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Official Payments Holdings (NASDAQ:OPAY)

Q1 2013 Earnings Call

February 05, 2013 5:00 pm ET

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

Gary F. Prestopino - Barrington Research Associates, Inc., Research Division

Operator

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

Jack Browne

Thank you, and good afternoon. My name is Jack Brown, and I’m the Controller for Official Payments. Welcome to today's call to review our fiscal year 2013 first quarter results. After the market closed today, we issued a press release announcing Official Payments' financial results for the quarter ended December 31, 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 (888) 397-5639. The telephone replay will be available until 11:59 p.m. Eastern Time, on March 4, 2013.

I want to remind you that various remarks that we may make today on -- may make on today's call about the company’s future expectations, plans and prospects constitute forward-looking statements for 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 recent annual report on Form 10-K, which is on file with the SEC, and those discussed in the Management's Discussion and Analysis and Risk Factor sections of our quarterly report on Form 10-Q, which we expect to 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 other 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 Q1 2013, Q1, the quarter or the first quarter, refer to the quarter ended December 31, 2012, and references to fiscal 2013, FY 2013 and the year, refer to the fiscal year ending September 30, 2013.

We use the term client to refer to the various legal entities with whom we contract to provide our payment solutions. The term customers refer 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 recently 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' gross 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 delivered our fifth consecutive quarter of adjusted EBITDA -- excuse me, a positive adjusted EBITDA, with a 7% increase in dollars processed versus the same quarter in fiscal year 2012. We anticipated some first quarter drag on net revenue as a result of our continued focus on platform consolidation, transaction quality and margin improvement, but total transactions and net revenue were lower than we expected. There are 2 primary reasons for the lower-than-expected transaction volume. First is a greater shift to lower margin transactions during the quarter than expected. Second, we didn't generate enough transactions from new clients to offset the effect of client losses in prior years. However, average transaction sizes continue to climb, and we suspect that the impending 2013 income tax increases caused some customers to defer some payments in the calendar 2013 to increase the deduction value of those payments versus higher tax rates. It's too soon to know how many payments were deferred into our second fiscal quarter. But January IRS payments were at record levels for us, so we remain optimistic about the rest of income tax season and the year as a whole.

In a few minutes, I'll expand on our continued progress and share further thoughts on our plans for the rest of the year. But first, our CFO, Jeff Hodges, will review our first quarter financial results in more detail. Jeff?

Jeffrey W. Hodges

Thanks, Alex.

We processed more than $2.7 billion of payments in Q1 2013, which is a 7% increase versus Q1 of last year, resulting in gross revenue of $33.4 million, a 4.1% decrease over Q1 last year.

The number of transactions declined approximately 6% to 4.7 million during the same period. With regard to lower margin transactions alluded to -- or Alex just alluded to, we saw a shift in payment mix towards ACH. As we discussed in prior calls, we have several contracts under which we received below-market fees for ACH transactions. The shift to ACH in the first quarter, combined with lower-than-expected revenue from debit card transactions in certain key property tax states, pushed revenue and net revenue down for the quarter.

Our Q1 2013 net revenue was $11.3 million versus $11.9 million in Q4 last year, a decrease of 5.2%. The largest decline was in state and local government clients due to the shift to ACH and the lower-than-expected debit card revenues that I just mentioned.

General and administrative expenses declined $2.4 million or 25.9% to $6.8 million in Q1 2013 compared to Q1 2012, primarily because Q1 2012's expenses included a onetime restructuring charge associated with the relocation of company headquarters to Norcross, Georgia. Additionally, we recorded approximately $1.4 million less in performance-related bonus accruals in 2013 as compared to the same period a year ago.

Selling and marketing expenses rose $0.6 million to $2.1 million for the quarter, an increase of 41.9% compared to Q1 last year. The main reason for the increase is that Q1 2012 included some advertising credits which we did not receive in Q1 2013, so advertising expense was higher in Q1 2013.

Adjusted EBITDA was $1.6 million in Q1 2013 versus $2.2 million in Q1 last year as a result of the changes in net revenue and core operating expenses I just discussed.

For the quarter, we reported a net loss of $0.8 million or $0.05 per share compared to a net loss of $1.6 million or $0.10 per share in Q1 of 2012.

As of December 31, 2012, we had $53.3 million in cash and cash equivalents. This amount included $16.5 million that we had not yet distributed to clients due to the timing of bank transactions and $8.8 million of accrued discount fees, both of which reduced cash available for company use to $28 million as of December 31, 2012, versus $31.7 million at the end of fiscal 2012. This decrease in cash available to us primarily reflects the payout of the fiscal 2012 incentive bonus that we've discussed in prior calls.

Official Payments' management board continue 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.

Now I'll turn the call back over to Alex.

Alex P. Hart

Thanks, Jeff.

Looking ahead, we expect to complete the platform consolidation project at the end of this calendar year. The consolidated platform will be a significant upgrade in terms of functionality and reliability for most of our clients. But we still need to be thoughtful about the timing of the upgrade process to minimize any potential complications.

Clients are moving to the new platform in logical groups, and the initial group was upgraded with very few issues, so we're feeling very good about the progress of our platform consolidation project.

We also feel very good about our sales organization, the hunters that are focused on bringing new clients into the fold. But the fact that we've lost a few more clients than we expected to and that we were surprised by their departures tells me that we probably haven't paid enough attention to maintaining existing client satisfaction. We have a large and distinguished client list and a number of very capable account managers, but we may have spread our account manager resources too thinly. As a result, we've reorganized the account management group and better aligned it with the marketing organization to better anticipate and react to the needs of our existing clients.

Another key to future profitability is cost control, specifically processor consolidation and the other improvements we're making on the cost side of the business. We're reducing the number of processing partnerships to reduce the operational complexity of our current environment and to get better pricing for the volume we generate.

We're also investing in more sophisticated routing and data analytics capabilities to improve our economics and better manage our payment mix. As previously noted, both gross revenue and net revenue were lower than we expected in Q1, primarily due to increased ACH and fixed fee debit card volume. As Jeff explained, we have a number of legacy client contracts that provide for ACH services at below-market prices. And we signed an agreement last year with one of our current association partners to offer fixed fee $3.95 debit card pricing in some new markets as part of a broader deal to improve our pricing overall.

We believe that offering less expensive payment types, such as a flat fee debit card option, will eventually enable us to increase our total transaction volume and to convert some of those low fee ACH customers to more profitable and more valuable debit card transactions. However, the short-term effect of the fixed fee debit card program was the cannibalization of some transactions that were considerably more profitable in prior periods, especially in the property tax market, without delivering the additional transaction volume we anticipated. Having seen this effect, we're in the process of adjusting our ACH and debit card offerings to better reflect the market opportunities available to us and to balance our desire to maximize revenues today while setting ourselves up for growth and improve operating results in the future.

To summarize, we recognize that the key to long-term success is accelerated profitable growth. We're confident that we'll have the platform, product set and processing capabilities we'll need to facilitate that growth, but we need to do a better job of closing deals, expanding existing client relationships and getting more leverage for the assets we have.

Our clients are relatively deliberate, so the selling cycle is longer than we like it to be. And the time that elapses between contract signing and the generation of meaningful volume is often lengthy, but we see opportunities for improvement. We have strong sales and account management teams, and we're working hard to close deals faster, to implement new clients more quickly and to leverage our marketing expertise more effectively to increase both the ramp-up speed of new clients and the penetration and utilization rates of our existing clients. Over the past year, we've piloted several new marketing programs that have delivered meaningful improvements in transaction volume, size and quality, and we now need to get more of our clients to take advantage of these programs.

We also need to find accretive, tuck-in acquisitions that will bring in new clients, geographic reach and product capabilities to our organization. We haven't found the right deals yet, but we're actively meeting with prospective partners. We also continue to explore ways to both provide more value to our 3-plus million registered officialpayments.com customers and to deliver more content, functionality and value to the 3,000-plus clients we serve. Electronic billing, new mobile apps and increased payment capabilities top the list of improvements, but we're also considering ways to deliver electronic bills and more electronic payments to our clients, potentially by providing network access to other bill payment providers on a per transaction basis.

For example, we've historically viewed the bank-centric bill payment model as a competing offering, but we think that there could be great value enabling bank bill payment customers to make payments to our billers through our network in cooperation with the bank on an expedited same-day basis or simply by replacing a paper check with a faster and less expensive electronic payment. It's too early to make any predictions about this cooperative payment model, but we believe it is an approach that deserves careful consideration, especially since our current customer penetration rate is only about 2.5% overall.

In closing, I'd like to reiterate that we remain confident that we'll achieve our previously discussed adjusted EBITDA target of $7.2 million for fiscal year 2013, and we're working aggressively to set ourselves up for growth and profitability in fiscal year 2014.

Thank you once again for your interest in Official Payments. We will welcome any questions you may have at this time.

Heather, would you please open the lines for questions?

Question-and-Answer Session

Operator

[Operator Instructions] And we have a question from Gary.

Gary F. Prestopino - Barrington Research Associates, Inc., Research Division

Could we just kind of very slowly -- you guys talked kind of quickly here in terms of some of these lower volumes. I kind of jotted down a couple of things: greater shift to lower margin transactions, deferred tax payments, things like that. Could we maybe just kind of go through real slowly what were some of the key issues here that led you to have a down quarter in gross revenue and net revenue?

Alex P. Hart

Sure. Let's start with the deferral of payments. We believe that some percentage of our customers, specially on the property tax side, where -- we tend to skew more heavily toward a more affluent customer profile given that those that are paying property taxes through escrow are not our clients. Those who are paying -- those that are able to pay because of their equity position on their own are our clients. We suspect that some percentage of them determined that taxes were going to go up for them or were likely to go up for them in 2013, and that the deductibility of the property tax payments bill ranking would have more impact at the 2013 tax rate than at the 2012 tax rate. And so they waited until January to do that, or perhaps even later in the quarter depending on what the schedule looked like and what penalties were assessed if they paid in 2013 versus 2012. So it's too early to know, but early indications are that volume is up in January. In fact, January IRS payments were significantly higher than they've been in prior years, and we're very encouraged by that.

Gary F. Prestopino - Barrington Research Associates, Inc., Research Division

That was for property tax, as well as any taxes paid to the IRS?

Alex P. Hart

Yes.

Gary F. Prestopino - Barrington Research Associates, Inc., Research Division

Okay. So -- and then you talked about the shift in payment mix to ACH, lower debit transactions as well. Did that come from a fact that this flat fee that you put out on -- for debit cards are for certain markets?

Alex P. Hart

Yes. There were a number of places where we had not previously offered debit -- separate debit pricing because we do not have a very positive financial arrangement with the card association, and at a certain point, a fixed fee charged to the client or customer was not met with a fixed fee to us. And so we were upside down on certain transactions, and in property tax in particular, it didn't take long for us to get to a point where we were making far less than we were charged for those transactions. So we got a better deal that protected us on the downside, but it also ran off some transactions that frankly where charged to us as debit card transaction but were charge to the customer as a credit card transaction. They didn't know if it was a debit or credit card, they simply put their number in. And so they were sort of the best of both worlds in terms of a single transaction, but they clearly held back the volume. So having a lower cost option, we think, is generating additional volume, but it's also cannibalizing some transactions that previously came through with the credit card income and debit card expense.

Jeffrey W. Hodges

Gary, this is Jeff, just one other quick point to note on that. That flat fee has been rolled out by the IRS for a couple of years, so that phenomena was what we think of a first quarter item.

Alex P. Hart

Yes, it was primarily a property tax issue because it has been available in other places. But for property tax, it was not, and so we're recalibrating. And it was a, as Jeff mentioned, it's typically a onetime a year kind of payment. So we don't expect much effect from that for the rest of the year, but it did surprise us a bit at its size -- or impact this quarter.

Operator

[Operator Instructions] And we have no questions at this time.

Alex P. Hart

Well, if so, then we will conclude. Jack, wrap us up.

Jack Browne

Thank you, Alex. Thank you, again, 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 First Quarter Fiscal 2013 Conference Call. Thank you.

Alex P. Hart

Thank you.

Operator

Thank you for participating in today's conference. Please disconnect at this time.

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