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Bottomline Technologies (NASDAQ:EPAY)

F4Q09 Earnings Call

August 5, 2009 5:00 pm ET

Executives

Robert Eberle – President, Chief Executive Officer

Kevin Donovan – Chief Financial Officer

Analysts

Jonathan Maietta – Needham & Company

Colin Gillis – Brigantine Advisors

Brett Huff – Stephens, Inc.

Gary Prestopino – Barrington Research

David Grossman – Thomas Weisel Partners

Operator

Welcome to the Bottomline Technologies fourth quarter 2009 earnings conference call. (Operator Instructions)

Statements made today may include forward-looking information subject to risks, uncertainties and other factors that could materially affect actual results. For further information please see Bottomline's report filed pursuant to the Securities and Exchange Act of 1934 which is available at the website, www.sec.gov.

During their remarks, reference to Bottomline's financial results related to non-GAAP or core financial results. These results are also referred to as core operating income, core net income and core earnings per share in our earnings release. A reconciliation of GAAP net income to core net income is provided in our earnings release.

These results exclude an amortization of intangible assets, equity based compensation, restructuring costs and acquisition related expenses. Throughout this call, when they refer to their financial results, it has that meaning. Bottomline will be providing forward-looking guidance on the call. A summary of the guidance provided during the call is available from the company upon request.

I would now like to turn the conference over to our host, Mr. Rob. Eberle.

Robert Eberle

Good afternoon. Thank you for your interest in Bottomline Technologies and welcome to the fourth quarter fiscal '09 earnings call. I'm delighted to have the opportunity to report on what was an outstanding quarter for Bottomline. I'm joined by Kevin Donovan, Chief Financial Officer who will provide a detailed review of the fourth quarter financial results and our guidance going forward, and as usual, we'll both be available for questions following Kevin's remarks.

I'm truly excited to be reporting today's results. The fourth quarter was an outstanding quarter for Bottomline and a solid conclusion to the year. From a financial perspective, we met or exceeded all our targets with solid revenue growth in a tough environment, significant margin expansion driving operating margins to levels double to what they were a year earlier and strong cash flow further increasing our cash balance.

Strategically, we made a major step forward forging a new relationship with a key strategic partner which significantly accelerates our business model, places us in a clear leadership position in the market and provides a new and incredibly powerful channel.

I'm going to focus my remarks on this relationship, but let me first start by highlighting the financial results for the fourth quarter. We had strong results in every metric; revenues, orders, profit and cash flow.

Revenues for the quarter were $34.9 million, up $1.6 million from the prior quarter and 6% from the prior year on a consistent currency basis. 64% or roughly two-thirds of our revenue was recurring. Orders were up $7.7 million a full 8% higher than our reported revenue, bringing backlog to a new high of $83.8 million.

We continue to drive increased profitability with all our key operating metrics, specifically EBITDA operating income and EPS moving forward, several historic highs.

EBITDA was $6.3 million, an increase of 74% from the prior year. Operating income was $5.4 million, more than double the prior year. Operating income was 15% of revenue which is up from 7% a year ago and approaching our longer term target of 20% plus operating margins. EPS was $0.22 which is double the level of a year ago, well above the high end of our guidance.

Finally, we had strong cash flow, ending the quarter with over $50 million in cash, an increase of $9.3 million from the prior quarter.

Kevin will provide more details on the financial results for the quarter. I'd like to turn my attention now to a very significant and strategic relationship.

Earlier this afternoon we issued a press release announcing Bottomline's purchase of Bank of America's corporate payment and invoice network. As part of the transaction, we've entered into a long term agreement to be the provider of the SAS service to Bank of America and its corporate customers.

This is a significant transaction for Bottomline. It accelerates our business plan and over time will add meaningful revenues and profits. Strategically, it puts us in a clear leadership position in this important and potentially huge market and it give us a new and powerful channel and business partner in Bank of America.

This is a unique opportunity and we are delighted to have been chosen by Bank of America and have entered into this long term partnership with them. We believe this is a true win win transaction, leveraging each organization's unique strengths and capabilities.

To help investors understand the implications of this arrangement, I'm going to cover several aspects. One, why was Bottomline chosen? Second, what did we purchase and how or at least the degree we can share information without putting ourselves or the bank in a competitive disadvantage is the transaction structure.

What does it mean for the market? And finally how will Bottomline and Bottomline shareholders benefit? How does it accelerate our business plan, and how will it create value?

So let me start with why we were chosen. This is a key platform Bank of America will continue to provide to its customers; customers who rely on it every day for the business critical functions of invoicing and payments. So while we are buying the networking business, which is important because we now own this strategic asset, we really were chosen as a long term business partner.

I say chosen and I think this is important for investors to appreciate, because the transaction while technically the sale of the business unit to Bottomline, the reality is the process more one of being chosen as a trusted and strategic partner; a trusted and strategic partner that has and can provide next generation solutions for integrated payables automation.

The chemistry between Bank of America and Bottomline Technologies, the overlap in our product offerings and the similarity between our roadmaps were all key decision points for Bank of America.

Our Business Exchange Platform has many of the key capabilities the bank desires. We are both headed in the same direction, targeting the same market with different strengths. Combining those strengths, Bottomline's technology and domain leadership with the bank's market power and scale, produces a clear market leader.

We share the same vision on how to deliver a payment/invoicing settlement network for businesses in a SAS model that adds value to each participant at all points in the financial supply chain. We're jointly committed to further enhancing the PayMode platform and extending our leadership position in the market place.

This is a special business opportunity, uniquely available to Bottomline because of our relationship with Bank of America, our Business Exchange Platform technology, our domain expertise and capability and our commitment to leading the market.

So what did we purchase and what's the structure? Bank of America runs one of the largest and fastest growing business to business payment networks known as PayMode. Operated as a software and service solution, the bank offers this to its corporate customers and it provides business to business payments processing and remittance delivery through an electronic network of nearly 80,000 vendors.

Today, over 500 Bank of America customers leverage PayMode for payables automation. It is in many ways similar to Bottomline's Business Exchange. The difference, which really highlights the strength in this combination, is that while Bottonline's Business Exchange has more technology capability reflecting Bottomline's strength as a software provider, PayMode has much greater scale and adoption reflecting the bank's distribution capability and size.

The components of the transaction are really quite simple. Bottomline is buying the PayMode SAS product offering, operations and network from Bank of America. Bottomline will provide the PayMode service and support for Bank of America clients under a long term agreement. Bottomline will also enhance the platform by incorporating and merging the capabilities of its Business Exchange platform and other features into the PayMode offering.

Bank of America will continue to market the offering to its customers and will join Bottomline's strategic advisory council. And finally, Bottomline will market the offering to Bottomline's customers and to other channels.

So what does this mean for the market? From a market perspective, the combination of two leading providers creates a clear network leader with a scaled network and a powerful suite of financial supply chain solutions. While the leadership position of both organizations is enhanced, this transaction is really all about customers, and customers are the primary beneficiaries.

Customers will benefit through expanded payment and invoice management capability, improved oversight over payment processes and control, greater prevention of fraud and better management of risk, reduced costs, increased working capital and cash management, and finally, alignment with corporate go green initiatives.

So how will Bottomline and Bottomline shareholders benefit and how does it accelerate our buiness plan and create value. Well first, this transaction establishes Bottomline as a clear market leader for electronic payment and invoice automation. It creates one of the largest and fastest growing vendor networks with unmatched capability and scale. And importantly, we are not just the technology provider, but rather we own the network.

Second, it accelerates the company's strategic plan and business model. We all understand the SAS model. Investors appreciate the market rewards predictability and profitability of the model. The challenge is that it takes years of investment to get the scale and the revenue to make the model profitable. This transaction adds significant scale to our host of invoice and payment offerings and accelerates our path to the key moment when revenues exceed costs.

Third, it establishes a major channel and partner relationship with Bank of America, the largest and arguable the most powerful bank in the market. We are truly aligned with the right organization and we are aligned in a manner not just to provide a service or technology, but for both organizations and for shareholders to benefit.

Finally, it represents a new platform for growth and future offerings, upgrade path for our existing customers and new capabilities that we'll be adding to the PayMode solution.

So if I step back and look at this, our ultimate ambition is to run the electronic network by which businesses manage invoices and payments as part of their overall cash management offering. We see banks as a logical and appropriate channel for this market. This market is huge with 80% of the estimated 13 billion U.S. invoices still paper. Automating that market provides significant benefits to customers, but also drives significant revenues and strategic positioning for the organization that can do that and win that marketplace.

Today, we took a major step towards being the company that leads that change and profits from doing so.

With that, I'll turn it over to Kevin Donovan who will provide some more financial perspective.

Kevin Donovan

I'm going to focus my remarks on three key areas; first, our strong fourth quarter results, second, financial implications of the PayMode transaction and third, increases to our forward-looking guidance.

I will start with our quarterly results. We are clearly executing across all areas of our business. We had a very good fourth quarter highlighted by growth across all our key financial metrics. Revenue was $34.9 million in the quarter with EPS of $0.22 which was up $0.07 from last quarter and doubled the EPS we reported last year.

We also delivered strong growth against our profit objectives for the quarter with year over year growth as follows; operating income of $5.4 million, up 102%, EBITDA of $6.3 million, up 74%, and net income of $5.3 million, up 105%.

Another highlight in the quarter was the expansion of our operating margins. Operating margin was 15% in the quarter, over double the levels of a year ago as we continue on a clear track towards our 20% plus operating margin target.

The balance sheet also remained very strong with $50.3 million in cash, a $9.3 million increase from last quarter. The increase in cash was driven by strong cash flow from operations of $6.7 million.

As we look forward, we continue to be very confident in our business and future financial outlook. With clear visibility into future revenue results, we are raising our forward looking guidance. I will provide additional details on the increase in guidance later in the call.

Now, to a more detailed review of the numbers. During the quarter, we had orders of $37.7 million, highlighted by continued broad based demand across all our product offerings. This level of orders represented a book to bill ratio of 1.08. We closed the year having generated $158 million of orders, a 1.15 book to bill ratio and a clear indication of the strength of our market position.

Revenue was $34.9 million for the quarter, a 6% increase from the prior year on a consistent currency basis and finishes a year in which consistent currency revenue growth was 14%. During the quarter, the revenue impact of lower exchange rates was $3.1 million. For the full year, this impact was $11 million.

One of our key revenue metrics is recurring revenues. In the quarter, recurring revenue was $22.4 million representing 64% of overall revenue. Recurring revenue is derived primarily from software maintenance and subscription and transaction revenues. Subscription and transaction revenues were $7.7 million in the quarter, 22% of overall revenue.

During the quarter, gross margins were 59% which was up 4% year over year and ahead of expectations. On our third quarter call, I highlighted that we saw an opportunity to expand our margins by 50 basis points in the fourth quarter and 100 to 200 basis over the next several quarters.

I am pleased to report that we exceeded our fourth quarter target with sequential margin expansion of 130 basis points. The overall gross margin expansion was driven by 3% sequential increases in both our subscription and transaction and service and maintenance margins.

Turning to operating expenses, core operating expenses were $15.1 million in the quarter, down 11% from last year and in line with the $14.9 million from last quarter. On a line item, sales and marketing expense increased slightly from last quarter, reflecting continued investment in this area of the business, while development expense decreased from 14% to 12% of revenue.

G&A expenses dropped below 10% of revenue reflecting greater leverage of our G&A infrastructure costs as the business scales.

We took another step forward in income during the quarter with a sequential increase in all of our key profit metrics. Operating income and EBITDA both increased over 20% from the third quarter. These increases were driven primarily by the gross margin expansion on our subscription and transaction and service and maintenance revenue streams.

Operating margin was 15% in the quarter, double the 7% reported a year ago. Over the course of the year, we delivered sequential increases in operating margin each quarter and have clear visibility towards the achievement of our two year 20% plus operating margin target.

Core net income was $5.3 million in the quarter, representing 105% growth on a year over year basis and earnings per share was $0.22 in the quarter, a $0.07 increase over last quarter and an $0.11 increase over last year.

From a balance sheet perspective, the company ended the quarter with $50.3 million in cash, a $9.3 million increase from last quarter. We ended the year with a cash balance equal to $2.08 per share.

DSO was 60 days, a decrease of two days from March and 11 days from last year. The strong cash position was driven by 6$6.7 million of cash flow from operations. For fiscal 2009, we generated $24.5 million of cash flow from operations, a 51% increase over last year and representing $1.00 per share of cash flow generated during the year.

Free cash flow was $6 million in the quarter and $21.4 million for the year. The strength of the cash flow numbers is another indicator of the success that we had in the quarter and the fiscal year.

Backlog at the end of June was $83.9 million, a $6.1 million or 8% increase from last year. Backlog representing contractually committed future revenue amounts also grew sequentially reflecting the continued strong order flow during the fourth quarter.

At the start of the fourth quarter, the combination of our backlog and recurring revenue provided visibility to approximately 85% of the revenue we recorded in the quarter. With this level of revenue visibility, we have a high level of confidence in our revenue forecasts each quarter.

I'm now going to shift my remarks from our fourth quarter results and provide some additional financial commentary on the PayMode acquisition. For competitive reasons, for both the bank and Bottomline, we are not at liberty to share all of the details of the transaction. I will provide here the details that we're able to disclose.

As Rob highlighted, we have purchased the electronic network for payment and invoice automation from Bank of America. The purchase price was $17 million in cash along with the issuance of one million warrants at an exercised price of $8.50. The $8.50 strike price represents the stock price of the point in time when the transaction was negotiated and agreed to in principal. Post warrant exercise, the net purchase price will by $8.5 million in cash and the issuance of one million shares of stock.

The transaction provides Bottomline with a strategic offering that is complementary to our Business Exchange. The combination of Business Exchange and PayMode creates a valuable strategic asset that we expect to appreciate over time as we add more customers, vendors and channel partners to the network. We also expect to bring on approximately 60 Bank of America employees as part of the deal.

In connection with the transaction, we will provide professional services to Bank of America to enhance the offering. The selling value of these professional services is expected to be approximately $5 million on an annual basis. We will track and report these fee amounts to Bank of America on a regular basis, but since we own the PayMode assets that we are enhancing, these services will not be recorded as revenue by Bottomline.

While we won't be recording these professional services revenues, we will receive subscription and transaction fees from Bank of America which will more than offset the professional services investment that we are making. Over time, we will be making additional investment in new enhancements to address broader market demands.

From a financial perspective, what this transaction does is accelerate the business for our Business Exchange. As everyone is aware with this SAS based offering you incur a high level of expense early on with very little revenue. This results in a significant up front cost investment. As revenue builds, you move closer to break even and ultimately to meaningful profit levels.

This investment period can last several years as our Legal Exchange offering and more recently Business Exchange has demonstrated. We are very early on in the product life cycle for Business Exchange, and therefore, still very much in the investment stage. With the acquisition of PayMode, we accelerate the business model by several years and move very close to the key break even point in time, driving a faster path to profitability.

We expect the PayMode transaction to close near the end of the first quarter and be accretive within the first year. Since the transaction will close late in the quarter, we do not expect a meaningful contribution from the transaction during Q1, and included the PayMode operations beginning in the second quarter.

Turning to our guidance, we are increasing both our revenue and profit estimates based on the overall strength of the business. From a revenue perspective, we are increasing our first quarter guidance to a range of $34 million to $36 million. For the full fiscal year, we are projecting revenue of between $148 million and $152 million.

Looking at profitability, we are also increasing our first quarter core earnings guidance from a range of $0.16 to $0.18 to $0.17 to $0.19. The change in earnings from the June quarter to the September quarter reflects a typical first quarter seasonality, particularly in Europe as well as increased costs for several major industry conferences and higher projected taxes in the quarter.

For fiscal 2010, we expect to grow earnings by at least 20% on a year over year basis with core earnings per share guidance of $0.73 to $0.75.

In summary, we had a very strong quarter with operating and net income more than doubling from a year ago. Operating margin expansion to 15% of revenue and $6.7 million in cash generated from operations driving over $50 million in cash on the balance sheet.

As we look forward into fiscal 2010, I am confident that we will deliver another successful year of revenue, profit and cash growth.

We will now open up the call for any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jonathan Maietta – Needham & Company.

Jonathan Maietta – Needham & Company

Congratulations on the deal. It sounds like a real strategic win. It accelerates the opportunity so it looks like a good deal all the way around.

Can you help us frame the size of the opportunity, not to put a time constraint around it, but to help us think about how this could scale over time?

Robert Eberle

If you think about it, in the U.S. alone, and the opportunity frankly for us is to bring this platform international. As you know, we've got significant distribution and customer base internationally, but in the U.S. alone, it's estimated that there are 13 billion invoices a year. If you take a look at 80% of those invoices today are paper, and the estimates for what that paper process can cost, can be anywhere from several dollars if you're in the top quartile, to numbers that get to be $15.00 to $20.00 if you're in the bottom quartile.

Automating that process and driving even a portion of that cost as revenue is a major opportunity. It also is significant what we're doing with Bank of America, is also very strategic, because not only will we drive the revenues into transaction volume and transaction fees for the use of the platform, from a bank perspective, it's how you provide technology.

If you're providing technology in a vendor network that automates your customers financial supply chain, what you've done in terms of retention of that customer in cash balances that will stay in the bank, with the bank from that customer, financing opportunities, it's a very strategic platform.

So it's part of the reason we're delighted to be doing with the bank as a channel, and frankly in the future, we see other banks coming on as channels.

Jonathan Maietta – Needham & Company

Is this a network that the bank had been growing or had they kind of reached full potential within their base?

Robert Eberle

No, absolutely. As the network that the bank was growing was I think that the part that they looked, it really is a wonderful combination. If you take a look at what the bank had done very successfully, they've gotten over 500 customers and nearly 80,000 vendors on the network. The piece that was more of a challenge was the enhancement of the product set, running the SAS offering, all the things that are core competencies of Bottomline.

Because we're able to do those things, able to do them both at the Legal Exchange and with the Business Exchange, because we had a business relationship with Bank of America, and then finally because we were able to come into this transaction with a commitment to joining with them, providing the service to them, providing enhancements to the platform, they saw the opportunity to put technology with Bottomline, better capabilities in terms of technology and future enhancements, yet retain their distribution, retain their customers.

Jonathan Maietta – Needham & Company

Are there more strategic opportunities out there similar to this given that banks are increasingly looking to outsource their technology development to vendors as opposed to in-house development?

Robert Eberle

If you would have asked me a year ago at the beginning of the fiscal year if we could have imagined the biggest, most strategic opportunity that we could have realized in the year, I'd like to think we would have thought of this. I'm not even sure we would have had the vision at the point in time to do so.

This is a major strategic step forward for us because we have linked with the largest, and we think the most influential bank. We are not only just providing the technology and selling the software, but we actually own and operate the network. So we're the true outsource partner if you will, with as big and significant a channel as we could have.

And as you know, we have the technology. We have the capability around Business Exchange. Getting scale in that is difficult from a vendor standpoint. Getting the scale from a customer market standpoint, and as Kevin highlighted, financially getting to the point where you're moving towards profitability is year of investment, we've accelerated on all of those metrics with this.

So I think it's difficult to imagine that we could have found a better fit or a more strategic transaction. We certainly could have bigger deals and there are bigger deals out there, but I don't believe size plus size is necessarily the path to success. I think this is really a perfect fit for Bottomline and I think we're a perfect fit for Bank of America.

Jonathan Maietta – Needham & Company

A great way to quickly add scale for the model. Orders, I know they bounce around from quarter to quarter, down a little bit sequentially, if you could talk qualitatively about some puts and takes what you saw from the customer base this quarter in terms of demand.

Kevin Donovan

One thing to recall is we had a very large order in the third quarter, with a top five global financial institution, so from a sequential perspective; orders would be up excluding that transaction in the third quarter.

Robert Eberle

I wouldn't necessarily expect orders to exceed revenue in each quarter. They certainly have in more recent quarter. Often case frankly in the first quarter we don't see that. We see seasonality. But I've been delighted with the order flow and receptivity of customers in this market in all segments. Our payments segment, document automation have both seen strong demand and what's been a little misunderstood with some of the investors is, what we sell to banks has been inconsistent demand because its customer changes.

Jonathan Maietta – Needham & Company

In the EPS guidance for the year, are you assuming an incremental million shares in the share count from this deal, or how does that work? How does the math on that work?

Kevin Donovan

There will be warrants that will be outstanding that will go into the diluted share count in the transaction.

Operator

Your next question comes from Colin Gillis – Brigantine Advisors.

Colin Gillis – Brigantine Advisors

Can you just walk me through a little bit about, what is the long term vision in terms of who is selling this product? What happens to the business' exchange code base?

Robert Eberle

There's three different things in there really; long term vision who's selling it and the code base. Selling it is easy. We'll be selling it directly to our customers and we'll have Bank of America as a channel selling it to their customers, and over time we think we'd get other channels, certainly other banks as channels will be targeted for us. So we'll sell it directly. We'll sell it through channels.

What will we sell in code base; we'll merge the Business Exchange technology with the PayMode platform, so we'll ultimately be running one platform with enhanced capability.

The ultimate vision is that we run the network which businesses settle their payment and invoices, and the principal channel for that network would be banks. You could look at the beginnings of Visa, the credit card industry and ultimately that's the type of opportunity we think we're starting to realize.

Colin Gillis – Brigantine Advisors

Do you have some confidence just in prior transactions that are similar to this in terms of visibility where you've merged two code bases and integrated customers across multiple platforms?

Robert Eberle

The merging for us right now, it's a perfect time to do this. Frankly, if we'd had more scale in the Business Exchange today, it would be a lot harder.

Colin Gillis – Brigantine Advisors

Can I get the backlog again and then the Legal Exchange revenue?

Kevin Donovan

The Legal Exchange revenue was just over $4 million in the quarter and the backlog number was $83.9 million.

Operator

Your next question comes from Brett Huff – Stephens, Inc.

Brett Huff – Stephens, Inc.

When I think about other competitive works, what's the other, because I think that's what we're ultimately driving to here, what's the other competition that's out there, and I guess specifically I wondered in you'd comment on the U.S. Bank Visa deal that was recently announced.

Robert Eberle

Your phone broke up; can you give me the last part again?

Brett Huff – Stephens, Inc.

Just commenting specifically on the bank and visa partnership that was just announced.

Robert Eberle

First off, who else is out there? There is a mix of different ways this technology could be provided. We think the best model, we think this model, the technology provider partnering with a bank, and truly partnering, not just being the provider of technology is the best model. We think it brings the best of both breeds, the capability, top technological capability as well as cash management capability.

Ultimately what this becomes is part of the overall cash management suite, and what the corporate customer will want to do is to sign on with their bank, be able to see their balances and their cash as well as what happens to cash, what payments are they executing, what invoices are coming in, what's the prediction for cash balances, and the like.

From a competitive standpoint, as there are in each of the offerings and markets we participate in, there are smaller, private, generally, actually almost exclusively privately owned companies that are offering or attempting to offer similar product to what we do. Their challenge is getting any level of scale.

Bank of America is not going to choose a privately held 40 person company to compete. Then when I look at some of the other players, I look at the ERP's; the ERP's have done a very good job of automating what occurs within the enterprise. They're not targeted and don't have the capability to provide a settlement network, to provide a platform that deals with payment types, remittance data, remittance messaging.

So we think we're uniquely positioned from a technology provider perspective. We think when we partner with a bank that gives us the channel and scale and market reach that we've been lacking frankly.

In terms of the specifics in the Visa deal, purchase cards are a component or one of the ways payments are made. The challenge with purchase cards is the interchange fees. It's very effective on smaller invoice amounts. It's prohibitive as you move to larger invoice amounts.

We'll be adding more card capability into the PayMode platform as we go forward, but we ultimately see ACH as a more likely payment methodology just given lower cost.

Brett Huff – Stephens, Inc.

Is the network proprietary? It seems like the value of the network is the fact that it should be open ended. Could you just talk a little bit about that?

Robert Eberle

We'll run the network, and what we'd like to do is run the network for others. So we would look at linking with other networks, but the principal way we'd grow the network is being the provider to other customers and other banks.

Brett Huff – Stephens, Inc.

Could you just talk a little bit about, you said it's getting you a lot closer to break even on this particular business line. Any other color on that?

Kevin Donovan

At this point we're not providing additional color on that. We are at a point in time where we're making investments in Business Exchange and this transaction over the course of the year will definitely move us closer to the break even point.

Brett Huff – Stephens, Inc.

Can you give us any sense of what the outlook would have been X deal? Can we get a sense of the organic part of the business? We have some visibility given that you've given us 1Q, but anything else?

Kevin Donovan

For competitive reasons we can't provide the break out from a revenue perspective on the transaction.

Brett Huff – Stephens, Inc.

You would just back in to what the payout piece is now, right?

Kevin Donovan

Right.

Operator

Your next question comes from Gary Prestopino – Barrington Research.

Gary Prestopino – Barrington Research

Trying to understand this as I'm relatively new to the company in this area, but you're basically running a network for payment remittance with this purchase from Bank of America? You're getting paid a transaction for every time there's a remittance that goes over the network?

Robert Eberle

That pretty much provides, I would say is it adds additional capabilities. So if I'm a customer, the benefit to me is I can go to this one network, and I can have ideally all my vendors, certainly many of my vendors on the network. I can also work with the network to add my vendors to that network and I can get my invoices, I can see what the status of invoices. I have work flow capability that's build into this system for approval and review, and then ultimately the payment and remittance data can all occur through this.

From a vendor perspective, now I can present my invoices, but I can also see what is the status of payment. So one of the more common calls you get into accounts payable is when am I going to be paid, what's the status? You can see all of that from an electronic standpoint.

And you're removing what today; the biggest benefit I suppose on both sides is just removing the paper from the process, providing automation and providing different tools that can accompany that automation.

Gary Prestopino – Barrington Research

So you're getting paid a transaction fee as owner of this network by the payer. So then how does Business Exchange, obviously you're out there trying to market this yourselves, what's the goal here? To get these 550 clients to hook up to Business Exchange or is that something that because you now own the network, they're going to get gratis and you'll just get maybe an enhanced transaction fee? That's what I'm trying to understand.

Robert Eberle

The way to think about it is to think about the Business Exchange and PayMode. It's really very similar. It's similar in capability, very similar target market and we're combining those two offerings. The slight difference is, we had some more functionality, and probably more importantly as a software provider, we are road mapped in the capability to continue to enhance that platform which was more difficult for the bank to do.

So look at the two as similar; PayMode network and Business Exchange, PayMode having far more scale; Business Exchange having some more capability and Bottomline having the technology expertise to add more to that capability.

So they're direct overlap. We're putting the two together. We get one network, greater functionality and from a combination of partnership, we get a technology provider that can continue to enhance and understand the technology underlying the platform and we get the breadth and scale and distribution of the Bank of America.

Gary Prestopino – Barrington Research

Is it really that Bank of America and yourself will be out marketing the Business Exchange to get new customers of PayMode?

Robert Eberle

We actually will go under the brand of PayMode, but really it will end up being one network that we market.

Gary Prestopino – Barrington Research

And there's the same transaction fee if they use Business Exchange?

Robert Eberle

As I alluded to earlier, we're going to fold Business Exchange into PayMode. Think of them as one and the same once we close the transaction.

Gary Prestopino – Barrington Research

Can you give us an idea of what the annual processing of electronic transactions has been by PayMode, like the latest 12 months or can you not do that?

Robert Eberle

That's the kind of competitive data that we're not able to or going to disclose.

Gary Prestopino – Barrington Research

Can you give us an update on what's going on with SWIFT?

Robert Eberle

We're active with SWIFT in some new enhancements into the platform. It will be coming out in the fall. They're customer reception has gone very well and we're looking forward to completing that process which will then allow us to by the March quarter revenue streams will begin from SWIFT.

Gary Prestopino – Barrington Research

So that would be the transactional revenues, right?

Robert Eberle

Right.

Gary Prestopino – Barrington Research

The last time we talked you had about 100 organizations I believe on Alliance Light. Is that still about the same?

Robert Eberle

They've signed up more since that time, but it's roughly in that area.

Gary Prestopino – Barrington Research

Are you getting the seven figure licensing fee this fiscal year coming up?

Kevin Donovan

We will begin to take revenue beginning in the January period. We've deferred all revenue up till this point until we deliver the second release, and then the revenue will begin.

Robert Eberle

If you step back, I appreciate your question. If you really step back and look at it, it's kind of interesting in both cases, we really have similar transactions. The similarities being two organizations saying who is the best company for us to look to for technology to run a payment or remittance network.

The difference here in this transaction, we've actually bought that network and assets, so rather than being the technology provider as we are in SWIFT where we get a subscription fee and a revenue share, in our transaction here with Bank of America, we actually own the network.

Gary Prestopino – Barrington Research

In terms of what we should use as taxes, the tax payment when we're calculating core income, can you give us an idea of what that should be?

Kevin Donovan

We'd expect taxes to be more on the levels of what we saw in Q2 and Q3 which was in the $500,000 to $600,000 level per quarter.

Operator

Your next question comes from Colin Gillis – Brigantine Advisors.

Colin Gillis – Brigantine Advisors

Could you give us a sense of who else bid for this?

Robert Eberle

That's the beauty, that's a great question. It wasn't a bid. And yes, we had a purchase price and yes we bought the asset, but if you think about the scale of Bank of America and if you think about what moves the needle, what's important to them, our purchase, it wasn't the purchase of $18 million. It isn't going to be somebody else was going to walk in the $20 million or $40 million or whatever number it would be.

It was really about who's in the best position to run the platform for them. So it's much more about choosing a partner than it was any kind of a bid process. I'd say frankly, our biggest competition was that they would do nothing and that they would continue to keep the platform and run the platform themselves.

And it was the domain expertise of our people, the technology that we built into the Business Exchange and was able to demonstrate in the Business Exchange and then last, our commitment and willingness to structure a deal as Kevin indicated with ongoing enhancements to the platform that brought us to that spot much more than any kind of a purchase price of bidding.

Colin Gillis – Brigantine Advisors

You said they have 500 customers on the platform right now, correct?

Robert Eberle

Correct

Colin Gillis – Brigantine Advisors

Could you give us a sense of the size of these customers, because I'd also imagine that as you just alluded to it, Bank of American will want to keep these customers pleased and can you give a sense of the range of size?

Robert Eberle

This includes some of their most important customers. We're not today giving out any particular customer names but you'd recognize obviously some of the leading organizations, some major government, State governments for example who are customers on this platform. So it is very important for the bank because it's much more at stake than revenues, current revenues to PayMode.

What's at stake is a relationship with that customer and part of this process, and it's actually an interesting process because there was more due diligence done on Bottomline in many ways of our capabilities of service levels and the like, as much done on Bottomline as there was done on PayMode operation.

Colin Gillis – Brigantine Advisors

This is obviously an enterprise solution, not a small business solution.

Robert Eberle

Yes, absolutely.

Operator

Your next question comes from David Grossman – Thomas Weisel Partners.

David Grossman – Thomas Weisel Partners

I'm wondering if I could just ask another question about the revenue model as opposed to acquisition. If I caught it right, you said that there are fees that are going to be paid that will not be necessarily characterized as revenue but will used to offset the maintenance of the system. Is that correct?

Kevin Donovan

We're going to do some enhancements to the system which would typically be comprised of professional services revenue. We will not charge Bank of America for that. We'll own the PayMode asset and we'd be enhancing an asset that we own, so we will report to them the value of the enhancements that are being made to the system, but they will not be charged and not recorded as revenue.

What we will get is subscription and transaction fees from Bank of America on a go forward basis.

David Grossman – Thomas Weisel Partners

So the cost of doing that then just get capitalized as part of the platform.

Kevin Donovan

As part of our expense structure, correct.

David Grossman – Thomas Weisel Partners

Is it expensed or is it capital?

Kevin Donovan

It's expense.

David Grossman – Thomas Weisel Partners

Once you're up and running with these clients, I just didn't follow the exact flow of what the revenue model is to Bottomline once the system, the transfer has taken place. Who's paying the fees and what is the marginal driver of incremental revenue once you get up and running?

Robert Eberle

It depends on the customer and how the customer came in. So the first instance, for existing customers from the bank, we would have transaction fees as they're using the platform. New customers would come on. We'd have a share of the transaction fee that that customer is paying to the bank, and a share of the revenues I should say more accurately that the bank is receiving.

In addition, Bottomline will be selling this directly, so in that instance we'd have direct revenues from the end user customer. And then finally, we'd expect over time that's not something we'll be doing, that's not our immediate focus today, but we'd expect over time the opportunity to add other channels which could be either a distribution channel where we would be paid by that partner or it could be more of a marketing channel where we'd be paid by the end user customer.

Typically, you have a transaction fee. You can have minimum subscription levels, annual subscriptions or volume subscriptions and from a financial institution perspective, there's also significant float income that's derived from account balances that are retained to this type of platform.

David Grossman – Thomas Weisel Partners

Does the float balance go to Bottomline or is that something that's accruing to the bank?

Robert Eberle

Part of our revenue model would actually be a credit of a portion of the float balance, yes.

David Grossman – Thomas Weisel Partners

If you think about us as we try to think about how to gauge the magnitude of what new customers mean or the number of transactions, can you give us a high level way to think about it? Is BofA one customer in the context of their install base or should we think of it as multiple customers each with their own transaction minimums and fees that go along with their contract and are there set up fees for example. I think you said there were sometimes minimums that come along with some of these deals.

Robert Eberle

First off, again this isn't closed now so what you're talking about is as we move out into further quarters. I think the way I'd look at it is today we have one important channel customer and that's Bank of America. And our focus is going to be on providing the bank with the service level and technology that it requires so that we'll gain additional customers together.

We will also as a second priority, be selling this directly. So at that point in time, I think we'll have more customers coming on directly and we can give you more detail around the specific revenue models that we bring new customers on as we bring them on.

David Grossman – Thomas Weisel Partners

How long do you think it will be before you think the sales force is up and running and ready to sell this? Is that immediate once it closes because of what you've been doing with Business Exchange or do you think there is a period of time before the sales force is really up and running and selling?

Robert Eberle

When you started to say your question, I assumed the sales force was the Bank of America sales force which maybe tells you a little bit about where the distribution is. So let me start with that if you don't mind.

Bank of America sales force has been selling this all along, and there's been a significant amount of communication ongoing beginning today obviously, but a significant amount of communication planned around keeping the energy around that and keeping the sales force and having the Bank of America sales force understand the benefits of this transaction.

So one sales force, a real important sales force is that group. From a Bottomline perspective, this everything our sales force could hope for because this gives you real vendor scale. This is now a proven platform.

The prospect frankly to come on as the second, third, fourth or fifth customer under a vendor network, that clearly an early adoptive position. Now where there's over 500 payers on this network and over 80,000 vendors, you're not in the new adopter, you're not the leading edge.

So from our sales force perspective, they're ready to sell today because they understand the functionality and capability, and second it dramatically enhances our market position because we now move from a newer offering to a clear market leader.

Operator

Your next question comes from Gary Prestopino – Barrington Research.

Gary Prestopino – Barrington Research

You own this network so are you excluded from selling this to any other financial institution because of the Bank of America relationship or can you go out and get a regional bank, another national bank, even community banks to get their clients on this network?

Robert Eberle

The way I'll answer that question is there are a couple of banks that we have a prohibition for a limited time that depending on how its crafted, but for a limited time some prohibition around some of the more obvious competitive threats to Bank of America. That's a very limited specific number of named organizations.

The vast majority, every community bank, every regional bank is absolutely an opportunity for us today and just for a limited period of time that we'd have some limitations on who else we'd work with.

Gary Prestopino – Barrington Research

Then just to be clear, on the revenue model, there's a transaction and subscription fees, annual subscription fees?

Robert Eberle

It can be offered a number of different ways. We offer with an annual subscription and a transaction fee.

Gary Prestopino – Barrington Research

It's either/or?

Robert Eberle

Sorry, both.

Operator

There are no further questions.

Robert Eberle

In conclusion I appreciate everybody's interest. We think we've had a very strong quarter in our operating income and EPS, growing our revenues in the year 14%, signing this new deal with Bank of America. It's all very exciting and we look forward to reporting on our first quarter in late October. So thank you for your interest.

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Source: Bottomline Technologies F4Q09 (Qtr End 6/30/09) Earnings Call Transcript
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