color on where it stands compared to earlier this year and a year ago, and the prospects going forward? That’s the first question, and then I have a follow-up.

Ray Crosier

Thanks, Wayne. In Q3 this year over Q3 last year, the pipeline today is about twice where it was a year ago. That’s fabulous. As I look at it from Q1 to Q2 to Q3, it actually up-ticked two over one by some 30%. And then we had some pretty significant sales in the second and third quarter. So it’s down slightly at the end of Q3 from the end of Q2 – but that’s just normal stuff coming through, and as they move through the pipeline and they sell, we are going to fill it up again. So, it’s not down significantly. And candidly, the late stage ones, the ones that are getting ready to pass out, they have never been better. I will make one other comment about the pipeline. That is always measured not in numbers, but in dollars of revenue to the company. And it’s a weighted number. So, as it ebbs and flows, we watch that. The sales we just made were 10% higher than Q2 sales and 76% higher than Q1 sales, in dollar value.

Wayne Johnson – Raymond James

Okay that sounds terrific. If I could ask on a rate of implementation, you partially answered that it sounds like the second quarter wins are starting to implement now. How long will it take, let’s say steady state in a vacuum, no more customer wins, which we want, and we are hopeful. But let us just say that is was a vacuum right now for the sake of conversation. How long would it take you to implement your remaining customers that you have won, that are in the backlog today?

Ray Crosier

A couple of quarters. In my comments last quarter, we talked about slowing implementations. One of the beauties of Online Resources and our staff is when we focus on something, we really do good things. And we did. We focused on it. We made some changes in how we did, how we executed in some of those areas, we have significantly shortened the time, we launched two of the Q2 top ten cards issuers, and we launched them within 30 days. Those used to take six months. I think we’re in a good spot right now. So we never sold another thing, we would probably run dry in a couple of quarters.

Wayne Johnson – Raymond James

That’s helpful. And then on the expedited payment side, can you give us an update on how that’s tracking? What kind of uptake has there been? Has there been a particular venue where it’s been used more successfully, or utilized in higher numbers than in others? Can you just give us an update on that new service?

Matt Lawlor

Sure. This is Matt. First, the product is performing well. That’s most important. It works, it’s well integrated, and it’s ramping pretty much as expected. The consumer feedback has been very positive. We’ve done a number of surveys and they’re saying all kinds of things that we want – not only in terms of the experience, but in terms of – even the pricing seems to be acceptable. The growth is coming from the obvious places – it is your mortgage, it is your credit card, it is your cell phones – it’s those areas where you’d expect. So there are no surprises there. And it’s very consistent with the expedited payments experience on the biller side of our business. We’ve also made some big progress in adding to our biller network, where we’re connecting our banks directly to the billers. That network is not only expanding for normal kinds of payments, but we’re adding the ability to do it same day and by adding some major end-points, which enable the consumer at the end, who is working with the bank to be able to pay more bills in an expedited way. So that’s an important part of the consumer experience and the product’s potential success. On the negative side – before I finish, I just want to make sure we’re balanced about it. We’re really slow in getting our big banks going, Wayne. It is the gap between having this product being a good solid product and an absolute winner. And the reason why we are slow is that we tie into other front-end software that is operated by our big banks. We’ve taken a bunch of steps to address this. The big banks that use us really want the product. They understand what it does for them. They see what’s happening in with the smaller banks, and we’re determined to get that fixed. It is separating us from being able to report some experience that, in fact, could be a material contribution to revenue.

Wayne Johnson – Raymond James

So what would be a timeline for integration with that front-end software at the bigger banks?

Ray Crosier

We can’t give you that, Wayne.

Matt Lawlor

It depends on how much work that the client has to do, if they are using somebody else.

Ray Crosier

It’s industry cooperation, as well. We’re comfortable that the software providers of our clients want to do what is right for the clients and not necessarily right for ourselves or themselves. So, we’re comfortable we’re going to get there. We’re carrying our discussions with a variety of vendors. But I’ve got to say we don’t have any near-term progress here, we are looking at that towards year-end.

Wayne Johnson – Raymond James

That’s great. And just two quick follow-ups on that and I’ll get back in queue. The number of banks you’re enabled at and the number of retail outlets you’re available at, for expedited payments?

Ray Crosier

Banking ex-pay is about 500 financial institutions. That was deployed the first quarter, there has been (inaudible) we basically deployed it to everybody who had the ability that we control the front end. On the walk-up side, I couldn’t tell you that one. We’ll have to get back to you. We’re enormous in the walk-up billpay market. Walk-up, there are about 15,000 retail locations that we’re now into, DolEx Global et cetera. But again it’s relatively small volume at this point in time. But we are there; we are there and hooked up.

Wayne Johnson – Raymond James

All right. Thank you. Appreciate the effort.

Operator

The next question comes from the line of Brett Huff of Stephens Incorporated.

Brett Huff – Stephens Inc.

Good afternoon and congrats on a nice quarter. I have just a couple of quick questions. On the internal growth, Cathy, you gave us that number last quarter. Would you be able to give that to us again this quarter?

Ray Crosier

Organic growth you mean, Brett?

Brett Huff – Stevens Inc.

Yes.

Ray Crosier

It’s pretty much 10% to 15%, in that range. Without the client losses, it’s about 10%. When you start factoring in the float, it comes about 15%. So 10% would be a good number to work with absent the float.

Brett Huff – Stephens Inc.

Following up on the implementation question that was asked earlier, it sounds like you have closed some nice deals this quarter. How should we think about that as adding to whatever baseline that you all are thinking about when you look at ‘09 revenue? Will those things add to ‘09 meaningfully that you close this quarter, and I don’t know, Ray, if that is a question to you?

Ray Crosier

With respect to the web-based collection product, what we’re finding interesting with that is, we can get it up pretty quickly. But all of these great big giant guys who want it for their card portfolios and their mortgage and auto loans, et cetera really need it customized. So what they do is, we go live, they open it up, they get some experience with it and then figure out how best they need to customize in the market. And they come up with those specifications given to us and off we go in the professional services world. So it probably takes six to nine months for that thing to really start to click. So even the ones that we sold in the second quarter and got live, they’re really not going to do anything meaningful for us this year, and probably not for the first quarter or so next. But we certainly have high hopes for them after that. When I look at it the Banking side, I think about some of the Command sales, our hosted, customizable internet banking and bill payment suite that we sell. We got three or four of those guys live in Q2. It is kind of a similar story, they come with some existing users, but it’s a very new consumer experience, and it really takes a little bit of time to ramp, and some of those folks are implementing in chunks. They will bring up internet banking first, keeping their current bill payer. Then they’ll then convert the billpay business when it’s the appropriate time and the contract is up. They’ll bring on account opening, et cetera. So those revenues in those clients ramp over time as well. It’s very unlike, says a year or so ago, when we would get a conversion and you just throw a light switch and a 100% of the revenue comes day one. It is not quite like that. But I would expect the recent sales and the ones that we’ll make here in Q4 should produce for us in the second half of next year.

Brett Huff – Stephens Inc.

Okay, that’s helpful. And Matt it was helpful that you broke out kind of your customers and the fact that 33% or so are credit unions. As I recall, the credit unions often – you often had a lot of success in co-marketing with them. But in general, I guess my question is – do you still have a lot of headroom in terms of penetration in that particular group, or more or less sort of room to grow organically in that group versus others, in terms of billpay trend growth?

Matt Lawlor

Credit unions over time have tended to be very high adoption rates for account presentment – internet banking. But they have been slower at billpay adoption versus their community bank counterparts, who are lower in presentation, and use the charge for it in fact and higher on bill payments where they’re more comfortable with transactions. The gaps are closing, they’re looking more and more the same; and frankly right now, it’s not even a factor in our planning, we mop them together and together, we do think that adoption will continue to expand, particularly in bill payments. We had a very good lift in the third quarter over second quarter. In fact, it was unusually large and I wouldn’t take that to the bank – no pun intended. There were some cross current factors that lifted the adoption rate this last quarter versus the prior quarter that won’t be repeated the next quarter. But bottom line, adoption rate continues to go up, as we expected, in both of those segments.

Brett Huff – Stephens Inc.

Okay. And then just a couple of more questions and I will get back in line. But I recall that the eCommerce, we talked a lot about the eCommerce margin. Can you give us a sense, even if it is just qualitatively, of where we are versus sort of the overall business on that? And sort of how quickly we think that that scale will benefit, to give us some confidence in margin expansion in ‘09?

Matt Lawlor

I would say, and Cathy can also elaborate. I would say we’re 40% of the way there. I’m not going to give you a specific EBITDA margin target, but we’re 40% and feeling real comfortable that we’re going to get there. Obviously, the division is doing fantastic. And the markets – we hit the markets right with the web collections; the upside on web collections is enormous. We’re now beginning to model, because we have enough experience with what the adoption rates are with consumers. And there is a learning period with our clients; they learn how to market it with our help and their ingenuity. But we’re getting great success and the market size is potentially enormous. And I will say, in the last year we’ve had very good success at transforming our pricing model from one of just a simple software license fee like payment to us to one that’s performance-based. So there is some real upside in our eCommerce division. This is high margin stuff – we are paid by the payments that are actually in the web collections. And we could get to our goals much faster than we would like. Now I’m sure Bob Craig sitting there at the other end of the line kind of saying, “What’s Matt doing, over-committing my division?” But I have great confidence in Bob. His team is doing fantastic and we’re confident we’re going to get there and I would estimate Cathy, would be at about 40% of our target in that range?

Cathy Graham

Yes, it varies from month-to-month, but in the 40% to 50% of the way there, we’ve got a lot of head room to go on growth.

Brett Huff – Stephens Inc.

Okay. And then last question is, Cathy, then I just wanted to make sure that I understand this right. It’s 28% exiting 2008 for pro forma EBITDA?

Cathy Graham

It’s 26% or better.

Brett Huff – Stephens Inc.

26% or better. And just to be clear, does that mean that Q4 will be 26%, or that Q4 in the last week, or whatever it will be?

Cathy Graham

Exiting Q4 will be 26% or better.

Brett Huff – Stephens Inc.

Okay, that is all I had. Thank you.

Operator

Your next question comes from the line of Doug Campbell of Spirit Capital.

Doug Campbell – Spirit Capital

Thank you. I have a couple of questions. First, – I was in another call because of traveling. Could you reiterate your goals over the next several years for a percent of your clients will be utilizing your billpay services, and if so, what was that? If you didn’t, are you pretty much on track, assuming (inaudible) statements over (inaudible)?

Matt Lawlor

Doug, this is Matt. We did not reiterate those long-terms goals. We are generally on track with those long-term goals and we will update those long-term goals as we do traditionally, on our fourth quarter year-end call, which is usually in February, where we look back at the year, and we look forward and reestablish the new long-term goals if it’s appropriate.

Doug Campbell – Spirit Capital

And your performance fees on web-based collections – is there a formula there based on the amount collected, or is that an event based if you collect something regardless of the collection size? How does that work?

Ray Crosier

As Matt mentioned, when we first came out with the product, it was a hosted software kind of model. We got some experience and we started to see how well it would perform. Certainly the largest clients are going to be on a transaction basis, but as we move further down in the other portfolios, we are looking and have been successful in getting paid as a percentage of the dollars collected. And that is what is skinning the game for us. We won’t come in with a big implementation fee. We’ll get it in, we will get it live, we will get it going, and as our client wins, we win. And that’s a very good model for us. But getting paid a percentage of what’s collected is good. And one of the facts that I think lends itself to that conclusion is currently 44% of the people who log in to web-based collections across everybody who has it live, make a payment. That’s unbelievable. Then you think these are people dodging, they are hiding from collectors, yet they are coming into this channel and making payments.

Doug Campbell – Spirit Capital

Can you indicate how many clients you now have, and how the pipeline looks, and how are you marketing this?

Ray Crosier

I talked about six of the ten top credit card providers – and 14 of the top 20 – but we have got it in our slew of asset receivable management clients too. I apologize, let me just say it is a dozen more, something like that. But we are probably in the 20-25 range, pipeline is very healthy.

Doug Campbell – Spirit Capital

Do you have a dedicated marketing effort or is this rolled in with other activities?

Ray Crosier

No. It is a dedicated crew that does that, it’s integrated too. Again, we are selling a suite of services to billers. And there might be a generalized sales person, but there is also a product-oriented sales person who focuses just on that product. And that person is matched up with dedicated sales engineers and dedicated product specialists.

Doug Campbell – Spirit Capital

You mentioned earlier on the call new products that are out there. Do you want to have any discussion at all of what might be coming down the pipe?

Matt Lawlor

I guess the main thing right now is you have heard mostly about our products – we’ve talked about mobile banking, we’ve talked about some of our PFM software, we’ve talked about business banking, we’ve talked about banking expedited payments, we’ve talked about account opening, we have talked about mobile. If anything, Online Resources has too many new products and we have really last year kind of had to pull back and say, “Look, we need to execute on these products” and we’ve now really stopped developing and really started selling. So the priorities right now are banking expedited payments to get that deployed, it is web-based collections, we’re having great success with account openings, and we’re having good success with our Command product for customized internet banking. That is not to say that we’re not seeing success in some of the other services such as business banking, mobile banking and so forth, but the priorities for the company are the ones that I outlined.

Operator

Your next question comes from the line of David Parker of Merrill Lynch.

David Parker – Merrill Lynch

In regards to the lower interest rate environment, I believe that you said earlier in the year that these investments would become more immaterial as average payment processing times decreased and you held the funds in transit for shorter periods. Can you just update us on the progress of that or are that still quarters away from now?

Cathy Graham

No, we’re actually seeing that. What we are seeing is obviously our number of payments is growing, but we’re seeing our float balances stay relatively flat, which is meaning that it’s being – even though we’re processing more payments, higher electronic rates and lower clearing times are holding us at about same balance that we had at the beginning of the year.

David Parker – Merrill Lynch

So, it’s still in that $150 million to $200 million?

Cathy Graham

Yes, average is around $175 million and we really haven’t seen that change.

David Parker – Merrill Lynch

Okay. And then just – congratulations on renewing TD. You mentioned that there were some volume commitments along with that new contract. Were there any concessions that you gave to them? Or anything you can mention in regards to that contract?

Ray Crosier

Certainly, I can’t talk about particulars of any client contract. But we had previous relationships with both of those, and they weren’t identically priced and they weren’t identical contracts. So, it was important for them and for us to get a single document, a single piece of paper, with a single set of terms and conditions that were advantageous to both of us. Obviously, you get a little bit from more volume commitments and that’s good for us and good for the client. But that’s pretty much the extent of it.

David Parker – Merrill Lynch

Okay, great and then just a last question. You reduced your head count by about 5%. And I think I heard you say that you’re going to maintain that or it’s going to be constant in 2009? Or are you going to be doing some hiring in some growth areas? Can you just clarify that?

Ray Crosier

Obviously as the business grows, we need to add positions. And I will give you a couple of examples. In the call center, as we add more clients, calls go up; we have to have to add more focus in that area. As we make more sales, we are probably going to need some more project managers to implement those sales, and we might want more sales people. As you look at where there is a return on the investment, we’re obviously going to add. Where we (inaudible) as we went to areas that didn’t have immediate payback. As we reorganized, we saw that we had some extra room, and that is how we are going to afford them over the next several quarters. But you are right, David, we are essentially going to do our best to hold the total head count number flat from where we are today.

Matt Lawlor

And needless to say, David, if our revenue expectation ends up being higher, again, we are going to be conservative and do not count on a lot of the upside, but if the sales expand, we will obviously want to support that growth. We just want to right size the business to where we are on the economy right now.

David Parker – Merrill Lynch

Understood. That is great, thank you very much.

Operator

There are no further questions at this time.

Matt Lawlor

Thank you everyone for participating in the call. I will now turn it back over to Beth for the final Safe Harbor statements. Beth?

Beth Halloran

As a reminder of our intent to take advantage of the Safe Harbor provisions, any statement in the preceding conference call that is not a statement of historical fact maybe deemed to be a forward-looking statement. These statements include forecasted growth in Online Resources’ customer base, increases in transactions being processed by customers, and growth in the number of consumers using online banking and bill paying services.

Other forward looking statements include those regarding Online Resources’ business outlook for 2008 and beyond and statements containing words such as anticipate, believe, plan, estimate, expect, seek, intend, and other similar words that signify forward-looking statements. I encourage you to review Online Resources’ detailed periodic filings with the Securities and Exchange Commission for a full disclosure of risks and uncertainties.

Thank you for joining us. This concludes our call.

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Source: Online Resources Corporation Q3 2008 Earnings Call Transcript
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