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Executives

Jack Browne

Alex P. Hart - Chief Executive Officer, President and Director

Jeffrey W. Hodges - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Analysts

John Campbell - Stephens Inc., Research Division

Ryan Lee Vardeman - Palogic Value Management, LP

Dan Weston

Sam Bergman - Bayberry Capital Management

Official Payments Holdings (OPAY) F4Q 2012 Earnings Call December 12, 2012 5:00 PM ET

Operator

Welcome, and thank you for standing by. [Operator Instructions] Today's conference is being recorded. [Operator Instructions] Now I'd like to go ahead and turn today's call over to Jack Browne. Sir, you may begin.

Jack Browne

Thank you. Good afternoon. My name is Jack Browne, and I’m the Controller for Official Payments. Welcome to today's call to review our fiscal 2012 and fourth quarter results. After the market closed today, we issued a press release announcing Official Payments' financial results for the fiscal year and quarter ended September 30, 2012.

A copy of the press release can be found on the Investor Relations section of our website www.opay.officialpayments.com. We invite investors who wish to speak to management about the company to contact our CFO, Jeff Hodges, at (770) 325-3102 or by emailing him at Jeff.Hodges@officialpayments.com.

A replay of today's call will be available later this evening on our investor website, www.opay.officialpayments.com or by calling 1 (800) 873-2149. The telephone replay will be available until 11:59 p.m. Eastern Time, on January 2, 2003 (sic) [2013].

I want to remind you that various remarks that we may make on today's call about the company’s future expectations, plans and prospects, constitute forward-looking statements for the purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the Management's Discussion and Analysis and Risk Factor sections of our most recently filed quarterly report on Form 10-Q, which is on file with the SEC, and those discussed in the Management's Discussion and Analysis and Risk Factor sections of our annual report on Form 10-K, which will be filed with the SEC later this week.

In addition, any forward-looking statements represent our views only as of today and should not be relied upon as representing our views as of any subsequent date. While we may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so even if our views change. These forward-looking statements should not be relied upon as representing our views as of any date subsequent to today.

In this call, references to Q4 2012, Q4, the quarter or the fourth quarter, refer to the quarter ended September 30, 2012, and the references to fiscal 2012, FY 2012 and the year refers to the fiscal year ended September 30, 2012.

We use the term client to refer to the various legal entities with whom we contract to provide our Payment Solutions. The term customers refers to consumers who utilize our payment services to pay amounts due to our clients.

During this call, we will be referring to non-GAAP financial measures that are not prepared in accordance with Generally Accepted Accounting Principles. The 2 non-GAAP financial measures that we will be discussing today are Payment Solutions' net revenue and adjusted EBITDA from Continuing Operations.

During this call, when we use the terms net revenue and adjusted EBITDA, we are referring to Payment Solutions' net revenue and adjusted EBITDA from Continuing Operations. We define the non-GAAP financial measures used in this call and we have presented reconciliations of these non-GAAP financial measures, on a historical basis, to the most directly comparable GAAP measures in the press release that we issued earlier today. That press release was furnished to the SEC earlier today as an exhibit to a current report on Form 8-K. The Form 8-K, including the press release that reconciles the non-GAAP financial measures to the most directly comparable GAAP measures, is available in the Investor Relations section of our website, www.opay.officialpayments.com under the heading Investor Relations.

Payment Solutions' net revenue is defined as Payment Solutions' growth revenue, less related third-party transaction processing costs, which we refer to as discount fees. Discount fees are comprised of interchange fees and other third-party transaction costs we must pay to process transactions.

Adjusted EBITDA from Continuing Operations is defined as net income or loss from our Continuing Operations before interest expense, net of interest income, income taxes, depreciation and amortization, share-based compensation expense and restructuring charges.

With me on the call today are Jeff Hodges, our CFO; and Alex Hart, our President and CEO. I'll now turn the call over to Alex.

Alex P. Hart

Thanks, Jack, and welcome, everyone. We appreciate your interest in the company.

We are proud of the progress we've made in the turnaround of the business as reflected in the consistent operating performance we've posted each quarter, and for the year as a whole. Fiscal 2012 was an important turning point in the business as we refined our long-term growth strategy and made significant enhancements to our technology infrastructure and sales and marketing programs to support that growth. These investments will continue, though at a reduced rate during fiscal 2013, and should significantly improve our operating results in fiscal 2014 and beyond.

For the fourth quarter and the year as a whole, we achieved modest growth in gross revenue and grew significantly in both net revenue and adjusted EBITDA, which we believe are more reliable indicators of our operating performance given the consistently large amount of interchange included in our gross revenue number.

Please note that the seasonality we've experienced in prior years continued in fiscal 2012, so fourth quarter was once again our lowest in terms of transaction volume compared to the rest of fiscal 2012. We expect a similar pattern of seasonality in fiscal 2013.

In a few minutes, I'll expand on our progress related to the strategic initiatives we've discussed in prior calls and share our expectations for fiscal 2013. But first, our CFO, Jeff Hodges, will review our fiscal 2012 and Q4 results in more detail. Jeff?

Jeffrey W. Hodges

Thanks, Alex. I'd like to begin by discussing our full year highlights, then review the fourth quarter.

We processed more than $9 billion of payments in fiscal 2012, a 10% increase versus last year, resulting in revenue of $135.7 million, a 4.3% increase over fiscal 2011.

Net revenue for fiscal 2012 was $45.9 million, a 36.2% increase over fiscal 2011, and adjusted EBITDA was $4.8 million in fiscal 2012 versus a loss of $500,000 in fiscal 2011.

Now turning to the fourth quarter. We processed more than $1.8 billion of payments in Q4 2012, a 10.5% increase versus Q4 of last year, resulting in revenue of $28.9 million, a 1.5% increase over Q4 of last year. The number of transactions declined approximately 3% in Q4 of 2012 versus Q4 last year, principally reflecting the loss of the last of several utility clients added via the 2009 acquisition of ChoicePay. We believe that the substantial majority of this churn is now behind us.

Our Q4 2012 net revenue rose 38.5% to $10.7 million versus Q4 last year. We achieved growth in net revenue in most of our key client types, with particularly strong growth in our federal, state and local government and higher education clients. This improvement is primarily a function of both benefits in the Durbin Amendment and other negotiated interchange in processing cost savings.

General and administrative expenses rose $0.9 million or 14.5% to $7.4 million in Q4 2012 compared to Q4 2011, primarily as a result of increased performance related to bonus accruals and increased headcount costs associated with our technology investment, which Alex will discuss in more detail.

Selling and marketing expenses rose $0.3 million to $2.2 million for the quarter, an increase of 15.7% compared to Q4 last year. This is principally due to severance costs related to the termination of a senior marketing executive at the end of Q4 2012.

Adjusted EBITDA was positive $0.2 million in Q4 2012 versus negative adjusted EBITDA of $1.4 million in Q4 last year. This is the first time since fiscal 2004 the company has generated 4 quarters of positive adjusted EBITDA in a fiscal year.

For the quarter, we reported a net loss of $2.1 million or $0.12 per share compared to a net loss of $3.6 million or $0.21 per share in Q4 2011.

As of September 30, 2012, we had $39.1 million in cash and cash equivalents. This amount included $1.7 million that we had not yet distributed to clients due to the timing of bank transactions, and $5.6 million of accrued discount fees, both of which reduced cash available for the company use to $31.7 million at the end of fiscal 2012 versus $32.7 million at the end of fiscal 2011.

As we've discussed in previous calls, during fiscal 2012 and 2011, we invested $8.3 million to upgrade our core IT infrastructure, including the purchase of hardware, software and related professional services. This project was deemed to be substantially complete in September 2012 and was placed into service.

Official Payments' management board continues to believe that our long-term interests are best served by preserving our cash position in the near to medium term in order to fund internal and external growth initiatives. We continue to actively review potential acquisition targets but are not able to predict if and when we might be able to find and close a transaction that meets our strategic and financial criteria.

Now I'll turn it back over to Alex.

Alex P. Hart

Thanks, Jeff. As Jeff noted, Official Payments made significant operational improvements in fiscal 2012 that attest to the progress we've made in the turnaround to date. I thank our entire team of employees for its dedication to an aggressive program of operational and technological enhancements over the past 2 years. It's been hard work, but the benefits of the effort are becoming increasingly clear. The operational aspects of the turnaround are nearly complete. And our technology infrastructure is now where it needs to be to deliver the high levels of reliability and performance that our clients and customers deserve.

In addition, we are now positioned to consolidate our 3 existing payment platforms onto a single, scalable, secure and reliable platform that will not only facilitate further operational efficiencies but will also enable us to innovate and grow more quickly.

As we alluded to in today's news announcement, our strategy to accelerate growth is focused on increasing adoption within our existing client base and expanding our list of clients through direct sales, expanded alliance relationships and potentially, tuck-in acquisitions.

The development and launch of new products and services will support both goals. The first of these new products is an electronic bill presentment solution that we believe will be attractive to existing and potential customers alike. Development is in full swing and we've had meaningful conversations with several existing and prospective clients, so we anticipate launching our bill presentment solution by the end of the second quarter of fiscal 2013.

We also believe that the iPhone, iPad and Android phone and tablet apps that we're launching after the first of the year will enable us to increase the convenience of our solutions and will ultimately increase both end-user adoption rates and new client acquisitions.

Smartphones outsold PCs for the first time last year, and we believe that the number of people using their smartphones and tablets to conduct transactions will continue to grow at an impressive rate.

Our efforts to increase adoption have historically focused on paid and organic online search, and we've developed a pretty sophisticated and efficient system for generating additional transaction volume in key markets.

We'll continue to make meaningful investments in online search, but we're also investing in our ability to help our clients market our combined solutions to their end-users more effectively with the goal of increasing our relatively low penetration rate with those clients. In terms of adding new clients, we continue to improve our ability to qualify, close and implement new client deals. We have added appointment-setting support to a now relatively well-tenured sales force and we're working to gain additional leverage through increased integration with the ERP and CRM solutions that have meaningful market share in our chosen markets.

We have also begun meeting with prospective acquisition targets. The list of possible targets is somewhat short at the moment, given our relatively small market cap and our cash position, but we believe that there may be some good opportunities to expand our client list and, potentially, our product capabilities through thoughtful acquisitions.

Two key developments that have enabled us to begin looking at acquisition targets are: first, the completion of our infrastructure project; and second, the development of a platform consolidation plan. Our current expectation is that we'll be able to substantially complete the development of our enhanced platform before the end of calendar year 2013. And all new clients and the vast majority of our existing clients will be on the new platform in fewer than 15 months. We believe that we'll spend approximately $3 million on the platform consolidation project, significantly less than the $10 million to $12 million we originally contemplated spending to build a new payment platform.

The primary reasons for the decision to consolidate onto a single platform are greater operational efficiency, the ability to build new products more quickly, and the greater ease with which we can enhance the safety, security and throughput of the platform. But we also believe that having a single platform would help us to integrate any future acquisitions as well.

I'd now like to briefly touch on our financial guidance for fiscal 2013. Based on our fiscal 2012 accomplishments and our current outlook, we expect to increase adjusted EBITDA by approximately 50% during fiscal 2013 to $7.2 million. Please note that our guidance includes the cost of the platform consolidation we've outlined, and although we're not expecting any financial benefit from the platform consolidation in fiscal 2013, we do anticipate significant operational benefits in fiscal 2014 and beyond.

At this point, we'd like to begin the Q&A portion of the call. Operator, will you please open the lines for questions?

Question-and-Answer Session

Operator

[Operator Instructions] Brett Huff, your line is open.

John Campbell - Stephens Inc., Research Division

It's John Campbell in for Brett Huff. If you guys could just maybe give us a little bit more color on, kind of, how you guys are improving this or just kind of improving the spread? Is most of that just due to negotiations towards the lower processing fees or just, I guess, just general lower interchange rates?

Alex P. Hart

Well, it's a combination of things. Obviously, the Durbin Amendment and the reduced debit card expenses associated with that have a meaningful impact, but we think it could be as much as half of the improvement. But the other half is a combination of better negotiated rates with our processing partners, better operational efficiency in terms of making sure that the transactions we have are being categorized and captured the right way, that we're not having transactions downgraded for reasons that don't apply in terms of the risk, a lot of our transactions are very low risk from a fraud and credit loss perspective. And we don't always get credit for that low-risk environment, so we're trying to make sure that we do in every case possible. And then other things we've done internally to improve pricing, to reduce the number of unprofitable clients we have. We've had some reduction in transaction volume due to some of our large utility clients leaving that were acquired with the ChoicePay acquisition in 2009. Some of those, we are sorry to see go; others, we, frankly, were not making any money on and so that's assisted us in increasing that net revenue number as well.

John Campbell - Stephens Inc., Research Division

Okay, great. And then just on employee headcount, I might have missed this earlier. But I think in the last quarter, you guys were like 229, somewhere around there, but could you guys give us an update of kind of where you're at now?

Jeffrey W. Hodges

Yes, we're at 237 at the end of the year.

John Campbell - Stephens Inc., Research Division

And could you guys give any kind of color on kind of where you guys are adding heads?

Jeffrey W. Hodges

Primarily in technology and almost solely in technology. Frankly, it's tied to the platform consolidation project we talked about.

Alex P. Hart

We're adding a couple of sales people that are focused on selling electronic bill presentment and mobile to our existing clients in concert with the farmers [ph] that manage those relationships today. But otherwise, as Jeff said, it's largely on the technology side of things.

John Campbell - Stephens Inc., Research Division

Okay, got it. And then, just a bonus question here. Just as a hypothetical, let's just say we take a big leap over the fiscal cliff and taxes kind of soar next year, could you guys just maybe give us a little bit of, kind of, where your head's at as far as what that would mean for OPAY?

Alex P. Hart

Well, obviously, our -- we are relatively sensitive to average transaction size and that is because we've gotten a higher concentration of tax payments of all kinds, personal property, real property, federal and state income tax, our average payment size will go up if, in fact, those rates go up also. So while it would hurt us all personally, professionally, it would not necessarily be a bad thing if tax rates were a bit higher next year, but we'll see where that goes.

Operator

And right now I show no further questions. [Operator Instructions] We do have another question. Sam Bergman, Bayberry Capital Management your line is open.

Sam Bergman - Bayberry Capital Management

A couple of questions. One, regarding the IRS and the position that you guys will be in next year. Do you have any idea on revenue and what kind of increase in revenue that would give OPAY in a given year when you go from 3 to 1?

Alex P. Hart

Well, you're speaking in terms of our position on their site? So we have -- we were at #3; 2 years ago, we were #2 which is, in fact, the worst position to be in. This past year, we're slated to be #1 for the 2012 tax season, which begins, obviously, January 1. And there definitely is an added benefit to being #1. In order of ranking, first is best, third is second best, and second is the worst place to be. So we do anticipate that we'll see some uptick. We've not tried to quantify that and probably shouldn't try to quantify that, but we feel very good about our position. And depending on what rates do, that might have an additional effect, although, that won't be felt until later in the year with property taxes and estimated taxes.

Sam Bergman - Bayberry Capital Management

Second question is when do you think you can announce some wins on the -- whether it's the new platform or the old platform, I know there was some discussion in the last earnings call of a win, but no mentioning of names. And I know there's -- that kind of news always gives the shareholders a big lift and we're looking forward to those kind of wins. And I'm wondering if they are announce-able or they can't be announced because of legal issues.

Alex P. Hart

Well, we have -- the largest win we've had in recent months, we are not allowed to announce because the client is unwilling to have us share their name, although they're willing to be a reference for us once they are live, which we anticipate happening after the first of the year. But in general, we tend to not announce wins unless they are very large. And to the extent that we close one of the larger deals we're working on today, we probably would feel compelled to announce that. We've not systematically announced smaller wins.

Sam Bergman - Bayberry Capital Management

And on the platform, how much of the platform going from 3 to 1 has been completed at this point?

Alex P. Hart

We are about 3 months into that process. We really -- we're ahead of schedule on the infrastructure project in many respects, and reached a point at which it made more sense to begin work on consolidation as opposed to further enhancement of platforms that were going to be sunsetted at some point. So we're into it far enough to feel confident that the deadline we have established is a good one. And we certainly would love to overperform, but we're very comfortable with the schedule as we've defined it thus far.

Sam Bergman - Bayberry Capital Management

Did I happen to see an exercise of options today by Mr. Sandip of 50,000 shares at site 22?

Alex P. Hart

No, there may have been a grant of options. But no, not a sale.

Sam Bergman - Bayberry Capital Management

Okay. And the only other question I have is in terms of acquisitions, you're saying that you're in talks or on a small-scale, do you have any idea or are you putting any deadline of when this would come to fruition going forward, or is that just a small chance at this time?

Alex P. Hart

Well, we certainly can't predict the timing of any of the things we're discussing at the moment. It's a 2-party -- it will be a 2-party transaction, the other parties would have to reach agreement with us for us to feel confident there was a time line involved. But we're -- and I should note that we're not talking to any one particular client or a target above all others. There are a number of folks that we have made an effort to get to know and to understand. And there are at least a handful of smaller companies in our space that we think are interesting and could benefit from becoming a part of a larger story.

Sam Bergman - Bayberry Capital Management

And last question, and then I'll let somebody else get on. What are your plans for 2013 in terms of Investor Relations and talking about OPAY's story going forward?

Alex P. Hart

Well, we have tried to get out after earnings the last few quarters. We certainly anticipate doing that in January as well. And certainly, wanted to tell the story more frequently. I think the interest level in the story has increased, and so Jeff and I will spend more time on the road in the coming quarters than we have in the past few.

Operator

The next question comes from Ryan Vardeman from Palogic.

Ryan Lee Vardeman - Palogic Value Management, LP

As it relates to the completion of the consolidation of platforms, you indicate you're going to realize significant cost savings on an ongoing basis. Where in the P&L is that going to show up? And can you help quantify or at least bracket what those cost savings may be?

Jeffrey W. Hodges

Yes. Ryan, it will primarily be in G&A with -- and some of it will also show up in our other costs to sales line which is down below net revenue. So -- and it's going to be primarily people call us to operate the system, and the number we've not guided to yet and won't on this call, but as we get further into the year, then we'll -- or really, towards the end of this year, I think we'll start talking more about that.

Ryan Lee Vardeman - Palogic Value Management, LP

Okay. And then -- so none of those cost savings, clearly, are built into the 2013 EBITDA guidance?

Jeffrey W. Hodges

No. As a matter fact, we're investing a bit this year some OpEx, some CapEx to get the project done.

Ryan Lee Vardeman - Palogic Value Management, LP

And how much of that would be on the OpEx side?

Jeffrey W. Hodges

Big round numbers, around $1 million.

Operator

Next question comes from Dan Weston.

Dan Weston

Most have been answered at this point but a couple of follow-ups. On the 2013 guidance, so your EBITDA, that was 60% growth, is there any color you can give us in terms of what you expect your overall revenues or net revenue guidance will be for this year?

Jeffrey W. Hodges

Yes. The net revenue growth, we expect to be in the high-single digits to low-double digits this year, and the residual will come from expenses.

Dan Weston

Okay. And then in the EBITDA guidance, is that all from organic means or are you factoring any kind of growth or incremental business from acquisition activity?

Alex P. Hart

It's all organic.

Jeffrey W. Hodges

It's all organic.

Dan Weston

Got you, got you. And then, lastly, on that note, in terms of some of these smaller tuck-ins as you call them, is there any particular area or line of business where you think you need to fill some holes specifically?

Alex P. Hart

No, there really are not. But I would note that our first priority is to find opportunities within our existing markets, not necessarily in adjacent markets. Although, we are open to the possibility of moving into an adjacent market. But for the most part, we're focused on governments, higher education, utilities and charitable giving, where we have one very large client but have not done much yet.

Dan Weston

And are there any particular metrics that you can share with us in terms of whether it be size or EBITDA contribution that -- or multiples that you are kind of targeting?

Alex P. Hart

No, we don't think it would be prudent to share much of that publicly. We are -- but we certainly will, we'll share what we can when and if we get a deal done.

Dan Weston

Got it. Well, maybe I mean, lastly, in terms of an acquisition, would it be reasonable to assume that if you're going to make one, that it would be a contributing factor of EBITDA in terms of...

Alex P. Hart

Well, we certainly would want it to be accretive, if at all possible. There might be very solid strategic reasons for it to be slightly dilutive, but our goal is always to do accretive acquisitions.

Operator

And right now I show no further questions.

Jack Browne

Okay. Thank you for your time and attention this afternoon. Again, we invite investors with questions about the company to contact our CFO, Jeff Hodges, at (770) 325-3102 or by e-mail at Jeff.Hodges@officialpayments.com. This concludes Official Payments Holdings Fourth Quarter Fiscal 2012 Conference Call. Thank you.

Operator

Thank you so much for participating in today's conference call. You may disconnect your lines at this time. Thank you and have a good day.

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