ACI Worldwide, Inc. Q2 2008 Earnings Call Transcript

| About: ACI Worldwide, (ACIW)

ACI Worldwide, Inc. (NASDAQ:ACIW)

Q2 2008 Earnings Call

August 12, 2008 8:30 am ET

Executives

Phillip G. Heasley - President, Chief Executive Officer, and Director

J. Ronald Totaro - Senior Vice President in the Office of the Chief Operating Officer

Scott W. Behrens - Principal Financial Officer, Vice President, Chief Accounting Officer

Mark R. Vipond - President, Global Product

Richard N. Launder - Senior Vice President, President, Global Operations

Tamar Gerber - Vice President, Investor Relations

Analysts

George Sutton - Craig-Hallum Capital

Zachary Shafran - Waddell & Reed

Brett Huff - Stephens Inc.

Tom McCrohan - Janney Montgomery Scott

John Kraft – D.A. Davidson

Gil Luria – Wedbush Morgan Securities

Michael Christodolou – Inwood Capital

Nikolai Fisken - Stephens, Inc.

Operator

Welcome to the ACI Worldwide financial results second quarter 2008 conference call. (Operator Instructions) Ms. Gerber, you may begin your conference.

Tamar Gerber

Good morning and welcome to the ACI second quarter earnings call. Joining me today as management speakers are Philip Heasley, Ron Totaro, and Scott Behrens. Available on the Q&A we will also have Mark Vipond and Richard Launder.

Our customary Safe Harbor and forward-looking language applies for this call. A full discussion of the forward-looking statements can be found on our website or at the back of the earnings release and presentation which we filed this morning with the SEC. I will now turn the call over to Phil for opening remarks.

Philip G. Heasley

Good morning. I’m going to make some brief overview and then hand it over to Ron.

The business is performing well from a revenue/sales perspective. We’re committed to moving revenue out to deferred and backlog to cover the current period revenues. We’re focusing more on margin improvement. The sales pipeline remains strong though the sales cycle is extended. We are now live on BASE24-eps version 8.2. This is the hallmark IBM enabled with release and was generally available about 2 weeks ago. The IBM alliance has performed to expectations in the first half of 2008 and it’s clearly bringing us larger size sales opportunities.

Time to close deal has lengthened, traditional selling cycle, we’ve always had was 275 to 450 days; in the last year and half to 2 years we’ve been in the 9 to 12-month cycle, we’re probably in the 15 to 18-month closing cycle right now. Moving up limitations out of backlog has become priority number one for us. More than 50% of our BASE24-eps implementations are now on the IBM environment. We are working with IBM to expedite our install timeline from a current implementation timetable of 18 to 24 months to something closer to a year to a year and a quarter.

As we mentioned in our press release, we are now seeing the departure of Richard Launder who is going to be leaving in the end of February 2009. Until his departure he’s going to be working closely with me and we’re going to be concentrating on our major relationships around the world, and I’m also announcing Mark Vipond’s departure at the end of this month after 23 consecutive years and most of his adult life. This is a major change for markets and major change for the company.

Global sales and product businesses are poised and they are ready to move forward. The geographic channels and product management will report to Ron effective immediately. Ron who joined ACI in March 2008 spent the last 5 months updating our strategic plan, and now that having its major architecture completed, he will take over the day-to-day market activities of the company.

As a result of this planning process, we intend to rationalize up to $30 million in annual operating expenses beginning the third quarter of 2008 and will continue through 2009. We’ll be implementing our professional services restructuring product rationalization and facilities consolidation. We expect near-term restructuring charges primarily in the second half of 2008 and less sizable charges in 2009.

We’re planning to reinvest $16 million funded by the cost savings achieved during our restructuring in the business to better align our global opportunities. These investments are anticipated in wholesale, fraud, and the aforementioned services organization. Approximately two-thirds of the capital expenditures with one-third being operating expenditure may tend to globalize our headcount or that is to re-align them so that our revenue structure globally and our people supporting those revenue structures are more closely aligned.

With that, I’ll introduce and hand it over to Ron Totaro.

J. Ronald Totaro

Good morning everyone. It’s good to be here with all of you on the phone today.

Moving to the quarter just ended, I’m going to run you through the business operations from a sales product and geographical perspective. If you turn to slide 8, you’ll see that the quarterly sales performance has exceeded that of the same period 1 year ago. Even though the overall sales figure was higher by 17%, we actually had less concentration of revenue with our largest customer sales and a wider dispersal sales dollars to more clients. We also saw a large upwards movement of implementation of professional services sales at 40% of all sales in the quarter, which is an indication that we’re expending more energy on the services implementation and ongoing services component of contracts.

We’re beginning to see more services revenue built in as a feature of our new sales contract, and this has already begun to be reflected in current period revenue as well. We do not have any sizable customer losses in the quarter. We had 14 small account closures with clients using products like GoldenGate or other non-core small tool products, but no strategic customer attrition. As is evident from the strong sales performance of 17% over last year’s second quarter, we had a number of larger sales in the developed economies, but we also booked a lot of smaller transactions throughout the world.

We spoke to you at the first quarter call about the Sermepa deal which closed in early May, and since then, we have also closed on a large transaction with Sterling Bank which we announced in the press release earlier in the year. During the quarter we also had sales bookings activity with processors in North America, and some of these deals were in progress for 15 to 18 months, so we were pleased to reach signing.

In looking at the pipeline for the second half of the year, we have a number of large IBM alliance transactions which we’re excited about and some of which we think will close before the end of 2008. Timing could be hard to call in these larger transactions, but some of them are fairly well along in the sales process.

Turning to slide 9, this page depicts several different views of sales in the second quarter. It’s worth noting that both Americas and EMEA closed ahead of the 2007 quarterly sales figures in spite of the fact that we did not see any large capacity events or much activity in the term extension portion of our business, and this is in an environment where we’ve been hearing much news about the challenges of financial services institution. So, it’s notable that our performance is ahead of prior year.

The new sales/new activity in EMEA and the Americas had several ramifications on the business. For one sense, there was not as much cash generation from sales as you would see in a typical quarter with higher term extension, but it also demonstrates that the product suite is very attractive to new customers and customers who were considered to be penetrated in mature market.

The Asian business has variability depending on the timing of term renewals and you can see that reflected in a drop in sales figures year over year. Another impact on the business from all of the new sales activity is higher sales commission and also higher implementation services fees in the short-term.

Slide 10 dives further into the progress on the IBM alliance. We’re very pleased with where we are today and the milestones indicate that we’re right on track with our relationship. IBM has dedicated what we consider to be a significant amount of heads for joint sales with ACI, and their target for Q3 is to nearly double that figure. We believe that the word has gotten out in the marketplace about our relationship and the industry interest has been underscored by the number of deals we’re tracking jointly in the pipeline.

You’ll note that the second half of 2008 has a more aggressive number of deals in place than the first half. This has been our plan as we expended energy in the first half of the year educating our workforce and theirs about the relationship and how we would grow the business opportunity together. Also, we’re beginning to do more joint sales planning regarding our approach to the wholesale market with ACI product in an IBM hardware environment.

Slide 11 shows sales by quarter going back six quarters to the beginning of 2007 with a split by new accounts, applications, add-ons, and terms. Given the slow sales start in the first quarter of ’08, we’re a bit behind last year’s sales at this point in time, but we are comfortable that this is not going to derail us for performance in the second half. The year over year performance does show the reliance in 2007 on term extension sales compared with this year and this variance also accounts for the softer cash performance in the quarter.

If you turn to slide 12, this is our standard depiction of customers and geography segmented by product. This is provided as an overall view of the business and the product ubiquity by geography.

Slide 13 takes you through the developments in our various product areas. The big news recently is that we have completed the 8.2 offering of BASE24-eps and it is fully optimized for the IBM systems z and blue stack. In the wholesale arena we have refined our long-term plan for investment and the payment solution hub and are committed to the wholesale solution set. We believe that both Sermepa and conversions within the industry will provide us with a lot of interesting opportunities.

Finally, the fraud products have also been optimized as part of the retail payment and due release for the blue stack and system z. This is another core product area for ACI and we intend to continue investment in enhancements of the risk offering. Today, we have over 147 risk management customers and we see demand globally for our risk solution.

Finally, my last slide before turning the deck over to Scott is slide 14. This encompasses the second quarter performance by geography. We see opportunities in nearly all of our markets. The Americas turned in a solid performance in the quarter with sales of about $50 million and revenues of $40 million which was a healthy increase over the $33 million performance of last year during the second quarter. The Americas revenue was enhanced by recognition of the MasterCard deal this year. This was a deal which we signed 18 months ago and it has now gone live. Both North and South America are providing us interesting opportunities although we’re seeing large deals in the near-term pipeline in the USA rather than in Latin America right now.

EMEA’s two large groups of deals were FasterPay and the Middle East Switch both postponed from the third quarter of last year and finally closed in this quarter. The FasterPay situation was the largest software event in the UK marketplace since the Y2K upgrades nearly as a decade ago. It was a long implementation process and our engineers and services team did a great job as evidenced by the smooth transition to go live in the faster payments environment.

EMEA sales were up 30% over last year at $43 million and revenue was substantially better than last year as well at $47 million. The big news in our Asia region was the provision of our business license for ACI in China. We’re really looking forward to penetration in the enormous China payments market and are working actively with IBM on strategies for penetration. For those of you who know the process to achieve a license in China, that was a large step forward for us in terms of beginning a relationship with the enormous Chinese payments market.

We also had sales in Korea, another key market where we have historically not had strong penetration.

Lastly we have invested resources in Asia in the quarter in the services area in order to hasten the implementation for customers to install had been underway for long periods of time.

We know that we have a lot of work to do rationalizing the cost of provisioning services, implementation engineers, and this is a situation which requires a lot of work not only in Asia but also in the EMEA channel where they have sold a lot of new systems and now needs to install them.

I think in summary our theme for this year and probably well into 2009 is one of managing the install timeline and ensuring that we do in a way that keeps our customers happy. While we did budget expense growth in 2008 in response to the need for services were throughout the world, it is clear that implementation is the most impressing area of investment for the near future, especially given the longevity of our customer relationships once these systems are installed.

The services implementation issue is the biggest productivity program in the company right now and while it has evolved from my first half that ACI is such a large strategic planning exercise. We expect that the roll-out of the strategic plan will speed up our investment services, shorten the install timeline for our customer base, and sharpen our focus on core product areas.

I look forward to updating all of you on the changes we’re making in the business as we refine and complete the details of the strategic plan.

I’m going to turn the call over to Scott now who can walk you through the quarter from a financial perspective.

Scott W. Behrens

Good morning everyone. I’m going to take you through our numbers this morning and share some views on both the quarter in our guidance for 2008.

Turning to slide 16, our GAAP revenue performance was significantly higher than last year as we did succeed in moving some large deals at a backlog, in particular the go live of FasterPay in the UK which contributed more than 39 of revenue in the quarter. In addition, as Ron mentioned, the go live of MasterCard in the US and the Middle East Switch also contributed to the overall increase in revenue year over year.

Additionally, we continue to experience growth in our recurring revenue, and as a reminder, recurring revenue is being monthly license fees, maintenance, and our processing services revenue streams. That growth was concurrent with the decline in initial license fees or ILF revenue. The primary driver for the decline in the ILF revenue on a comparative basis, June 2008 compared to June 2007, was due to higher capacity deals in the prior year that did not recur in 2008.

Sales rebounded in June quarter of 2008 on a sequential basis compared to the soft March quarter and/or higher comparatively to the June quarter of 2007. And as you saw in Ron’s presentation on slide 8, we do continue to experience strong growth in sales, new accounts, and new applications.

Operating free cash flow was certainly not where we liked to see it, but there were timing issues both with billings and our investment decisions which contributed to the overall cash outflow in the quarter. The new Omaha office was the use of cash in both the physical buildup of the facility as well as a cash rent prepayment. OFCF was clearly impacted both positively and negatively by the go live of FasterPay and some of that impact is timing. We simply had the base in the timing of the go live we simply had some billings that had not yet been paid by the customer as of June 30th which did impact June cash flows by about $5 million. We also spent more money in 2008 on contractors, particularly related to the services implementations driven by our large number of projects that are currently being implemented as well as the complexity of the product implementations.

Like we told you in February, February services was certainly a risk for 2008, but we believe it makes sense to concentrate on expediting our installation process and we regard that as a productive use of cash.

Another point to add on the higher personnel cost is that we are over-achieving on sales of new accounts/new applications this year compared to what we originally anticipated. These sales are obviously good business indicator, yet they do require us to run higher commission expense both on a GAAP and a cash basis than we had anticipated when we planned for overall cash outlays in 2008. As evidence of that sales, new accounts and new applications are running at about 40% of sales in the current quarter versus 23% in the second quarter of last year; so that differential has resulted in higher commissions.

Another aspect of cash although not specifically highlighted on the slide, the difference from second quarter of last year, is that we’re not seeing as many large capacity deals coming through. We do continue to re-negotiate with our large existing customer base for terms extensions and renewals, but at lower discounts than in the past. This can delay the renewal process. We now expect some of those renewals later in 2008, some may roll into early 2009 as the customers approach the expiration of their current existing contract.

Finally, a 12-month backlog decreased on a sequential basis compared to March 2008 and that was driven by the release of backlog to the large transactions in EMEA being FasterPay and the Middle East Switch and also in the US markets with MasterCard. We do regard the reduction in 12-month backlog obviously to generally fit situations as it does indicate that we are moving projects out of backlog and taking them live.

Moving to slide 17 and continuing with review of the quarter, you can see the short-term deferred revenue also shrank in line with the movements in 12-month backlog. We expect those movements to be fairly consistent. Operating expenses are something we’re trying to closely manage while also ensuring that we invest appropriately in the services installations so that we can reach project go live status.

We did spend $9 million more in services personnel in 2008 than we did in 2007 and that was invested both in the geographies and in our wholesale ACI on-demand product categories. Selling and marketing expenses, as I mentioned in the context of the OFCF on the last slide, were higher as we experienced higher commission expense on higher sales than comparable in 2007 and also higher value deals with an increase in sales new products/new application on a comparable basis.

We also invested additional resources in the IBM alliance, sales initiatives, and lastly overall operating expenses were also impacted by the IBM outsourcing and the related transition in severance expenses.

Finally, regarding other income, we did experience a favorable change in the fair value of our interest rates swaps giving us a $2.9 million non-cash mark-to-market gain in the June 2008 quarter, this combined with approximately $800,000 reduction of foreign currency losses contributed to positive other income in the quarter.

Turning to slide 18, this slide highlights the relationship between backlog in current period sales as it relates to GAAP revenue conversion in the period, much like the March 2008 quarter we are seeing most of the GAAP revenue derived from backlog. We don’t think that these ratios will stay at the 10% to 11% range for the rest of this year. We do expect to see more current period sales flow through to GAAP revenue in the second half of 2008, more like the 15% to 17% range as far as we can see based on sales pipeline right now. Again, that ratio can change depending on the sales mix, but based on our current forecast we expect that ratio will move up a few percentage points.

Turning to slide 19, this is a breakout of non-recurring and recurring revenues. This is a historic view by revenue and by type looking back as far as 12 to 14 quarters. Really the key takeaway here is the growth in both services and monthly recurring fees. On an absolute basis there was a significant growth in both categories while the ILF has shrunk as we’ve actively moved away from pay upfront deals. We clearly still have capacity deals which are a function of the growth in e-payments rather than any business tactics on our part and those capacity events which will recur annually for some customers, biannually or more regularly for others. However, capacity events will continue to provide us with sporadic increases or some degree of lumpiness essentially in our revenue stream and a nonrecurring license fee revenue line.

Finally, turning to slide 20, that covers our guidance for 2008; we told you in May that we’d be re-broadcasting an updating guidance here in the second quarter call. I’ll start with the matrix that did not give us significant change compared to our original guidance and then circle back to cash. Generally, we think our sales guidance from earlier this year was very close to where we see it now, a decrease of 2% to 5% as probably the only change there based on the fact that the banking community is slower to commit capital outlays right now. Given that, sales will be slightly lower than our visibility was in February. This will obviously have a trickle down impact on backlog and revenue. So we have lowered the Rev-log guidance from $200 million to a range of $190 to $195 million for the year.

Cash tax is already in line with our original guidance, expecting that to run at $14 million for the year. Operating expenses, we’re expecting, should grow between 8% and 10% over the 2007 calendar year. This represents a slight increase in expense over the 7% to 9% growth rate that we told you in February, but that’s primarily as a result of the IBM IT outsourcing deal which we signed in March. That adds about $8 million to the calendar year 2008 operating expenses. And even though we are running higher OpEx year over year specially in the services area, we have planned for an expected rise in implementation expenses on our previous guidance given in February.

As our expenses are in line with our expectation, operating free cash flow has been primarily impacted by a reduction in cash receipts driven by several factors, one being a longer sales approval process amongst our customer base that’s resulting in a delayed timing of deal closure as evidenced by the March 2008 quarter sales being approximately half what they were in the corresponding period in ’07, and even though in the June 2008 quarter it is higher than the comparable period in ’07, we’re still behind compared to prior year on a year to date basis. Though we still expect to come in a few percentage points lower compared to our original guidance for the year, the timing of deal closure is expected to risk slippage of the actual cash receipts into 2009. Additionally, though the total economic value of deals is tracking substantially to plan, the actual sales mix is more heavily weighted towards new customers and new applications than we had expected which is driving lower cash receipts, pending reaching implementation milestones as compared to the sale add-on business, and term extensions to have shorter time periods from deal closure to cash receipts.

So, as an overview, generally speaking, it was a good quarter in terms of sales deals closed and for the recognition of some large deals that had been lingering out in backlog for some time. And obviously go live is very important because it begins the recurring stream of revenue in cash from the commencement period and allows us to free up resources to focus on other implementation projects so that we can move them closer to go live. And while the expense line is obviously tracking at the higher end of our range, we continue to believe that the planned investment and services implementation is a good thing for the business given the sizable number of projects that we’re working on in backlog. Also, as you heard from Ron, we have identified large areas of the business that can and should be re-engineered, and I think over the next few months, will begin to provide clarity by region and functional area, just how that restructuring will impact our organization.

That’s it for our prepared remarks. Operator, we’re ready to open the line for question and answers.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of George Sutton with Craig-Hallum Capital.

George Sutton - Craig-Hallum Capital

You mentioned that getting the implementations out of backlog is the number one priority and you did mention some work you were doing with IBM to quicken the pace. I am not real clear what specifically you are doing differently to try to accelerate that move out of backlog.

Philip G. Heasley

The effort we have going with IBM is what we’re calling the payments transformation team, and what we’re doing is we’re going through an environment I said in the beginning where 50% plus of our deals are now on IBM platforms, both p and z, and at this time more p than z platforms. And what we’re doing is we kind of have our left foot in our past legacy of implementations and we have our right foot in these new eps and multi-sales kinds of deals. What we’re trying to do is put together a highly coordinated process between platform provider and the software provider instead of two different vendors showing up at the same site getting work done and we’re hoping and we’re expecting for that to be a much smoother process. That’s important, George, because when somebody has very large deals having that kind of coordination is going to be crucial aspect. We’ve gone and we’ve done very very well from a share standpoint, we’ve built a very large backlog of deals that we have to get implemented. Right now is a point that we have good controls around where we are as a business and what not and it’s time to get that historical backlog behind us and have to be more forward looking current product backlog moving forward. So, I’d like most of what we’re doing with IBM to be 8.2 going forward and these previous releases 7.4, 6.4, whatever, would like to have those all behind us and be in an 8.2 environment.

George Sutton - Craig-Hallum Capital

You mentioned that your deal cycle is slowing a little bit and I am curious when you are going to market with IBM and you’ve got a somewhat combined hardware software package, does that not help accelerate the sales process?

Philip G. Heasley

I think two things have happened there. One is there has been a definite slowdown. I would tell you that we are better at measuring and what not, but our pipeline is probably better than it has been since I’ve been here. Getting that pipeline to closure is clearly taking longer; instead of going through a capital approval once, goes three times or whatever. We’ve not really seen any deals being pulled off the table except for some really small low-medium to small kinds of companies and in the 25% to 50% probability ranges in the pipeline, not further up in the pipeline. In the very larger deals, I think the larger deals are having more scrutiny. So even if we have more coordination with IBM there is more scrutiny going on in these deals, and in a very large deal, stage one of doing a deal is doing a proof of concept, and you don’t really get the final deal until you combine go and do your… You may be chosen and what not, and then you go through this proof of concept kind of deal and then you move into the next step. That also slows the growth in the actual backlog and the growth in the business by the very large deals having that extra step.

Operator

And the next question comes from Zachary Shafran with Waddell & Reed.

Zachary Shafran - Waddell & Reed

Two questions. I am wondering what you can say about the amount of headcount that’s now being dedicated to implementation generally and then specifically from IBM. And then second question, as you’ve talked about lengthening sales cycles, if you can be more specific and may be talk about if you are seeing anything different from a competitive standpoint?

Philip G. Heasley

What’s your question, how many people do we have devoted to implementation?

Zachary Shafran - Waddell & Reed

Yes. Generally and then specifically, how many are IBM versus third party versus ACI.

Philip G. Heasley

Direct ACI is about 500 people. We’ve actually had a good R&D year and we’ve actually had efficiencies in R&D, but all the efficiencies in R&D have been reinvested in getting these projects done. So, we’re probably devoting closer to 600 of our people on average in terms of it. And I think we spent $6 million in contractors in the last quarter. IBM’s actual supply of people except on a great year basis at this point has been very little. We are working with them in terms of rebuilding the process, but that’s a goal forward in our streamlining the process, but they’ve actually put very few people in.

Zachary Shafran - Waddell & Reed

Will they be adding people over time?

Philip G. Heasley

I think what we’re going to do is decide what IBM does in the joint installation with the blue stack and then what we do. So I actually believe that we’re going to be doing more that surrounds our payment domain and they’re going to be doing more that surrounds their IO or which is the interface between our payments domain and their actual physical environment. So, I actually think that we’ll be doing more of what we’re experts at and they’ll start doing more of what they’re experts at, but we’ll do it in a joint versus a co-primes versus two separate vendors.

Operator

Your next question comes from the line of Brett Huff with Stephens Inc.

Brett Huff - Stephens Inc.

A couple of quick questions; on the rationalizing or the cost reduction that you all talked a little bit about in your prepared remarks and in the release, I am sure you are in the planning stages now, but can you give us some more details on when we’ll start seeing some of that show up in the expense lines and sort of where the focus is and where that expense might hit on which OpEx line?

Phillip G. Heasley

I’ll let Ron and Scott answer that. I will tell you that it’s probably more further along than you think. There’s an awful lot of initiatives that are actually well defined and Ron has been a very busy guy for the last 5 months.

J. Ronald Totaro

Yeah. We had a management meeting two weeks ago which sort of culminated in 5 months of effort; sort of been a bottoms-up assessment of the business looking where our growth opportunities are coming from, looking at areas where there is duplication; frankly we haven’t done a great job in the past with some of the integration of our acquisitions; so it was just a step-back approach to see how do we best align our resources for growth, and also given that we have the IBM alliance, we’re committed to doing business in different ways and we have different interactions to consider as we think about how we’re going about our day to day. So, having said that, we looked at the market opportunity and we looked at the implementation services, we looked at our 5-year sales broadcast and projected where our business is going to come from, and from that we said, “Okay, how do we start to move our resources around?” That process will begin in September. Some of these events will happen fairly quickly. Others have been identified, but they will take another 6 to 12 months to evolve. So, we’re pretty excited about where we are at as a management team; again, there are a lot of people at ACI involved with this bottoms-up approach, but we need to focus to execute certainly.

Scott W. Behrens

I guess from a geography on the P&L and in terms of where the cost reductions are going to come from and where the expenses are going to be charged, it’s really a broad-based plan. So, you are going to see expenses really across all the expense categories being reduced on a go-forward basis to some degree, and we haven’t quite quantified what that is per expense line item, but it is a broad-based restructuring plan.

Brett Huff - Stephens Inc.

And so in that it’ll be both OpEx and in cost of sales or mostly in OpEx?

Scott W. Behrens

You will see it across all, the cost of sales lines as well as the operating expense line, but again to what extent, the magnitude on each line, we’re not at this point prepared to quantify that, but we will see both cash and GAAP expenditure on the personnel displacement and then we’ll also see benefits on each line prospectively starting as early as Q4 this year.

Brett Huff - Stephens Inc.

And my second question is; on the two folks who are leaving, one in August and one in February, insofar as this was planned, did we know about this as we were thinking about the analyst day and things like that, I mean, when was this planning sort of started and can you give us a sense of that timeline?

Phillip G. Heasley

Can you ask the question again, and I will tell you whether I can answer it or not.

Brett Huff - Stephens Inc.

Just the timeline on when we knew about when the two folks were leaving.

Phillip G. Heasley

I don’t think I would say anything other than we’ve been timely. You are talking about us communicating with you?

Brett Huff - Stephens Inc.

Yeah.

Phillip G. Heasley

I don’t think we were ready to communicate it till a very recent time period.

Brett Huff - Stephens Inc.

Okay. That’s all I needed. Thanks.

Operator

Your next question comes from the line of Tom McCrohan with Janney Montgomery Scott

Tom McCrohan - Janney Montgomery Scott

Sequential increase in the 60-month backlog, what proportion of that do you think is attributable to the IBM alliance?

Scott W. Behrens

I don’t think I have that information. You are talking about the 60-month backlog increase from March to June.

Tom McCrohan - Janney Montgomery Scott

Yeah. I am sort of just adding to a little comment on IBM, just trying to look for a method that we can use to kind of track the progress of success joint selling with IBM.

Scott W. Behrens

Right now we’re not, at least in these early stages, are not breaking out our backlog into IBM and non-IBM frankly, especially in these early days. As the activity increases over time, maybe that’s something that we’ll look at, but right now we’re not prepared to do that.

Tom McCrohan - Janney Montgomery Scott

Okay. Fair enough. And Scott, on your comments on the cash flow dynamics, although I know there are a lot of moving parts in there and you kind of have to do a little estimation about how you build up more cash spent upon the implementation, but can you give us any insight into the moving parts going into the second half; what would contribute to improvements in cash flow, and I am particularly looking at the deferred revenue line for the 6 months on your cash flow statement where it is really down dramatically from the 6-month period last year. So if you can just talk through how you see the dynamics in cash flow improving in the second half with particular emphasis on which moving parts relate to the deferred revenue.

Scott W. Behrens

Obviously the driver of deferred revenue in the June quarter this year was really pulling out of deferred revenue some of the large projects, FasterPay, MasterCard, Middle East Switch, pulling those out of deferred revenue and bringing those into the GAAP revenues in the quarter. For the second half of the year, obviously the deferred revenue is going to be driven by our sales before grasping our ability to hit that. Obviously, we’re still shooting for $430 to $440 million in sales; so obviously closing those deals and the cash events that correspond with closing those deals as well as the continuing implementation and hitting milestones, we should see increases in the deferred revenue, but at the same it’s a combination of closed deals implementation, but we are also expecting to go live with other projects. So, we’re going to have ebbs and flows in that deferred revenue as we go throughout the year.

Tom McCrohan - Janney Montgomery Scott

Is it fair to assume that when you do sell a large deal that does have these implementation milestones, that ACI still receives a portion of cash upfront or is there any change going on in how you negotiate those deals where you don’t collect any money upfront, you say, until we hit milestone 123 and then you pay us.

Scott W. Behrens

No, generally speaking upon signing a deal and on hitting the milestones, those are going to be cash events, but the magnitude of those are going to be depending on; historically we may have significant discounted a deal to get the cash upfront, but we won’t enter into that sort of a contract if it is disadvantageous to us from an economic perspective.

Phillip G. Heasley

That having been said, the two largest deals that we closed in this quarter had very very little cash on signing and almost all the cash on milestones.

Tom McCrohan - Janney Montgomery Scott

That explains some of it. And my last question is for Ron. Ron, on slide 11 you introduced a new slide that had a lot of information on it. I am just wondering if you could just give us the primary takeaways for that slide and including a definition for total economic value of sales. And that’s all I have. Thanks.

J. Ronald Totaro

Yeah. I think slide 11 was the slide that Tamar was asked to provide from a prior analyst call showing sort of a timeline of how revenues were evolving, and I think the takeaway here as it may relate to some of the cash questions that are on term extension and how that business is evolving, it you look a March 2007 term extension number of $43 million to 06/30/2008 of $15 million, you see that as we take in less in term extension, that’s going to have more of a negative impact on cash as our mix of sales is going to new apps and new accounts.

Philip G. Heasley

I think an important point o understand here in terms of understanding the terms of cash, especially the Americas is doing a very good job in terms of renewing the business at reasonable margins, and what’s happening is that that’s extending where we tended to renew an account on average of 48-month and 60-month contract or whatever in the 40th month, these contracts now are running much later. They’re coming much closer to closure, so that represents a deferral with a margin of opportunity versus a sale now with a lower margin opportunity, and I would take that tradeoff from a business standpoint and the fact that new applications and new accounts are continuing to move strong and then renewals of our business are being paid for more volume for the business that we’re doing is going through this metamorphosis that we said it was. If I were a betting person, I would have thought that without the economic problem that the banks are going through, we’d probably have less push back in terms of getting our fair payment. Right now, with the budget pressures they’re having and what not, that’s being extended. That’s not lost business. That’s delayed business, but it’s both delayed cash as well as delayed sales. From a backlog perspective, it still keeps sitting there in the 60-month backlog as a renewal account, so that’s the dynamic. It’s mostly in the US. In terms of the deals, they’re closing. They are succeeding, and I think it’s the right strategy, and I continue to support them on that, and what page 11 does is that it lets you see in a granular basis how the sales are coming across and then as well as by the different types of things we sell, so you can kind of make 11 and 12 make sense of each other a little bit, and then your question about economic value, we just make sure that we value sales the same way we value backlog, so that there’s no translation from when it goes to sales into backlog.

Operator

Your next question comes from the line of John Kraft with D.A. Davidson.

John Kraft – D.A. Davidson

First question is for Richard. It sounds like you’re staying around until around February. Are you going to be full time or act as a consultant?

Richard Launder

I’ll be full time and helping whoever is filling that position as well as anyone who wants me to help, so I’ll be full time.

John Kraft – D.A. Davidson

Phil, earlier in your prepared comments you mentioned that you’re having some success in the smaller institutions’ sales in the small institutions here, and it doesn’t sound like that’s a function or an effect of the IBM relationship. Are there trends to see here, or is that simply a function of the longer sales cycle in the larger banks, and is that primarily domestic?

Philip G. Heasley

It is not primarily domestic. It’s primarily EMEA, and I think the reason we’re seeing a larger number of smaller sales is that it’s a less arduous process for them. It’s more the developing world, whether it’s the Middle East or whether it’s in Asia Pacific and what not. They’re very actively trying to get into the global business system and build payment systems, and their deals are just coming to closure faster. It’s funny; we’re booking more deals as a percent, but we have more megadeals in our pipeline than we’ve ever had before, and those megadeals are just going to take longer to work their way through the system.

John Kraft – D.A. Davidson

Okay, that’s helpful. Scott, the sales and marketing expense line was higher certainly sequentially. Were there any one-time items there, and also can you talk about the timing of commission payouts for Sterling and Sermepa?

Scott W. Behrens

Well, I would say really it’s much of an effect in there in terms of marketing events. It’s really personnel and related costs, like higher headcount to work on the IBM alliance sales initiative than any marketing commission expenses. It’s just really higher value deal and higher sales volume compared to last year, so the payout on those particular deals, I couldn’t tell you off hand in terms of their timing, but obviously depending on when they close in the quarter, there’s some lag period between the sales close date and the commission payment date, but it does vary by customer. It depends on the marketing commission plan, so I don’t have that information on those particular deals.

Operator

Your next question comes from the line of Gil Luria with Wedbush Morgan Securities.

Gil Luria – Wedbush Morgan Securities

I had a couple more question on IBM. In terms of the milestones that you’ve set with IBM, are you still hitting all those? Are you still on track to getting more of the incentive payments from IBM?

Philip G. Heasley

From a sales standpoint, we met or slightly exceeded our first half goals, so that’s done. As it relates to our enablement projects, we told you we made 8.2. We’re actually slightly delayed as it relates to what we initially thought we were going to do. Some of that has to do with the amount of time we took for planning, saying this is what we think we are going to do, and then once we finalized it, so that’s been a little bit delayed, and Gil, we’re definitely on schedule in terms of our earning whatever additional dollars that are out there.

Gil Luria – Wedbush Morgan Securities

And the sales that you’re generating, to the extent that they’re also new sales for IBM, are you also collecting commissions from IBM for the boxes that they sell?

Philip G. Heasley

We’ve redacted an awful lot of that contract, but the whole idea is for us to be incentivized is that it incents us every time we do joint deals together, and of course none of that shows up in GAAP, and we’ve been very clear about the cash that’s come through, and the reason it doesn’t show up in GAAP, I’ll defer to Scott, but that has to do with the equity accounting and what not. Scott?

Scott W. Behrens

Right, as we’ve talked about in the past, there are obviously three components to the Alliance deal, with them being the warrants that we granted, the technical development spend, and then also incentives on sales, but from an accounting model perspective, really any incremental dollars that we received as a part of the incentives on sales would all be deferred till we reach the end of the development period, so there’s no P&L recognition of any of that until we’re completed with the technical development of milestones.

Gil Luria – Wedbush Morgan Securities

So, you wouldn’t even get those incentives for sales until you’re done developing the product?

Scott W. Behrens

On sales, it depends. It depends on the sales efforts between now and when we completed with the technical development projects, so obviously there are different triggers throughout the agreement based on when we get certain levels of sales, so it’s really driven by the agreement.

Philip G. Heasley

Gil, to answer your question, we get the cash and we get the cash up front. That’s why people said that that’s real cash, and I said it’s absolutely positively real cash. Right? We have to earn every penny of that cash, so that has to do with that. As it relates to GAAP, it doesn’t show up in GAAP till we go through this completion process, as Scott just was explaining, but as it relates to cash, we have been getting it, and we will be getting it. We just can’t call it GAAP revenue till we hit that completion point, and that’s why I get little agitated when people say well the IBM cash is really not real cash. It is absolutely positively real cash, and we’ve spend a king’s ransom in terms of investing behind this and what not, so from a cash standpoint, that is real cash payments to us. It’s our money, and that’s why that first large chunk of it is nonrefundable.

Scott W. Behrens

Right. And what you can watch is and we disclosed in our Q is the amount of cash that we’ve received and advance of it becoming essentially nonrefundable. A portion of what we receive is still refundable, and that is subject to hitting milestones whether it is technical development or sales milestones, so as that nonrefundable portion grows, that’s indicative of us hitting various milestones within the agreement, so for the most part, we have received cash in advance of it entirely being nonrefundable in terms of the different deliverables under the alliance agreement.

Gil Luria – Wedbush Morgan Securities

On that topic, of your operating free cash flow guidance of $65, I think we previously talked about the fact that about $50 million of that you were counting was from IBM. Of the new $45 to $50 million guidance, how much of that is IBM cash?

Scott W. Behrens

I don’t think at this point we are revising or changing that original $50 million. I don’t think anything has really changed that would drive that number up or down from the original guidance we gave.

Gil Luria – Wedbush Morgan Securities

One last question. In terms of de-emphasizing some of your products, which of the products are the ones that you are going to de-emphasize as you go through a restructuring?

Mark Vipond

We are in the process of making those decisions right now. This is definitely a scenario as Phil pointed to. We are looking to increase investment and wholesale and fraud, and to do that, this company hasn’t really sunset products in the past in an aggressive way, so there is an opportunity that sort of reallocates some resources to the products that we are not forecasting to have huge growth in, where we may move some of our development resources to higher growth areas as we look for third party alternatives to help beef ourselves up, so these are all the dynamics that during the month of September we’ll be finalizing.

Philip G. Heasley

But, Gil, we have a myriad of products that we have either purchased or developed in the past that where we have “sunset” them and we’ve never really brought them to end of life or put them on a time and material kind of basis, which I’m not going to tell you point in verse what they are, but it’s fairly obvious that it’s not EPS, so we are talking about not a generation ago or this generation. We are talking about two, three, four, five generations or miscellaneous wired kinds of stuff, and there are certain of our tools that just don’t make sense anymore whatsoever too, so I mean there is actually some on the tool side also.

Gil Luria – Wedbush Morgan Securities

Actually, let me ask one more question. The faster payment revenue. Is there any of that in the third quarter or fourth or was that all in the second quarter?

Scott W. Behrens

We’re going to have some FasterPay revenue still going forward. There is one customer that still has to reach their phase one go-live, and that’ll occur in the second quarter, and then we have other, and as we go into phase two of FasterPay, there will be continuing revenue streams amongst all the banks that were in the FasterPay, so we do have some continuing revenue coming through.

Philip G. Heasley

And they are going into maintenance. We’ll start getting maintenance. On the cash side, we didn’t bill that $5 million you talked about. It’s actually $5 million in cash that we were owed, half of which we have been paid since the quarter closed. And on SPAN, those projects haven’t all closed out in Saudi Arabia either. There were twelve banks involved in that, and they are not all done yet either, so there will be some third quarter close also.

Operator

Your next question comes from line of Michael Christodolou with Inwood Capital.

Michael Christodolou – Inwood Capital

A couple of sets of questions. First, I noticed there was no stock buyback in the quarter, and I’m curious if you were blacked out at all due to either the restructuring or the management departures. Can you remind us what is left on the authorization?

Scott W. Behrens

We did not have any formal or official blackout. We generally look at the cash buyback as a very good use of cash when we are not investing in the business, and obviously this quarter, we had a significant investment in services implementations, and obviously as we look forward, we are going have a near term use of cash involved with restructuring efforts, so that is about all we can say on that. I don’t have the dollar amount handy in terms of the amount that is left on the buyback. We can get back to you with that information. (pauses) $86 million.

Michael Christodolou – Inwood Capital

Phil, you used the phrase pigs passing through the python with respect to certain projects, and clearly in this quarter, a few passed through. I’m wondering if you can give us any further thoughts, I guess, just on the business over the next 3 to 9 quarters. You have always been talking about a 3- to 5-quarter kind of transition period converting the deferred revenue to sales and revenues, and it seems like a little bit more of a delay here because of industry dynamics and a little bit more management change and another restructuring, and I saw that you even joined another board the other day, and I’m kind of curious about where you see the next several quarters and how you are spending your time?

Philip G. Heasley

Well, we have always said that we had a whole series of steps, and we were going to announce those steps as we moved along this that got us to the second half of ‘09. With these changes, I’m more comfortable, not less comfortable as it relates to the second half of ‘09, and actually by the second half of ’09, I would suspect that our GAAP and our non-GAAP performances start merging pretty quickly. We will have taken the abnormalities out of the business. In terms of the pig going through the python, I think we gave enough data that you can see pretty clearly that we are kind of in the stomach and small intestines at this point versus the throat. I hate to be so graphic, but what we are watching now is we are watching the beginning of stabilization. We went up to almost 150 in deferred revenue. First quarter, we went up about 12 million in deferred. Second quarter, we came back, so we are now at the point that we have about the same deferred revenue that we came into the year with. We’ve made the decision that we have to speed up, not keep at the same pace the amount that we have coming out, and that’s not only in terms of capturing the service revenues and what not that you see that have grown, and that’s another way of looking at it, it’s the way you look at the growth in service revenues versus our other revenues. That’s in effect all these new projects working their way through. That’s the tape so to speak. What we really want is the long-term maintenance and the last values that come from these accounts, so we feel pretty good about it. We knew we had to get into a much more disciplined set of processes, and quite honestly that’s why I hired Ron almost half a year ago, and instead of having him go dive into the nearest fire or whatever, and said, gee, we really got to sit back and we have to understand what is done, what does finished look like, and how do we line up the pins in a way so can throw strikes, so I feel very good about that. In terms of my outside activities, I did resign from two boards and go on to one board. That’s correct. You don’t have to worry about me spending my 80-90 hours a week here. I’m still doing that. That’s not an issue. We’ve been rope-a-dope. We went through this crazy period with stock and the material weaknesses. We’re not in rope-a-dope anymore. We’re in the best shape in terms of really making this into a third millennium kind of company that we’ve been in two years. This is where the real ground-fighting takes place. This is where there’s going to be blood and casualties and real transformation. One of the things we did, right or wrong, we went and added almost three hundred people in terms of Romania, India, and what not. We went and started this globalization so that we could actually start rebalancing the corporation, so we got thrown a little of a left hook in terms of our customer base having to through a tough economic period. If you look at it and we gave enough information on page 11, you can see that it isn’t coming from the market place not supplying incremental business. It’s coming from a slowdown in renewing the existing business that we have. We still believe that our attrition rates are less than 3% on a name basis and it’s actually negative attrition on a volume basis, so we’re on plan, but sober to the marketplace realities around us.

Operator

Your final question is a followup from Nikolai Fisken with Stephens, Inc.

Nikolai Fisken - Stephens, Inc.

Have you guys dramatically increased your professional services rate in some set products? How are your competitors trying to capitalize on that?

Philip G. Heasley

Let’s put it this way. We had the unfortunate behavior of charging certain customers less than it costs us to supply them services. This was largely in the United States, and we brought in a general manager who put together an SG&A team that was able to make it really clear that this was a behavior that had to change. We are still in a situation in the US that we could actually probably do more services if we had more trained experts in payments than we do right now or if we didn’t need our people for other key installations that are going on around the world. I don’t believe that move was anything but a move to sanity. Certainly, we’ve not gone to some grievous rate structure that allows people to drive tanks underneath us. I think we’ve done quite the opposite. I think we’ve gotten ourselves to a rational environment.

Nikolai Fisken - Stephens, Inc.

Okay, so how are the competitors trying to capitalize on sun-setting products?

Philip G. Heasley

Well, I’m sure there are going to be some people that are going to try to capitalize. We have competitors that are showing up all kinds of deals and I think the proof is in the pudding. When it comes to medium to large banks, we have a dominating share in terms of that business. People can go and say, “Well, gee, we lost 15 Windows-based deals to some competitor.” Well, we’re going to continue to lose Windows-based deals because we don’t have Windows-based kind of products, so it a mom-and-pop needs a low-value box kind of structure, we’re going to lose out to mom-and-pop or Windows-based kinds of environment. We’ve decided not to play in that space because it’s hard to sell Rolexes and Timexes because you’ll end up selling your Timexes because of the prices. We have enough other opportunities not to do that. So, no, that’s not a concern.

My biggest concern is to take this very valuable customer base that we have that has a large inventory of installation that they’re waiting for us to complete, and get those completed. I mean quite honestly if things speed up a little bit and we were to get every sale we wanted this year and it all came in the fourth quarter, that would be the absolute best possible thing for this company because this company really needs to have a more manageable backlog, and I would just assume we wouldn’t start working those installations any sooner than if we did the sale in the second or third quarter. As it relates to these renewal guys, I’m not worried about these big customers. I’m not going to talk about who they are, but they’re very large customers, and we’re not going to be jerks, and they’re not going to jerks, but we’re not going to, for the sake of a quarter, give 10% to 20% discount to get some revenue and cash in. So, do I like the fact that our customer base is going through the problems they are? No, I don’t. Am I comfortable with our role there? Yes, I’m very comfortable with our role. Am I worried about the competition? Not in the phase that we can see them; I’m not worried.

On the wholesale side, we have very good competitors, and on the retail side, we dominate. On the fraud side, we have good competitors and we do well. On the wholesale side, there are two or three very good competitors, and we get our just desserts and they get their just desserts. We are up probably five to ten times the amount of wholesale deals we were getting two to three years ago, so should we up ten to twenty? I don’t know. That might be asking too much of ourselves and the marketplace. I’m comfortable with where we’re going. We absolutely proved that we can grow the business. Now, we have to prove we can effectively implement and maintain it. Does that answer your question?

Operator

There are no questions at this time.

Tamar Gerber

Thank you for joining us.

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