John Kraft - Vice President of Investor Relations & Strategic Analysis Philip G. Heasley - Chief Executive Officer, President, Director and Member of Strategy, Technology & Process Committee Scott W. Behrens - Chief Financial Officer, Chief Accounting Officer and Senior Executive Vice President.

Paul Condra - BMO Capital Markets Canada George F. Sutton - Craig-Hallum Capital Group LLC, Research Division Wayne Johnson - Raymond James & Associates, Inc., Research Division Brett Huff - Stephens Inc., Research Division.

Good morning. My name is Dkitri, and I will be your conference operator today. At this time, I would like to welcome everyone to ACI Worldwide Reports Second Quarter Earnings Conference Call. [Operator Instructions] Thank you. Mr. Kraft, you may begin your conference..

Thank you, and good morning, everybody. Today's call, like all of our events, is subject to both Safe Harbor and forward-looking statements. You can find the full text of both statements on the first and final pages of our presentation deck today, a copy of which is available on our website, as well as with the SEC.

On this morning's call is Phil Heasley, our CEO; and Scott Behrens, our CFO. With that, I'll turn it over to Phil..

Thanks, John, and good morning, everybody. ACI had a solid quarter. Our momentum continued in quarter 2, with 16% growth in sales, net of term extensions, and we're on track to surpass our annual target.

We're providing control, flexibility and security to an industry that is pressured by regulatory burdens, growing transaction volumes and emerging technologies. It's clear that our solutions and strategies are being well received by the market. Let me take a moment to highlight a few notable successes.

One of the largest Canadian banks went live with BASE24-eps during the quarter. We signed a large BASE24-eps contract expansion with a top U.S. bank. Also, in the U.S., we signed one of the largest EBPP contracts we've ever signed with a large consumer finance company.

In Asia Pacific, we contracted with an existing customer to upgrade the national network to BASE24-eps UP. Looking ahead, our worldwide pipeline remains at record levels and we are progressing with several large -- very large opportunities. Moving to revenues.

We grew our top line 24%, driven by the acquisition of Official Payments as well as strong execution within our organic operations. Our SaaS subscription and transaction revenues grew 58% and represented 42% of our total in the quarter.

This revenue, combined with our cost discipline and scalable software model, produced adjusted EBITDA non-GAAP operating income growth of 46% and 76% respectively. On July 21, we announced our intent to acquire Retail Decisions, or ReD. With ReD, we gained a leadership role on the fast-growing fraud prevention and e-commerce space.

This is the next chapter in our Universal Payments story, marrying ACI's brick-and-mortar payment engines with ReD's e-commerce solutions, all protected by industry-leading anti-fraud technology. We'll provide retailers a compelling true omni-channel payments infrastructure. We hope to close the acquisition during the current quarter.

It's an exciting time for retailers, and we intend to be at the forefront supplying tools for change. Lastly, we are reiterating our organic guidance. While we will update guidance for ReD when the acquisition closes, our existing businesses are on track to achieve our full year's targets provided to you earlier this year.

I will now turn the call over to Scott to discuss our financial results in more detail. Thank you..

Thanks, Phil, and good morning, everyone. I first plan to go through the highlights of our second quarter and then provide an update on our outlook for 2014. We'll then open the line for questions. I'll be starting my comments on Slide 6 with key takeaways from the quarter.

We had another strong quarter of sales bookings, with sales net of term extensions up 16% on a consolidated basis and up 14%, excluding the contribution from Official Payments. We saw a growth in both 12-month and 60-month backlog, and our backlog continues to provide a high percentage contribution of our quarterly revenue.

Our non-GAAP revenue is up 23% compared to the prior year quarter. And excluding the incremental contribution from Official Payments, organic revenue grew 4% compared to the prior year quarter. Our hosted SaaS subscription and transaction revenues were up 58% over Q2 of last year and represented 42% of total revenue in the quarter.

So overall, recurring revenue grew $191 million -- to $191 million or 75% of total revenue. Turning next to Slide 7. Our operating expense growth compared to the prior-year quarter was primarily driven by the inclusion of the OPAY operations. So on an organic basis, operating expenses were up less than 1%.

So the combination of solid revenue growth and continued strong cost disciplines delivered non-GAAP operating income and adjusted EBITDA growth of 76% and 46%, respectively, compared to the prior year quarter.

We also saw strong growth in operating free cash flow of $28 million or 29% compared to the prior year quarter, and we ended the quarter with $55 million of cash and $753 million in debt. And finally, on this slide, as Phil has already discussed or announced, our acquisition of Retail Decisions.

Just to add to that, we will finance the $205 million cash purchase price with our existing credit facility and an incremental term loan. We expect the acquisition to close in Q3, and it is expected to add $18 million in revenue and $4 million in EBITDA during the remainder of 2014. And lastly, turning to Slide 8.

We are reiterating the 2014 financial guidance we provided at the beginning of the year, which does not include any contribution from the pending acquisition of ReD at this time. We continue to expect 2014 revenue to be in the range of $1.06 billion to $1.08 billion and adjusted EBITDA between $290 million and $300 million.

And looking into Q3, we expect to generate non-GAAP revenue in the range of $250 million to $260 million. And again, we will update our full year guidance once we close the ReD acquisition.

So overall, we are very pleased with the solid Q2 performance with strong growth in new sales bookings, solid growth in organic revenue, earnings and cash flow, and we do expect this momentum to continue as we get into the second half of the year, allowing us to reaffirm our full year guidance expectations. So that concludes our prepared remarks.

Operator, we are ready to open the line for questions at this time..

[Operator Instructions] And your first question comes from the line of Paul Condra..

First question just -- I wanted to ask about the SNET growth. So midteens, that's pretty strong, but you're still guiding for December single digits for the year.

So I just kind of wondering why you think that's going to slow, and then, what kind of internal targets you may have kind of beyond 2014 for SNET?.

Yes. I mean, I agree. We are tracking higher than expected at this point. But I -- last year, we were -- we went into second half of the year with certain expectations.

We saw a deal slip out of the year and -- so right now we're still comfortable with the high-single digits and essentially sort of hedging ourselves against any deal slippage that could fall out of 2014. But we're still comfortable with that number for now..

Okay, that sounds good. And then, I guess, I wanted to also ask just if you could maybe speak broadly about deals internationally. You mentioned some -- you called out some good deals in APAC there but sales are still soft.

I wondered if you could just kind of give us a little update on where you're seeing things happen internationally, what kind of products people are looking for. I don't know, just kind of run through that..

Maybe I'll start and then Phil -- I mean, obviously, if you look at Q-over-Q, we saw strong growth in EMEA and in the Americas. Asia Pacific was off of last year but I think that's more of a comp quarter -- any particular quarter on a comparable basis by region can vary, but obviously, very solid pipeline in Asia Pacific.

But the two key areas driving growth in this quarter were the Americas and the EMEA..

Yes. And so -- and if you look at the Americas, offshore growth in Canada and offshore growth -- offshore growth in Canada, offshore growth in Latin America are also both going to be very strong for the remainder of the year. And we expect the EMEA growth to be strong for the rest of the year also..

And are you seeing any changes in terms of competition in international regions?.

Well, we compete -- most of our competitors compete against aspects of what we do. We haven't really seen changes in -- yes -- we're moving more and more towards solutions than individual product pieces, which make it a little bit more opaque to us. But no, we're not seeing a lot of change in behavior.

We are seeing the European and the American banks -- certainly, the American banks are getting away from their mortgage debacles. And the European banks says they are getting past the batch-oriented requirements of SEPA becoming much more interested in the transaction sides of their institutions. We're seeing that change in behavior..

[Operator Instructions] Your next question comes from the line of George Sutton with Craig-Hallum..

Relative to the large opportunities that you had previously mentioned, Phil, I wondered if you could break that down a little bit in terms of where you're seeing some of those larger opportunities come from. I assume the UP platform is key in that opportunity set.

I'm curious if direct connections is also an area you're seeing some of those?.

Well, we are seeing it in both, in direct connections, as well as -- I think Direct Connection's going to manifest itself further out in the line.

We'll end up probably doing more POCs, proof of concepts, before we're going to actually do sales, right? So there is very good interest in direct connections because it has more margin impact on our customers than -- although, direct connections are going to require UP, right, so one gets you the other.

We have -- I would say right now Canada, the United States and -- not EMEA, but Europe, we're seeing strong interest in UP. And of course, we announced a national network going to UP 2.0 in Asia. So I'm not saying there's no interest there. There is interest. So there's pretty genuine interest across the board.

But we're seeing it begin to convert into sales. We haven't seen any mega sales at this point from it.

And I think the size of our sales are going to increase by definition and this is -- I think this is going to be the tipping point in terms of drawing in the Classic customers into the change process, where we've been -- over the last several years, been drawing in the non-Classic.

So the really large customers are -- the really large users in the marketplace are much more interested in the UP strategy than they've been with the interim -- in the transitional stages leading up to it..

As an unrelated follow-up, relative to the ReD acquisition, I wondered if you could give us a broader sense of kind of what is -- how does your addressable market change with respect to this transaction? How does the go-to-market strategy changed? And what kind of cross-selling opportunities do you see?.

Well, what it does for us is it allow -- we had found out over the last couple of years is as retailers have seen the opportunity to manage more closely their role in the point-of-sale process and the just absolute explosion of the online channel as a payment source, that the concept of having multiple payment channels is -- first created a lot of opportunity for the retailers.

And now it's creating both opportunity and complexity because a lot of people will end up initiating a sale on 1 channel, be it voice or -- but mostly online but then, it will end up completing the transaction in person, which is, by the way, what the retailer wants because it promotes cross sell, right? And the ability for them to navigate multiple platforms when it was just an add-on channel, it was great incremental sale.

When it's now their core customer using both channels but they're viewing it as a relationship with the store, there is a real need for an omni-channel. So a lot of our sales opportunity is actually to our existing customers and bringing together the ability for them to bring their channels together.

And ReD gives us the -- under the same technology, we and ReD operate under the same technology. So under the same technical base to bring that together was a -- absolutely a triple home run. And then to be able to bring, on the payment side, the multiple channels together in the same -- in same step, that also created cross sell.

And then, at the same time, to give them -- coming out of from the Postilion side, to give them the ability to have multiple endpoints versus hardwired endpoints in terms of saying they can do low-cost routing or they can do direct connections.

They can do what -- they have their -- in fact, they have choice, they have a democracy in terms of making as efficient as possible the cost of payment. It is real -- I -- it's multiplied. It hasn't added percentage to our market sizing. It's multiplied in the breadth of our current relationships.

And then the increase in both geography and market, markets that are interested, the number of retailers that we just signed -- we're not going to talk about, it's next-quarter thing, but we've begun to really start adding very large retailers in new geography.

We just signed one in the third quarter that we'll talk about next quarter when it's more firm. I mean, it's signed.

But when the strategy more firms up that you're going to start seeing us move more solidly across the -- Europe and get the multi-continent players that want to have more global strategies versus point-by-point strategies in terms of how they're managing. So this is a very tough -- this is a very -- well, it's incremental acquisition.

It's a very important strategy because it's one of the first times we've done an acquisition very similar to -- in this regard is that the technology is very homogeneous. Its objectives are very homogeneous to what we're trying to do for our customers and we don't have to take them through a sunset or an end of life or migration or whatnot.

It's -- one and one is going to get them more than -- get them more than 2. So it's important to us..

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

Just a question on the overall results for second quarter.

How much of that, if any, was impacted by makeup business that was not booked -- or excuse me, was not recognized in the fourth quarter of '13?.

In the first quarter, we had a 51% increase in sales year-to-year, which did have a transfer from the fourth quarter. And we had a $49 million increase in 5-year backlog. We have purchased 3 businesses that had much, much more aggressive revenue recognition than ACI does.

And I know it doesn't make people that follow us happy that we have a much more conservative way of looking at revenue than the companies that we purchase. So when we pack away $49 million in future revenues versus taking them upfront, it makes our current period results not look that --that great.

But last quarter, we packed away $49 million in the 5-year backlog. This quarter, we packed away another $14 million in the 5-year backlog. And our sales were up 14% organic, 16% including Official Payments and whatnot. So it doesn't reflect anything from last year.

As a matter of fact, we're getting very good at booking stuff at the beginning of the next -- let me tell you, a very good July. We're getting very good at booking stuff at the beginning of next quarter because everyone wants to book stuff these last 2 weeks of the quarter because they think that that's the best time from a pricing standpoint.

We'll end up booking at the first week of the succeeding quarter because we can't afford to go along with that, Wayne..

Well, Phil, I appreciate that. Just so you know, this analyst completely appreciates your conservatism. So we're on the same side there. Is there any -- can you give any greater transparency on the origin of those bookings on how much is directly related to eps versus how much is related to S1, how much is related to ORCC? You mentioned a big EBPP win.

That's great. And if I understand correctly, part of the rationale for acquiring ORCC was to use their industrial-strength infrastructure to swim upstream, so to speak, and to go after bigger fish.

Could you provide any color?.

Well, we don't usually do that. But -- we don't -- and we probably won't going forward because it overlaps. What's really clear in the math is that OPAY has -- is 2% OPAY, because with or without OPAY, there is difference between the 14 -- the 14% and the 16%.

And what makes it really easy for us to say is that the growth with or without ORCC is about the same, right? They grew about the same. The payment -- the EBPP business actually grew a little more than the other business. It's smaller, right? They actually grew a little bit more than -- at a higher rate than the base business did.

But it's really hard to do that on an apples-to-apples basis because our much larger distribution creates opportunities that wouldn't be there on an apples-to-apples. We do things with our really big customers on an EBPP side that would not be done if we didn't own EBPP.

So we're using it in different -- we're using it as an IP provider that ORCC would not have used it as an individual bank. So -- but it's very fair to say that the growth is equal with a little bit more volume coming from the EBPP side. But it's coming because of our distribution mechanism. It's not coming because there's piece A and piece B..

Yes. And the only other thing I'd add to that is obviously, the BASE24-eps 2.0 product release was really released in December of last year. So it is -- it's getting a tremendous amount of traction and we're seeing a tremendous amount of year-over-year growth in eps. But that's primarily driven by the product release and the UP capabilities.

And we're expecting that growth and that interest to continue..

I gave several examples of eps sales, right? But we're not going to break that..

Your next question comes from the line of Brett Huff..

Question, Philip, on the UP conversation. So you mentioned a couple of large opportunities you are working on and excited about. You had mentioned that I think -- if not last quarter, maybe on the fourth quarter call.

Any update or more clarity on approximate number, ballpark sizes, I think when you had said that UP installation could be larger maybe on BASE24? And then, once you -- presuming you close some of those, how quickly do they come from backlog into revenue? I assume they're complex projects that might take maybe longer than a typical BASE24 project?.

I think we're going to see a typical UP project. I think they're going to come in potentially different -- depending on the needs of our customer, they're going to come in different ways.

I think some of the very largest projects are going to end up remarrying Classic and eps under our common UP umbrella, with new products coming on the eps side and important older products slowly migrating across from the other side.

So I actually think the projects are going to end up being longer-term projects in that -- instead of being 12, 18, 24 months, they may actually run 24, 36 months. But they will be up and operational sooner. But they will be more multi--- they'll end up being more multiphase and whatnot.

And I would love to tell you that means that we will be seeing revenues faster and whatnot, but Scott will probably more have to weigh in on that and the revenue gods [ph] because software industry is....

Yes, it's -- well, Brett, I actually think it'll map itself a couple of different ways. I think you're a Classic customer already and you need to get the UP capability, that's going to be -- that's going to take more time.

But if you're an eps customer today and you're getting the -- you're upgrading to 2.0, really, the key with UP is you're driving more transaction volume through. So the -- those who are already on eps, the whole notion of UP is you're pushing more transactions.

And so when a customer is pushing through x number of transactions and UP gives them the capability of doing 2x and 3x, you're going to see it in the form of a capacity sale, which can and are quicker conversion to revenue. So I think you'll see it depending on current installment base we have with particular base customers..

Okay. And then one follow-up. Can you talk about -- so you also mentioned that when you buy companies and you take kind of their more aggressive rev rec maybe license all upfront rev rec. Can you kind of spread it out over time? I know you all have been selling -- had some success per last quarter of selling S1.

I think it was the cash management deal that you had some good sales on. I know that, that used to be sold upfront license. I know, if you're selling a lot of that now, the mix might be a little bit tough on rev recognition.

Can you talk about when kind of what the negative impact to revenue growth that might've been this quarter and when we might see that abate?.

Well, maybe let me start. I -- if you look at the 2 deals we cited in the last quarter, one was sold is on [indiscernible], the other sold was hosted, both of which are really -- they've gone to backlog. And I -- in both cases, they're going to have an installation period, which is not going to result in revenue this year.

The bigger issue will be, say, in 2015, when they both go live, one is going to have a license fee and service fee, set-up fee, recognized so the upfront piece, the hosted piece will get spread over time. So in and of itself in that example, those 2 deals really wouldn't provide a drag this year. It would be really the deals we sold that were SaaS.

Really, where we started seeing the success was post acquisition of S1 back in 2012 and the deals we sold in 2012 that would've otherwise have come to -- when they get complete here in 2014, we're not seeing the big release of licensing and services. We are seeing the growth in the hosted revenue..

Yes, but to answer your question even a little bit differently is that if you were to look at our service revenue, you'll see that year-to-year, our service revenues are actually down, right? Even though our other revenues are up and whatnot because -- and another part of being conservative is that instead of "custom building new and online system or whatever", we're building a universal online system.

And we've got -- we're building well over a dozen of them right now instead of trying to -- or need to be paid service revenues as we go.

We're going to be paid a nice license and maintenance revenues once they're built, right? And we're going to forgo what our -- what S1 income model would have been a lot of services revenue working its way up to completion. That's really not in our -- it's really not in our operating model.

But our operating model is to get a good margin from when that's either delivered to the customer, which we get to see the money sooner; or installed, we get to see it as a very high margin once we operate it.

So I think what you and I were talking was that we will have suffered for 2.5 years after having acquired S1 in terms of how we recognize our revenue over 5 years versus them recognizing the perpetual nature of their licenses the way they did business.

The good news is we're within the quarters -- 1 quarter or 1.5 quarters or so of that 2.5 years being behind us. We have a little bit more time on the services side to go. But that's largely behind us. Now the really good news is that those revenues are all sitting in the backlog, right? It's not like they -- it's not like the sales didn't happen.

And it's not like the revenue isn't sitting in the backlog..

And there are no further questions at this time..

Well, thanks, everybody for joining us. We look forward to catching up in the coming weeks..

This concludes today's conference call. You may now disconnect..