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Executives

Matthew P. Lawlor - Chairman and Chief Executive Officer

Catherine A. Graham - Executive Vice President and Chief Financial Officer

Raymond T. Crosier - President and Chief Operating Officer

Beth Halloran - Sr. Director, Corporate Communications

Analysts

(Derek Klein - Unknown Firm)

Robert Napoli - Piper Jaffray

Glenn Greene - Oppenheimer & Co.

Wayne Johnson - Raymond James

Brett Huff - Stephens Inc.

John Kraft - D. A. Davidson & Co.

Thomas McCrohan - Janney Montgomery Scott

Online Resources Corporation (ORCC) Q4 2008 Earnings Call February 26, 2009 5:00 PM ET

Operator

Good afternoon. My name is Marlene Sharon, and I will be your conference operator today. (Operator Instructions). And now it gives me great pleasure to turn the call over to Ms. Beth Halloran.

Beth Halloran

Thank you to everyone who has joined us today on our conference call for fourth quarter and full year 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 in the press room of our website at orcc.com. In addition, we will be referring to several slides that are also available with the press release labeled, “Fourth Quarter Earnings Call Slides.” For those of you joining us online, we have incorporated these slides in our webcast, which is available in the Investors Section of our website.

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.

Matthew P. Lawlor

Welcome everyone. Our call today will cover two topics. First, we’ll review fourth quarter results. In a nutshell, our fourth quarter cash flow and earnings increased nicely over the third quarter of 2008 and we had excellent new client sales. Transaction growth moderated somewhat, however, causing lower than expected revenue. Second, as we typically do each fourth quarter, we will take a long term look at performance and set some new three-year financial objectives.

I’ll now turn the call over to Cathy to report on our financial results.

Catherine A. Graham

Good afternoon everyone. Today, I’d like to comment on our fourth quarter and full year 2008 financial results as well as our already issued guidance for the first quarter and full year 2009. Fourth quarter and full year results with the exception of net GAAP net income were below our expectations, due to lower than anticipated transaction volumes and payment, average payment amounts, during the 2008 holiday season. Ray will give you more details on this in a moment.

GAAP net income for the quarter and year exceeded our expectations because of derivative mark-to-market adjustments that benefited the interest expense line. Although revenue was lower than expected in the fourth quarter, we were still able to generate a substantial increase in cash flow and earnings over the prior quarter. This reflected the permanent and temporary cost control measures we implemented to offset increased revenue uncertainty in the current market environment. Ray will tell you more about these measures as well.

Additionally, we met our goal of achieving the 26% EBITDA margin in the fourth quarter, and we stand by our goal of improving that to at least 28% by the fourth quarter of 2009. On a full year basis, revenue increased by 12% due to year-over-year adoption and transaction growth, and to a full year’s revenue from our ITS acquisition. Although, full year EBITDA and free cash flow and core net income were flat with 2007 results, both would have been more than $5 million higher if interest rates had stayed at 2007 levels.

We strengthened our balance sheet during the fourth quarter, increasing unrestricted cash, equivalents, and short-term investments by $6.4 million to $24 million. This was after repaying another $3.2 million in principal on our senior debt, reducing its balance to $75.4 million.

As you can see from Slide 1, in 2008, we generated $5 million in free cash flow after bank debt service. We expect free cash flow to increase to $8 million in 2009, even after a $6 million increase in scheduled principal repayment. Continuing to look forward, we are not changing our previously issued guidance for either the first quarter or full year 2009. We are comfortable with our current cost structure and confident we can respond to changing market conditions. And while we have already taken action to ensure the continuing health of our business and bottom line, we still have additional levers that can be pulled if necessary. We anticipate continuing to generate cash and increasing our cash balances and still keep pace with product development, maintaining infrastructure, servicing debt and making scheduled repayments.

That said, we need to recognize that uncertainty has increased in the current environment. This combined with the unusual fourth and early first quarter transaction slowness we experienced would suggest conservatism. This is particularly applicable to revenue where we have more limited influence over sales cycles and consumer behavior patterns. We believe that revenue could be at the lower end of our guidance ranges, particularly in the first quarter where we have not had the time to see how some of our upside opportunities play out.

However, given our expectation that we can control costs to produce margins on revenue for 2009, we would not make the same suggestion with regards to our earnings measures.

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

Raymond T. Crosier

Today I’ll cover three areas. I’ll start with fourth quarter transactions, which were lower than expected, yet pretty much inline with others in the industry. I’ll move to market share advancement where we really moved the needle with strong sales and renewals. Then I’ll conclude with some comments on how we proactively managed to the bottom line, given the uncertain economy, which resulted in the strong sequential earnings growth and increasing cash flow that Cathy just highlighted.

As you can see in Slide 2, both banking and eCommerce payments slowed, but for different reasons. Banking bill payments was adversely affected by how the calendar played out with respect to processing days in the quarter. It could also have been affected by consumers’ view of the economy and how that factored into the payment behavior.

On the eCommerce side, slowness was in the User Paid payments, the majority of which we get from our Asset Receivable Management, or ARM clients. You think in an economic downturn that industry would be booming. Actually it’s just the opposite. Consumer delinquencies are rising and placements are up at our own clients. But at this stage of the business cycle, stretch consumers make fewer payments and for smaller dollar amounts, both of which impact our revenues.

Moreover, since a user paid transaction generates dollars for us instead of cents, that hurt the quarter’s revenue. As the economy recovers, we expect to see this reverse.

Having said all that, January transactions were inline with December’s and February’s are ahead of January’s. While it’s still too early to draw any conclusions from that, they are nonetheless positive signs.

Moving to Slide 3 and market share advancement, we had a great quarter. We renewed 11 current top 100 clients and added five major new ones which we expect to move into that group. Banking added Apple Bank, a $7 billion institution, converting to our full suite of banking, payment, and value-added services. The second we’ll announce soon. The banking division also renewed four of their major clients. eCommerce added three big clients, two of which are very large card issuers, who purchase web-based collections. We now serve 6 of the top 11 issuers in the country with that product. Additionally, the team renewed seven of their major clients.

Turning to my last Slide #4. We’ve been proactively managing the bottom line for several quarters now, given the uncertainties with this economy. Back in the spring, as a precautionary measure, we enforced hiring freeze on new headcount. Then in the fall, we right-sized the business with a 5% reduction in staff, curtailed non-essential CapEx, and allowed senior management to exchange a portion of their cash compensation for equity.

Just recently, we reduced salaries 5% to realign our compensation framework with the current market and we continue to control discretionary spending. And so you know, we have the flexibility to do more if need be. We will stay ahead of the curve and meet earnings objectives. And the way we’ll do that is by serving our clients well and maintaining our high service quality. There we won’t cut back. We continue to travel, meet with our customers, and expand and deepen relationships, and we will continue to investment in whatever level of infrastructure it takes to meet the needs of our growing business.

Before turning it back to Matt, I’d like to take this opportunity to thank our staff who has remained positive throughout all the change. They’ve repeatedly told me with their words and their actions that they believe we’re on the right course, and agree with the steps we’ve taken to assure our longer term success. Their support and continued strong effort is very much appreciated.

Matthew P. Lawlor

As we have done during our fourth quarter earning for 10 years of the public company, I will review our long term performance and future financial goals. Let’s begin with a look back to better understand our look forward.

Turning now to slide 5, revenue has grown consistently at a compounded annual rate of 31% per year. Note in the chart that the gray colored bar shows 2008 actual revenue and 2009 guidance adjusted for interest rates. Our new three year strategic revenue goal is 10 to 20% reflecting moderated growth in 2009. Setting this target we used an average bill pay transaction growth rate of 13% over the next three years which is inline with what most industry analysts forecast. In addition, our targets factor in increased service per client and appropriate increases and market share offset by expected pricing decline.

Turning to slide 6, EBITDA has grown very robustly until 2008 where we were flat. But as Cathy discussed, we expect to exit 2009 at a 28% EBITDA margin, giving us the confident that we can reach our 30% goal for full year 2011.

Next, slide 7 shows our core EPS performance. After the short decline in 2006 caused by the Princeton acquisition debt, our compound annual growth rate was 30%, and number of factors point to substantial growth in EPS over the next three years. First, we expect increased volume over a relatively fixed cost. Second, repayment of debt is accretive. Third, large increases in spending for product development and staffing have tapered off. And lastly, the drag from interest rate declines and client losses is likely behind us.

In setting these goals we’re mindful of a number of risks. One cannot ignore the uncertainties in the banking system and in consumer billpay patterns. This is particularly important given its potential adverse effect on revenue growth where small changes have an amplified impact on the bottom-line. We also need to keep a close eye on pricing, though we see unit cost continuing to decline in parallel.

On the up side, I’m heartened by the continued demand for our online services in both the banking and commercial markets. We benefited from trends towards outsourcing, conversion of paper to electronic payments, and the use of the web as a cost-efficient sales channel. This also bodes well for our new products and increased market share. This first series of slides showed how we performed historically. The next three slides take a look at how we performed versus expectations. Note that for each period we state the guidance range and mark the actual with a diamond.

Slide 8 shows that we did a fairly good job at predicting quarterly results. Slide 9 and 10 show that our annual revenue and earnings predictions were in zone, but at the low end following our acquisition of Princeton.

While we have done a relatively good job of predicting in the short term, I should add that we could have done a better job hitting our three year targets. As uncontrollable as the circumstances were, the acquisition related departures and interest rates factor equate to approximately $20 million in annual EBITDA that isn’t going to materialize in 2009. In sum, as forecast periods lengthened and the company grew in complexity, our ability to predict future results declined. At the same time, given our recurring business model, our ability to predict future results is much better than most other companies.

Slides 11 and 12 compare our performance versus our financial technology industry peers. Using data provided by FD partners, we show the range of revenue and earnings growth for 49 FinTech companies for each year. Note that the data for each year is divided into quartiles. The horizontal line in each column marks the quartile and rank of online resources compared to its peers. The company has been in the top quartile of performer in both revenue and earnings most of the years 2004 through 2007. We were more affected by lower interest rates in 2008 than our peers and fell into the second quartile.

Interestingly looking forward, the investor analyst rank us conservatively in the second quartile of revenue but in the top quartile of earnings expectations in 2009, 2010, and for the three-year period. While we think we can do better in revenue, we are pleased that they understand the leverage in our model.

Finally, in reviewing our strategic performance, slide 13 shows our expansion beyond the community banking niche to a powerful diversified provider of online financial services to multiple complementary markets. Slide 14 highlight significant growth in our operating metrics over the last five years. To sum it up, we’ve truly transformed the company all the while keeping our financial performance strong relatively to historic benchmarks and relative to our peer group. Our track record of projecting our performances mixed, and we must better account for market and execution uncertainty.

I’d like to turn now to how we plan to deliver on our long term financial goals of 10% to 20% annual revenue growth, 20% to 25% core EPS growth and 30% EBITDA margin. As you can see on slide 15, we have three key priorities. Our first is to complete our five year strategic plan developed in 2007 after the acquisition of Princeton eCom. At the heart of the plan, we have married our network of banks with Princeton's network billers. This has created meaningful cost synergies and now as we look forward, sizable potential revenue opportunities.

On slide 16 we show the strategic growth plan as presented to investors in 2007. We are still only half way through the plant, but I believe you will see that we are very much on track. By the end of 2009, we expect to hit 12% consumer adoption of billpay as set forth in the plan. We increased option 1.5% points last year but lower interest rates ate up all the benefit. Assuming rates are added at rock bottom and all other factors such as pricing stay equal, I believe we can return about $0.80 per share with every 1% increase in adoption moving forward.

In the second phase of the plan, we look to increase Biller Service Provider or BSP market share. Indeed, we have doubled eCommerce revenue since 2006 and we expect continued high growth over the next few years. We expect this growth to shortly increase eCommerce division margin providing further left to achieve our corporate EBITDA margin target.

Also in the second phase of the plan, revenues from seven new products built over the past few years are starting to be harvested. Our web-based collection service for example had potential any revenue for $10 to $35 million. This is based on full deployment and slowly raising adoption with confirmed clients who include six of the top 11 credit card issuers in the US. Obviously, we are also looking to increase market share to other consumer credit providers, banks, credit unions, billers and collection firms.

In the final analysis, our level of success in harvesting new products rests with getting the services quickly into the various distribution channels than getting consumers to adopt them. We know these fundamentals well and are looking to adapt our bank consumer marketing to these new channels.

We are mid way through the five-year strategic plan, so we are just entering the third phase. We have started technology and business development, positioned our unique online data capabilities. We have also invested in new advanced CRM capabilities to cultivate and support cross-divisional opportunities.

Finally, as a continuing growth plan priority, we have looked to build market share, both organically and by acquisition. Here I’m really excited about the possibilities. In addition to the substantial increase in eCommerce market share I’ve already discussed, we are making great progress in the banking markets. I believe we have a winner in our highly integrated customizable internet banking offering, add value that no core processor can match.

Turning now to Slide 17. It is more important to than ever to execute on our fundamentals. This means leveraging our relatively fixed cost base, with recurring usage fees to drive increased cash flow and profit. Note the little plus sign beside our 30% EBITDA goal. We want you to that know that we have not given up on achieving margins in the mid 30s. This is achievable under better interest rate circumstances and adoption of some of our new high margin SAS products.

Cathy has already shown cash flow expectations for 2009 and our current cash position. We have a comfortable cushion in covering our debt and are confident we can keep it that way with a relatively visible business model. I appreciate that investors are concerned about the level of debt and the impact it has on our stock price, but there is a silver lining. It certainly keeps us focused. Debt reduction also will have a major accretive impact over the next few years as we pay it off.

Turning now to our third long-term priority, navigating choppy waters. Slide 18 shows you how we look at the uncertainly associated with our weakened economy. Under normal conditions, our business model gives us a lot of financial visibility. The current down economy obviously increases uncertainty. Managing in this environment requires that we be proactive and constantly vigilant.

As Jeff Immelt at GE says, quarterly meetings become monthly, monthly meetings become weekly, weekly meetings become daily. Thankfully at Online Resources, Ray insists we keep the meetings short. Ray has also described one of the cost initiatives we -- some of the cost initiatives we have already taken and I echo his comments on how well our staff has responded. But not all of our cost control is tactical. We are also addressing our cost strategically.

Slide 19 shows that we’ve made great progress in developing our end-to-end online payments network. When we combined with Princeton about 30% of electronic banking payments were captive to our biller network at little or no cost. Today, over 50% of these payments are processed in network. We are confident that we can do 70% or more.

Please turn now to Slide 20, the final one in our presentation, yes let me join you on a rising share. There are several takeaways from this strategic review. First, our financial performance has been relatively strong and barring further economic shocks, recent slowing in growth should reverse. Second, our strategy is right on and we’re seeing through. We’ve made the investment as fellow shareholders, now let’s reap the return.

Finally, I would like to acknowledge that 20 years ago, this past week this company was founded. It started on the bootstrap and the trust of clients, staff, and shareholders. That trust was built on transparency and a genuine desire to do the right thing over the long term. I like to thank all of you who made this journey possible. The best is yet to come.

We’d be happy to answer any of your follow-up questions. Thank you again for listening.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from (Derek Klein).

Derek Klein

Just a quick question on pricing Matt; can you just a little bit, you said price declines are inline I think with the passing of 5% and costs are inline with that, but can you just elaborate a little more what you’re seeing on pricing?

Matthew P. Lawlor

Yes, you’re right Derek. It’s been about 5%. We see 4 to 6% year-over-year and quarterly declines. Last quarter we saw flat, no change in pricing and this quarter we saw 2%. And, I don’t want to get optimistic, but there are some parallels perhaps with online banking. There were pricing declines as the product took off, a lot of leverage against fixed costs, those prices came down and then began to decelerate. It’s pretty mature to say that we’re getting deceleration in billpay pricing, but there as some signs of it. We nonetheless took basically the same kind of 4 to 6% cost declines in our long-term projections. Remember too that we’re levering on those declines, margins are in fact increasing while we make those assumptions of 4 to 6%.

Derek Klein

And then secondly, I want to just go back to the guidance you gave for EBITDA for ‘09, and if I go back to the slide that you put up in your Analyst Day, you’ve gone through some of this and you’ve answered part of this. But I want to just understand better how you get from call it just over $30 million in EIBTDA to $40 million for ‘09 and what looks like to be a very challenging environment. Particularly, when I look back and I’m referencing Slide 81 from your Analyst Day, this is the slide titled Metrics History, where it appears that the only segment that really posted revenue growth is Biller Paid?

Matthew P. Lawlor

I’m not sure. We don’t have, we’ll look to get to access to Slide 81. Remember a couple of things and I’ll let Cathy chime in. Remember, when you look over 2008 and 2007, year-to-year is 12%. Let’s just start with the removal of negatives. In 2008 versus 2007 there was a huge impact of clients that had departed our platform related to acquisitions that we would have made or acquisitions of their businesses by others. And there was a huge impact in interest rates. Going into, interest rates for example went down $5 million in revenue and in EBITDA from 2008 to 2007. There is another $4 million in EBITDA that we assume in 2009 versus 2008 caused by declining interest rates. So that continues, but it’s offset by, first we’re not spending anywhere near the levels that we have spent before in terms of new products, advancements, staffing, all of that gearing up, scaling up the company doesn’t happen anymore.

Second, you’ve got without the interest rate declines other than what we’ve all assumed because they are at rock bottom, the leveraging of almost $0.08 a share from every 1% increase in adoption rate. So, when you put it together, I think I went through this, strategically we are very comfortable with hitting the EBITDA number of $40 million versus the roughly $32 million that we came in this year. Cathy, if you want to just we now have the slide and maybe we can answer your question directly on that.

Catherine A. Graham

Actually, I think I’m going to just go with, I know what it is that you are looking at. I think what we’re looking at here is that instead of talking and Matt let me referred to some of this, instead of the fact that the growth in EBITDA that we expect from 2008 to 2009 being unusual, it is more that the EBITDA in 2008 was really held down by factors. And the ones that he already mentioned. So, just the combination of what we would expect to see from, our increase in operations coupled with the cost savings that we will get in this year. Then what you are going to end up having is the fact that you are not seeing the impact of large loss clients and you are not seeing the kinds, the same kind of decline in float interest, that’s the reconciliation for us.

Matthew P. Lawlor

Derek, I believe, I don’t want to be beat the subject to death here. I don’t think we’ve been as crisp as we should have been answering your question to be quite honest. There is very specific information. If the investors and listeners want to go to the slide in the Investor Analyst Day presentation, Cathy reconciled our guidance and there was a slide in there and that’s specifically in hard numbers reconciles how we plan to achieve the $40 million versus $32 million this year. I think the general themes that we talk about here are the same, but she has specific numbers that actually do that.

Catherine A. Graham

And this was Slide 83.

Derek Klein

I see it, yes.

Catherine A. Graham

If you want to pull it up. So, primarily what you are seeing is a reduction in float earnings, residual impact of large client losses, but over $10 million in services, in EBITDA from services revenue growth.

Derek Klein

Okay. And I want to allow other investors opportunity to ask questions. But one more question I have is just looking over the Slate of Canada, it’s put forth by Tenenbaum, I want to ask why you wouldn’t want a guy like John Dorman on your Board?

Matthew P. Lawlor

Derek, we would love to answer that question and we’ll answer the question, but we can’t answer the question until we file our proxy material. So, I need to beg off, but we’ll be very articulate and comment on that when we are allowed to legally.

Operator

Your next question comes from Robert Napoli - Piper Jaffray.

Robert Napoli - Piper Jaffray

Just looking at some of the trends on the User Paid, essentially the user paid transactions have declined. It’s pretty much straight through ever through quarter this year and the, just to understand, is there, I mean what do you expect out of the User Paid transactions in 2009 and what’s going to turn; do you expect that to continue to decline in that way, or is it all in the collection side, what is driving that sequential quarter decline?

Raymond T. Crosier

You can see, actually looking back several quarters, it’s relatively flat with 4Q. But I mentioned in my comments, that particular segment of our business is really a lagging indicator, not a leading indicator. As the economy worsened, think all the way back to Q1 of 2008, then what happened in the media in 2Q and then 3Q and so forth. Lay offs started to happen, people started getting their pay cuts, all kinds of wild and crazy things going on out there in the real world. Sure enough, delinquencies go through the roof. You’ve read that from every card issuer who have astronomical delinquencies right now. So, placements go up as it relates to that.

Unfortunately, people don’t have the money to pay those debts. So, while the pipeline is starting to build within the automated and collection industries, they can’t get more transactions, more and more dollars out of the rock. So, really what we’re going to see is as the economy makes the flip whenever that is, that that bulge starts to reverse itself and our transactions go the other way, they go north. When that’s going to be, your guess is probably as good as mine, but we continue to add new clients which hopefully will either keep us flat or slightly increase while we wait for that to happen.

Robert Napoli - Piper Jaffray

Yes, you are correct. The transactions are flat. I guess the revenue has declined. On pricing, the revenue per transaction while it’s still extremely high relative to anything else that you have; do you expect to continue to decline? I mean is that a mix issue or is it a pricing issue?

Matthew P. Lawlor

Bob, it’s a function of the dollar size of the transaction. If someone pays a $500 debt or bill, we get more than if someone pays a $50 debt or a bill. So as I mentioned, we’re not only seeing fewer transactions, but the dollar size had gone down, so therefore our dollars per transaction have gone down. And you hit the nail on the head. In the rest of our business, where we’re charging cents per you can drop transactions and it doesn’t have much of an effect. But in this particular segment you dropped transactions and dollar size, you see it and you actually saw it in 4Q.

Robert Napoli - Piper Jaffray

Let me ask, on the Biller Paid, conversely the trends there actually better than what we thought. And the pricing, the revenue per transaction is actually gone up each quarter. Why has the revenue per transaction increased, is it new customers with different products or new products, what is driving that increase and what do you expect in ‘09 on….?

Matthew P. Lawlor

Bob, that’s exactly what it is. It’s all about mix. We’ve added some new clients and we’re actually into two new verticals that we typically haven’t been in and the transaction per is something in between the dollars that we see it in the User Paid and the lower cents that we’ve typically seen in the Biller Paid, so we’re getting a pick up there.

Robert Napoli - Piper Jaffray

Then just last question; a number of people have written down goodwill this quarter, you did not, why did you not? And if you have to in the future, is there any effect on any of your banking covenants?

Catherine A. Graham

The answer is we went through the analysis as of 12/31. Actually we had done it on an annual basis in October. We did it again given share prices and market cap declines as of 12/31. And the analysis indicated that we did not have an impairment. That is not to say we will not in the future. If market prices, if our stock price stays down at the level it is or drops further or a number of other factors, we could have an impairment this year or in the future. However, that would have no impact on our debt covenants or anything else having to do with that.

Operator

Your next question comes from Glenn Greene - Oppenheimer & Co.

Glenn Greene - Oppenheimer & Co.

First question, I was just wondering, maybe Cathy can help me with this, how much revenue lift do you think you’ll get from new business that you signed in ‘08 or even early in ‘09, likes of the Apple savings on other certain notable wins that you had, how much incremental revenue could you get?

Catherine A. Graham

You know Glenn, I think in 2009 we’re not going to see this be materially different from the numbers we’ve given you guys in the past, which is that if you look at -- if you look at our revenue for the year, it’s somewhere in the neighborhood of 5 to 7% of revenue comes from people who are not on our system as of January 1st. Particularly, the things that we’ve talked about, a lot of them are in our Banking Command world, which is more customized and these are longer implementations and so they would -- we’re not going to see these until mid to the end-of-the-year from a revenue standpoint. So, I don’t see a huge difference in ‘08 revenue, but these things should be fully on-board in -- ‘09 revenue, but they should be fully on-board at the end of the ‘09 so for full year of 2010.

Glenn Greene - Oppenheimer & Co.

And then looking at the banking payment transactions, just some of the other questions, but if I look at the sequential trends there on bill payment, they’ve been running $39 million or so, for the last three quarters. What are you factoring in for ‘09 and is there any reason why that hasn’t shown reasonable sequential growth?

Raymond T. Crosier

As I pointed out in my comments, transactions were weak in fourth quarter, particularly towards the end. It is showing signs of stabilizing, but it’s too soon to tell what if anything that means. The economy certainly continues to create a level of uncertainty and therefore lower predictability. But we’re positioned to deliver whatever transaction level turns out to be. We’re hopeful that it rebounds; if it does, that’s great. If it continues somewhat depressed, then we’ll do whatever it is we need to do to hit our numbers.

Glenn Greene - Oppenheimer & Co.

You’ve obviously got a certain amount of implicit sequential growth pulled into your model to get your revenue numbers that you are guiding to, I mean because that’s, this is your biggest revenue line on just sort of wrestling what’s the, the fact that it’s been flat sequentially and we’re in a tough economy, I’m not sure what changes it.

Catherine A. Graham

Glenn, let me pick up on that one. We have for Q1 ‘09 through Q4 ‘09 built in slightly better growth than we had for sort of the Q4, Q2 to Q4 period of ‘08 and the reason I use Q2 to Q4 is that the Q1 to Q2 of ‘08 change really had to do with the departure of one of our large banking clients CNE, that we’ve talked about before. So, we’ve done a step-up from that, but nowhere near in our guidance back to sort of what we would consider to be more normalized transaction growth. So, it’s a little bit of an increase, but not a huge increase and that’s pretty much the reason why we’re confident that should that increase not materialize, we can still manage to the bottom line.

Glenn Greene - Oppenheimer & Co.

I mean is it couple percent a quarter type of thing, or anyway you could us let us know what you are thinking? Or you don’t want to?

Catherine A. Graham

What you need to, I think if you refer to the slides that we post with regard to the sequential and look at the year-over-year growth for Q4, what you’ll see is that we are probably slightly better than that.

Glenn Greene - Oppenheimer & Co.

And then back to the ARM transactions, similarly what have you assumed for the ‘09 transaction trend going forward, I mean obviously it’s tough and we don’t really have light at the end of the tunnel for the economy to get better, but obviously we don’t know yet, are you assuming it gets better or worse than the 1.6 million transactions a quarter?

Catherine A. Graham

It pretty much looked as the same thing, Glenn. We have not assumed that those would grow back to what we would expect. We have not expected that we would see that reversal in 2009. So, we’ve essentially built in transaction growth largely for the fact that we think we can add clients and those kinds of things not for increases or change in consumer behavior.

Glenn Greene - Oppenheimer & Co.

And then…

Raymond T. Crosier

Increases in adoption.

Glenn Greene - Oppenheimer & Co.

Yes, okay. And just finally, what’s your client renewals coming up this year that we should be aware of, any notable clients coming up for renewal, or the mix of your business that might be coming up for renewal?

Catherine A. Graham

Not really. As we said before, we’re now at the point where nobody is more than 3% of our revenue, our top 10 only represent about 16% and we now have our client base including our large clients renewing relatively ratably over a sort of three to four year period of time. There isn’t a clustering coming up in this year or going forward. And given what we’re seeing in renewals, we don’t see anything out of the ordinary or anything we should be concerned about.

Operator

Your next question comes from Wayne Johnson - Raymond James.

Wayne Johnson - Raymond James

Could you remind me again and I apologize for this if you guys have already spoken about it. On the cash flow, what’s the expected cash flow from operations for ‘09 and what’s the expected CapEx?

Catherine A. Graham

Sure. Let me just pull to this, which is what I’m looking for. What we’re looking for, Wayne, is about $28 million in cash flow prior to debt service. After CapEx is about $12 million, okay. So, $28 million…

Matthew P. Lawlor

$40 million; EBITDA $40 million, minus the $12 million and…

Catherine A. Graham

It’s $40 million, sorry $28 million, $40 million minus the $12 million in CapEx, $20 million in interest and principal repayments, which would get to the $8 million in free cash flow after that.

Wayne Johnson - Raymond James

Okay, terrific. And where is that $12 million going, how is that allocated for capital expenditures?

Catherine A. Graham

It’s probably about 55% to 60% in capitalized software development labor and the remainder is in hardware and software. Matt did mention earlier that we’ve sort of moved away from new product development, but we still are in implementation, product enhancement, and infrastructure. So, I would say it’s probably 60-40 software development and the rest is servers, software licensing.

Wayne Johnson - Raymond James

There was a mention about the on-network transactions and if I was following this correctly, were approximately 50% today, is that right?

Matthew P. Lawlor

A little over 50%, yes.

Wayne Johnson - Raymond James

Okay. So, can you talk about the economics for a transaction like that versus something that’s off network?

Matthew P. Lawlor

Well, if it’s off network it will be in the range of $0.03, $0.04 or something, $0.05 if you’re off network; paying some intermediary to get the job done. And then if it’s in network, you’re talking practically zero to; we define it up to a quarter, $0.005 or something like that in terms of some incremental costs. So, it saves you in the order of $0.03 to $0.05 in it what we use $0.0035 or $0.04 as a round number. The bigger benefit is instead of on a commodity transaction where you are a typical electronic bill payment, if you start getting into expedited payments, then you’re really talking very large substantive margins that come to the company.

And then the other factor too is as we begin to parse payments with the bigger banks, we’re beginning to take payment streams from bigger banks that allow us to leverage that network or reversely getting a 100% margin.

Wayne Johnson - Raymond James

On the expedited payments, where does that stand and then can you give us any metrics on how you are dealing with the expectations are for this year compared to where we were at the end of the fourth quarter or that kind of thing?

Matthew P. Lawlor

The product continues to be in the range that bounces around. December was in the range of 1% of payments that were eligible for expedited treatment. So, whereas the banks where it’s been deployed at the 500 banks that it’s been deployed. The rule of thumb is about 1% of eligible payments end up being expedited and we get a fee, insured the fee with our client. There are two big challenges Wayne, where there has not been as much progress until just recently frankly.

One is where there has been recent progress is expanding the eligible billers that can accept an online payment and just in January we had two big, big players come on-stream. So, that should, the 1% number still stays the same, but the number of payments that are eligible goes up. So, that’s one key driver. And then the second key driver where we haven’t made as much progress, but we have, but there are good signs and that is deploying the product beyond the 500 community banks that we have into clients that uses for bill-pay-only, where we have to plug in to somebody else’s front-end server for the online banking. So, we’re working with the various players to do that and it’s a key priority particularly in getting to some of the bigger clients that we have.

Wayne Johnson - Raymond James

And just quick followup on that; how many eligible billers do you have on the expedited system now?

Matthew P. Lawlor

It’s, I don’t know, if that’s $400 in that range right now that…

Wayne Johnson - Raymond James

$400.

Matthew P. Lawlor

It’s not a good answer to tell the truth, Wayne. First, the way we look at it is, first you want to look at the payments that are likely to be expeditable. If you don’t pay your gardener for doing a lawn on time, if he doesn’t cut your grass for an extra two weeks it is not the end of the day. It’s on the other hand, you don’t pay your mortgage on time, and there are services consequences. So, its using your standard percentage of payments is not a way to do it.

What I would say and this is just term of our basically of eligible expeditable payments, we are in range of about 25% of where we want to be. So, we got some work to do and those big clients that came on-stream just recently were very significant and as we move up that percentage to 60%, 70%, 100%, and we’ll get there. It’s going to make product that much more appealing to the end user and obviously more profitable to our clients and ourselves.

Operator

Your next question comes from Brett Huff - Stephens Inc.

Brett Huff - Stephens Inc.

I was doing a little math on incremental EBITDA margins based on the slide that was referenced earlier from the Analyst Day, and the numbers were something like $10 million on $16.5 million of EBITDA versus services revenue growth and that works out to something like 60% EBITDA margins. Is that a fair way to think about incremental margins?

Catherine A. Graham

Remember Brett, let me just expand that a bit which is obviously to, this is on an anticipated mix. Certain products have incremental margins that are much higher than that, others have margins that are much lower than that, but across the board, yes, that’s pretty good way to look at it.

Brett Huff - Stephens Inc.

And given that, assuming we’re starting from that base if we had to walk to where we are now, obviously we had lower EBITDA in ‘08, does that mean that we are now anticipating more EBITDA to get to the $40 million, it sort of has to work that way, so in what mix is that incremental EBITDA? And two, what kind of impact from a percentage of EBITDA basis does the, do the cost cuts have, do we go to 65% or 70% EBITDA margins, I mean incremental, can you comment on that.

Catherine A. Graham

You know Brett, I haven’t done the math, but your point is well taken. Yes, in order to make up for lower… If there is going to be lower revenue or you are starting at a lower EBITDA point, obviously you need to get higher incremental margins on your future revenues in order to wind up at the same place. When I say I haven’t done the math, essentially we are getting the same margins, it’s not so much a mix issue, and it’s not what I would call a variable cost issue or variable cost savings. What we’re really are talking about here is leveraging over the fixed cost base and extending the time over which we make investments in our fixed cost base sort of. In most cases, we are investing ahead of our revenue growth. We are investing less ahead of our revenue in this case. I can look at the math for you, but yes, 65% or 68%, something like that. I’m just going to do the same thing, you are going to do and work back into it.

Brett Huff - Stephens Inc.

And then on your guidance for 1Q, Ray mentioned some calendarization stuff and I know that can impact growth numbers. What are you seeing for 1Q from a seasonal and/or calendarization point of view, Ray?

Raymond T. Crosier

Brett, as I mentioned in my comments, February is actually ahead of January on fewer days. So, we think that’s a very good sign. Whether or not that continues to the end of the month or the end of the quarter, I’m not real sure. I certainly looked at the calendar, when months don’t end on a weekend and you don’t have holidays on a Thursday that people take off, not only Thursday but Friday, probably better things are going to happen to you then if that was the scenario and you can look at the calendar as well as I can. You can see some of that stuff back, I’ll forward to you and candidly I don’t see that in 1Q.

Brett Huff - Stephens Inc.

And then the last question, can you give us any update on your internal watch list on various banks that are in trouble or might be bought by somebody else and sort of relative plusses and minuses and what’s the net outcome from a risk or potential upside point of view?

Matthew P. Lawlor

I think we are in pretty good shape Brett. We do track that obviously. We look at our top 100 clients to be candid and even then that goes pretty deep into, we’re so diversified with our revenue right now that, it takes on less of a fruitful exercise. We do have I want to say three, what we would call large clients that we are keeping an eye on, either well south of 2% in all three cases that I’m thinking of. There seems to be positive developments. I think frankly this is a good news story for Online Resources. I know this is a negative potentially for all of us that served the financial and banking industry, but for us, you take a look at largest clients and thankfully they are some of the strongest in the industry. We did just quite the opposite. We see some of the potential consolidation going on obviously affecting us on the downside, but candidly, I have a feeling here we are going to end up stronger because of the larger clients that we have that will be the drivers in any consolidation because of the strength in capital and so fourth. So, net, net who knows, but our watch list is pretty small. It doesn’t seem to be something that is serious right now and in fact there may be a silver lining for us.

Brett Huff - Stephens Inc.

I think that 2% number is collective or each of those?

Matthew P. Lawlor

They are less than 2%, they are not collective but they are well less than 2%.

Brett Huff - Stephens Inc.

Each?

Matthew P. Lawlor

Yes, about a half of 1%.

Raymond T. Crosier

So, the two that I’m thinking off and the third I just don’t, I couldn’t, but the other two are less than 0.5%.

Catherine A. Graham

Remarkably, they are less than 2%...

Matthew P. Lawlor

2%. It’s been rescued by our team.

Catherine A. Graham

Well, I’m going to jump back in for a second here and answer your first question again, because we did some number crunching while you were talking. It’s in the mid 70’s is where that number is from an incremental margin and I’ll just say again it isn’t sort of direct margin we are talking about, it’s fixed cost base.

Operator

Your next question comes from John Kraft - D. A. Davidson & Co.

John Kraft - D. A. Davidson & Co.

I want to follow-up on something Wayne was talking about and you’ve mentioned Ray, the Princeton Inn network percentages in going up by 30% to 70% is pretty impressive and obviously that’s a pretty strategic thing for you, and I guess I’m not sure exactly how your going to do that it’s got to be more than simply signing billers, can u talk a little bit more about that?

Matthew P. Lawlor

Ray would be far shorter and more articulate in saying and talking about it and would have answered your question long ago. A lot of it candidly is good, it’s working on the ground. It’s for instance biller network tended to be small mid-sized guys. Very early with Bob Craig’s leadership up there in Princeton, he brought substantial resources to expanding that network endpoints. We are out there using some technology, some leverage means to get smaller, billers on the network. But a lot of the growth is coming from strategic calling to very large billers where we are bringing to them because of our scale very large amounts of transactions and this is one of the benefits of being in the network type business, the scale business.

We have their attention, we had great luck with these very large billers. In addition to use, and that’s just good sales and legwork and vision candidly too. They’re not going to just use us putting them at an end point, with more than being an end point. We start talking about some of our other capabilities and we developed a lot of services potential outside of just then being an endpoint. So, again it’s 70%, we think it’s very, very doable and through a combination of working with big guys at Princeton wasn’t so strong in and is now getting strong in and then smaller guys where you use leverage means to either technology with automated signups for endpoints and then also partnerships.

John Kraft - D. A. Davidson & Co.

And then a couple of clarifications. Ray, the Apple and the unnamed bank those were command deals and those are going to be implemented sometime implemented sometime in mid to late 2009, did I hear you correctly?

Raymond T. Crosier

Actually, Apple is going to go live at the beginning of the fourth quarter. It was the full sweep. They bought the ASP service, they did not buy Command, they bought ASP, they bought account opening, they bought call center. They purchased the whole shebang from us. So, that’s a pretty good size client. The other one we’re working on the announcement it’s going to be for account opening, but it’s sizeable, top 100 where it will be as soon as they go live and that one was one that can probably get lid up the whole lot quicker, because of what they bought. So, we’re cautiously optimistic, but we’ve got plenty more of those in the pipeline.

John Kraft - D. A. Davidson & Co.

And then Cathy, I don’t want to leave you out here. The clarification I’ve got for you is about the interest rate, it sought of suggest sounded like you were expecting maybe that interest rates might improve a little bit in 2009, and I guess I just wanted to clarify what you are assuming on your guidance?

Catherine A. Graham

Thank you for not leaving me out, I’m glad you didn’t hurt my feelings. No, we have planned for absolutely no interest rate increases in 2009.

Raymond T. Crosier

And indeed in our long-term plans on the revenue growth, very little, I think a little bit in 2010, very little bit in 2011, nowhere near. Frankly, where I think interest rates are going because it doesn’t matter with a lot of other things. We got to live with the reality that we have now, shut our business and make the adjustments as we have and go from there.

Operator

Your next question comes from Thomas McCrohan - Janney Montgomery Scott.

Thomas McCrohan - Janney Montgomery Scott

I had really just two clarification questions. On the 5% salary reductions, can you quantify that in dollar terms, how much that saved you and what we can expect going forward this year for any incremental salary reductions?

Matthew P. Lawlor

It was $2 million.

Thomas McCrohan - Janney Montgomery Scott

And going forward it sounds like you had more flexibility, that’s tough to kind of push through those type of things, it’s going to be tough, but its obviously the employees are pretty much excited about the prospects to do that. But I mean how far can you go with future reductions, had we guys talked about that with employee base or…?

Matthew P. Lawlor

That’s really not the thing that’s on, any one of the things that’s on our list of triggers that we can pull, we’ve done that. We’ve taken out some staff and certainly that had its impact. We’ve now reduced the salaries and that’s had its impact, but just so you know employees are much better served and told us, they’d much rather had their job than just seeing another person sitting next to them get taken out which makes them work all more harder.

We are better serving our clients by not doing that as well, and the 5% really just aligns us with the rest of the market in today’s economy. But while we could go there I suspect we have done there. We got all kinds of other things on the list that depending on what we see coming down the pipe and we’ve been ahead of the curve and we’re going to stay ahead the curve. We’ll pull those triggers and move those levers as we see how much we need to do. Hopefully, we won’t have to do any.

Thomas McCrohan - Janney Montgomery Scott

That $2 million that’s a quarterly number or annual?

Matthew P. Lawlor

No that’s annual. It’s 11 months and $43 million in salaries.

Thomas McCrohan - Janney Montgomery Scott

And lastly, Cathy on the operating data, the quarterly metrics on page 5 of the press release, does that metrics get restated from the ones that you published at the analyst day, there seems to be a little bit difference.

Catherine A. Graham

Yes, we did restate them a little. You will recall at the analyst day, we had some that were labeled preliminary because we had not gone through and pushed back some of the changes, we’ve now completed that.

Operator

Your next question is a followup from Brett Huff - Stephens Inc.

Brett Huff - Stephens Inc.

I had one more clarification on the income statement, could you just give us explain a little bit there isn’t no values in the interest expend, debt issuance cost, other expense while can you just walk us through that Cathy?

Catherine A. Graham

Yes, absolutely. This is a mark-to-market adjustment; this is where we run our mark-to-market adjustments through the interest expense line. The reason this has flipped so much is that we had a mark-to-market adjustment of about $2.8 million related to our preferred stock related derivate in Q4. This is basically looking at, if you look, there was actually quite a significant decline in the company’s share price between Q3 and Q4, and that’s affectively what drove that revaluing of that derivative. And, so we’re looking at quite a high number flowing through. That’s in interest rates of course.

Brett Huff - Stephens Inc.

Okay, and that shows up is that, is that the $0.10 in the reconciliation, the 2.9?

Catherine A. Graham

I am looking at the reconciliation now,

Brett Huff - Stephens Inc.

Changing their value theoretical swap derivatives?

Catherine A. Graham

Yes, that’s it.

Operator

There are no further questions.

Matthew P. Lawlor

Thank you everybody. We look forward to our first quarter results and I’ll turn it now over to Beth Halloran who will read the safe harbor statement.

Beth Halloran: As a reminder, of our intent to take advantage of 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 forecasting growth in Online Resource’s customer base, increases in transaction being processed by customers and growth in the number of customers using online banking and bill paying services. Other forward looking statements include those regarding Online Resources’ business outlook for 2009 and beyond and statements containing words such as anticipate, believe, plan, estimate, expect, seek, intent, and other similar words that signify forward looking statements. We encourage you to review Online Resources’ detailed periodic filings of the Securities and Exchange Commission for a full disclosure of risks and uncertainties. Thank you for joining us and this concludes our call.

Operator

This now concludes today’s conference call, you may now disconnect.

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Source: Online Resources Corporation Q4 2008 Earnings Call Transcript
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