FUNDtech Limited Q3 2009 Earnings Call Transcript

FUNDtech Limited (FNDT)

Q3 2009 Earnings Call

November 2, 2009 8:30 am ET

Executives

Margie Petrasek – Investor Relations

Reuven Ben-Menachem – Chief Executive Officer

Michael Sgroe – Chief Operating Officer

Yoram Bibring – Chief Financial Officer

Analysts

[Tom Erhlich – RBC Capital Markets]

John Kraft – DA Davidson

George Sutton – Craig-Hallum Capital Group

Raghavan Sarathy – Dougherty & Company

Gil Luria – Wedbush Securities

Presentation

Operator

Welcome to the FUNDtech third quarter 2009 operating results conference call. Today’s call is being recorded. (Operator Instructions) At this time for opening remarks and introductions, I would like to turn the call over to Margie Petrasek.

Margie Petrasek

Good morning everyone and welcome to FUNDtech Limited’s third quarter 2009 financial results conference call. As a reminder, today’s call is being recorded. Joining me on the call are the Chief Executive Officer, Reuven Ben-Menachem, the President and Chief Operating Officer, Mike Sgroe, and the Chief Financial Officer, Yoram Bibring.

As a reminder, some of the comments made in this call by management including any guidance about further or future periods and the responses to your questions may contain forward-looking information. Such statements are subject to the risks and uncertainties as described in the Safe Harbor language in the company’s press releases and filings with the SEC. Please refer to this Safe Harbor language contained therein. The company has no duty to update such forward-looking statements.

I would now like to turn the call over to Mr. Ben-Menachem.

Reuven Ben-Menachem

Good morning everyone. During the third quarter of 2009 we started to see improvement in market conditions as we started to receive large orders from our high end customers and our revenue exceeded the high end of our third quarter guidance and reached $30.6 million.

As you can tell from our fourth quarter guidance, we expect to continue to post revenue growth in the fourth quarter and if we exceed the low end of our revenue guidance, the fourth quarter may well be a record revenue quarter for FUNDtech.

Looking towards 2010 I expect our payment business with the larger banks to continue to be our main growth catalyst with strong growth across the globe. I also expect our financial messaging business headed by DPP to show solid growth and I expect our international cash management business which includes our invoicing and payments also to grow nicely outside the U.S.

The one market segment that has yet to show meaningful recovery signs is the small to medium size banks in the U.S. which represent less than 30% of our business. Because [inaudible] 70% of our revenues in this market segment, maintenance and hosting revenues, I do expect some growth in revenues next year even in this slow moving segment of the market.

So overall, while we are not prepared to provide 2010 guidance at this point, I do feel good about our overall growth prospect in 2010 and I think it is reasonable to say that next year we will be back to double digit annual organic growth.

I want to spend a few minutes discussing our recently announced transaction with Bank of America/Merrill Lynch. This is a very important strategic transaction and potentially [inaudible] for FUNDtech. By the same token, it may mean a difference in our prior system sales. That’s why we saw aspect of technology between what we will be delivering to Bank of America and the potential market to aid FUNDtech.

Until service architecture came to the scene there was a clear distinction between back office systems like payment systems and formed office systems like cash management systems. Each of the systems provided response specific functionality and [inaudible] was connected to the various other systems in the bank through hard wire interface.

Back up relations were supported by a series of systems. This means that a bank that wanted to improve certain functionality aspects of the system would often find need to invest large amounts of money directly to functionality in multiple systems. In this era the situation is very different.

The creation of cycle services of functionalities, it can be shown by the banking system in the bank. So for example, if we look at fees the banks charge the customers for high venue wire, one can create a service that can be shared by each of the cash management and the payments systems of the bank.

So that means that for the customer that wants to transfer $1 million from his account in the U.S. to his vendors in the U.K. we’ll be able to do in real time using the cash management system that he or she uses through the Originet console, the fees of wiring the funds and associated fees and select [inaudible] their needs.

This can be a new service that the bank can offer its customers as part of its cash management system using this service. It is scaled by the cash management system as well as other back office systems in the bank. It was so expensive to provide the cash management system which complicated the back end functionality.

While our existing market for new system stay the same, the new significant market opportunity for payment services is being created for FUNDtech. It means that we can now source our services with enhanced wire systems in the bank without the need to replace them.

And we know, replacing systems is a painful and expensive process and until now we couldn’t really offer much to bank who wanted to improve their systems that they had without replacing them in the short term. This should now change in the larger banks like Bank of America transaction.

In addition to our leadership position, by providing SAW based solutions, we continue to make strategic solutions for banks who want to ensure that they are using the best and the most modern technology which will provide them the long term competitive advantage.

Bank of America which we typically saw the important functionality and performance of its cash management systems and back end systems without replacing them in the short term. This project will last into 2011 and we believe that we have an opportunity to continue to grow in the bank in the years to come.

At the same time I believe that most segments of our target market are back in buying mode and I’m excited about our new products and our growth prospects in this post financial crisis world.

I will now hand you over to Mike who will update you on our operations.

Michael Sgroe

Good morning everyone. During the quarter there are several metrics that demonstrate the increasing strength of our franchise in the transaction banking space. We closed 15 new system sales as compared to 10 in Q2 and 9 in Q3 of 2008.

Although the number of contracts closed during the quarter was down from the prior quarter, 120 versus 148, our performance was well ahead of the year ago quarter of 66 contracts signed. Note that Q2 deal count was affected by U.S. payments clients signing for upgrades in support of the Feds cover mandate going live later this month. Also during the quarter we brought on 10 new bank customers compared to four last quarter, and six in Q3 of last year.

The make up of our new customers is also noteworthy. They demonstrate the breadth of FUNDtech’s product line and strength of our new product introductions. Of the 10 new bank customers, one purchased our newly introduced Global PAYplus FTS, one purchased Global CASHplus, a product we’re seeing growing interest in across multiple geographies, one purchased ACHplus, a product that was introduced into North America market a little more than a year ago, two purchased PAYplus FTS and five became our newest Swift service bureau clients.

Throughout the world we’ve seen growing interest among banks to replace their legacy transaction banking infrastructure. This is due in part to the need for greater efficiencies through our nation, but can also be attributed to a renewed interest on the part of banks to differentiate their service offerings with new and enhanced capabilities.

There’s no better example of this than Bank of America as Reuven indicated, who announced their purchase of GPSP as the foundation of their next generation online banking channel for Treasury management.

Global PAYplus continues to attract new clients. In addition to the new customers already mentioned, we’ve been informed that GPP has been selected by two additional banks in the U.S. Similarly during the quarter, we were informed that Global CASHplus has been selected by a European bank soon after its introduction into this geography. We’re currently working through the contract process with each of these banks.

I’m pleased to report that current and ongoing GPP projects are making good progress. Over the next several weeks, HSCP will be migrating all geographies to their latest release of GPP and work is also underway on the implementation and roll out of the GPP set to direct debit module at the bank.

During the quarter, Barclay’s South African unit actually went live with GPP and work continues on scoping and planning for the next phase of the bank’s larger strategic initiative, the U.K. high value payment processing.

At Citi, we’re preparing to deploy GPP into several additional countries to add Asia, and we’re making good progress at Lloyd’s.

One other brief point before passing the call over to Yoram, this quarter we announced the addition of four corporate clients to our Swift service bureau. We see increasing interest among corporate in becoming members of the Swift network as an alternative to connecting directly to the banks.

This is due to the increased flexibility and often lower costs that a Swift connection offers corporations. Corporations see a value in the ability that a direct connection with Swift provides to more effectively manage their relationships across banks, a concern which is a direct result of the banking crisis.

To date, we’ve had good uptake of our software as a service based offering, labeled Swift for corporate and anticipate good continued growth in this important population of corporate subscribers.

So in summary, a great deal of activity across the organization as we follow through on client commitments while at the same time working to enrich our offerings.

With that, I’ll now hand you over to Yoram who will discuss our financial results.

Yoram Bibring

Good morning everyone. Third quarter revenues and EPS exceeded our guidance. Our revenues in the quarter were $30.6 million, up 8% sequentially and 3% lower than the third quarter of 2008.

License revenues were up sequentially by $1.5 million. Service revenues were up by $1 million. Maintenance revenue was flat and hosting revenues were down $200,000 due to one time items.

Overall maintenance and hosting revenues mainly recurring revenues were up 18% year over year and comprised 50% of our revenues in Q3.

Including stock based compensation, our gross margin in the third quarter was 55.3% compared to 54.2% in the second quarter and 672% in the third quarter of 2008. Excluding stock based compensation costs, gross margins were 55.7% in the third quarter compared to 54.7% in the second quarter and 57.6% in the third quarter of 2008. The sequential improvement in margin is due to the increase in total revenues.

Included in our expenses for the third quarter is $661,000 relating to stock based compensation expenses. These expenses were allocated as follows: $121,000 in maintenance hosting services costs, $41,000 in software development costs, $166,000 in selling and marketing costs and $333,000 in G&A costs.

The following analysis excludes the impact of the stock based compensation expenses. Research and development expenses were $5.1 million in the third quarter down $50,000 from the second quarter. Third quarter sales and marketing expenses were $4.3 million, $100,000 lower than the second quarter and G&A expenses were unchanged at $4.7 million.

Third quarter operating profit before amortization expenses and stock based compensation expenses was $2.9 million compared with $1.3 million in the second quarter and $4 million in the third quarter of 2008.

On a GAAP basis, third quarter operating profit was $1.7 million compared to break even in the second quarter and $2.7 million profit in the third quarter of 2008.

Financial gain in the third quarter was $100,000. Current income tax expenses was $250,000 and deferred taxes were minimal.

On a GAAP basis, our net income for the third quarter was $1.6 million or $0.10 per share on a fully diluted basis compared to $500,000 or $0.03 per diluted share in the second quarter and a profit of $1.5 million or $0.09 per diluted share in the third quarter of 2008.

Third quarter net income before amortization and intangibles and stock based compensation known as adjusted non-GAAP net income was approximately $2.8 million or $0.18 per share on a fully diluted basis compared with $1.8 million or $0.11 per diluted share in the second quarter and $3.3 million or $0.20 per diluted share in the third quarter of 2008.

Moving on to the balance sheet, cash, short term deposits and marketable securities and long term marketable securities were $42.4 million on September, 30, down by $2.8 million from the end of the second quarter. The decline in cash and equivalents is a result of the fact that we collect our annual maintenance and fees and European hosting fees for the most part in advance in the first quarter of the year.

Therefore, cash and equivalents and deferred revenues usually peak at the end of the first quarter and decline thereafter. Accordingly also, during the third quarter deferred revenue decreased by $7.1 million.

Our DSO decreased from 87 days at the end of the second quarter to 81 days at the end of the third quarter. Operating cash flows for the nine months ended September 30, 2009 was $13.8 million compared to $7.5 million in the equivalent period last year.

The main reasons for this improvement is that 2008 DSO’s increased by 19 days during the nine months period ended September 30, 2008 while in 2009 the DSO declined by four days during the equivalent period.

Good will and other intangible assets increased during the quarter by $.5 million. The increase is due primarily to $1 million contingent payments for the acquisition, net of the quarterly amortization expense of $.5 million. There were no other material changes in the balance sheet since June 30 that are of note.

Some of the buy back during the quarter, we didn’t buy back any shares as we were waiting to receive special approval from these very courts. As you recall, we needed to receive this approval before continuing our buy back. We recently received the approval and will proceed with our $10 million buy back program.

In the interest of maximizing shareholders value in executing the buy back, we will not be providing any additional information on our future buy back plans.

Moving on to the guidance, for the fourth quarter 2009 we expect revenues of between $31.5 million and $32.5 million, GAAP earnings per diluted share of between $0.10 and $0.14, non-GAAP earnings per diluted share before amortization expenses and stock based compensation expenses between $0.17 and $0.21.

FUNDtech estimates that quarterly financial income for the fourth quarter will be approximately $100,000. The tax expense excluding deferred taxes will be approximately $200,000.

FUNDtech estimates quarterly amortization expenses for the fourth quarter will be approximately $500,000 and the stock based compensation expenses will be approximately $600,000.

FUNDtech guidance for the fourth quarter 2009 does not include the impact of deferred taxes. Also it does not include the impact of any future impairment of any intangible assets.

Just a reminder, the financial guidance is current as of today only and FUNDtech takes no obligation to update these estimates.

Now we’ll turn you over to the operator to begin the question and answer portion of the call.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from [Tom Erhlich – RBC Capital Markets]

[Tom Erhlich – RBC Capital Markets]

Regarding the business tone recovery that you are seeing. Could you provide us with a little bit more color on how you’re seeing the sales cycle and decision making in the big banks and perhaps your other customers and how do you see the back drop changing?

Reuven Ben-Menachem

The quarter we have signed extension to contracts with our larger banks and we added the Bank of America as a customer. The sales cycle with Bank of America was six to nine months, relatively short.

The deals we did with our existing banks were deals that were on hold due to the crisis and as banks started to feel the recovery, these orders were given to us. So we didn’t see a real sales cycle. These were discussed before the crisis, but were put on hold and released in the last few months.

[Tom Erhlich – RBC Capital Markets]

Regarding the solo architecture product, first could you give us, quantify to us how does this expand your market share and in addition could you let us know if any of your competitors have a similar product?

Reuven Ben-Menachem

The picture, the focus was written the last couple of years, three years I would say. It allows us to get into a new market that is called the payment hub market and some analysts are convinced that the market will go into this direction and some have quantified 60 sales in the next few years. So it’s a new large market.

We have a couple of competitors that claim that they have similar technology but we have been in bids and we believe that the technology that we are coming out to market with, which is just two or three old, and our competitors had this technology in the market more years before we did, is the best technology in the market and we believe that we will continue with our leadership also in the payment hubs market.

Operator

Your next question comes from John Kraft – DA Davidson.

John Kraft – DA Davidson

Congrats on locking in Bank of America. On that contract though, you said they would be using GPP to improve their cash managements but you also sort of suggested that they may at some point be looking to just do a complete replacement. Did I hear you right?

Reuven Ben-Menachem

I believe that our opportunities in Bank of America will grow over time. I don’t know what they will replace in the future, but we believe that our strengths in the business, we will grow.

John Kraft – DA Davidson

It’s certainly not a temporary fix that you’re trying to do over there.

Reuven Ben-Menachem

I believe that it’s a very strategic investment that the bank is taking. In every statement that came out from the bank that was public, the bank has stated that this is a strategic investment.

John Kraft – DA Davidson

You mentioned the Swift, the changes there as it seems like the attitudes for the more and more corporate are going direct, is that a permanent change do you think and are you seeing that across all corporate or certain sized groups?

Michael Sgroe

It is a permanent change in the sense that Swift has been going through a process over the last number of years with the member banks to understand how best to provide the service to that corporate segment of the market, so corporate are now connecting directly into the Swift network which is different than the prior model.

That’s in part also a function of the pressure that corporate have placed on their banks as they automated and enhanced their internal operating platforms through implementations and various different things. So corporate have grown more sophisticated. I think the banks, the move to allow banks direct access, direct response to the growing sophistication of corporate and that will continue and we see it as something very good for us.

We’re touching corporate now in various different places, certainly through the Swift connectivity as well as what we’re doing with EIPP and so we’re very optimistic about that as a development for the business going forward.

John Kraft – DA Davidson

As far as the size of the corporate, you primarily would deal with the larger corporate, but they also have that Swift now. Are you seeing it across the board?

Michael Sgroe

We are seeing it across the board. The largest of the corporate’s, they would probably tend to go directly into the Swift network using their own technology and infrastructure as opposed to coming through a service bureau as an example. But if you look at Swift’s own documentation or documentation of what’s going on with Swift corporate’s, the largest segment of the population will likely be coming into the network through service bureau offerings like ours. Once again today we feel we’re very well positioned in that regard.

The smaller guys that are using Swift, also it’s an indication that those guys that are coming on to Swift will likely outgrow that offering once they begin operating in the Swift environment and be looking for other more sophisticated offerings like what we’re offering.

Operator

Your next question comes from George Sutton – Craig-Hallum Capital Group.

George Sutton – Craig-Hallum Capital Group

You had mentioned Barclay’s in particular that you were going through scoping and planning phase of your next generation of the relationship. Could you give us a little bit more detail in terms of what you’re referring to there?

Reuven Ben-Menachem

We are working with Barclay’s over the last few years. We have implemented the cost of payment systems in Barclay’s. We have implemented the global liquidity with Barclay’s and we are in the process of closing a global payment arrangement with Barclay’s. That’s what Michael is talking about.

George Sutton – Craig-Hallum Capital Group

So in the process of closing a GPP which is…

Reuven Ben-Menachem

Global GPP for multi-geography. Multi-geography is including different continents.

George Sutton – Craig-Hallum Capital Group

On the same lines, you have kind elevated Lloyd’s into the discussion of large customers and mentioned there was good progress there. How should we be viewing Lloyd’s relative to some of these other opportunities?

Reuven Ben-Menachem

Lloyd’s will a singular opportunity, but like now we are working together with Lloyd’s integration work that is worked on now and we are the partner in the payments area and as we move forward into the integration process, we will take a bigger part implement all cycles of global payment systems of Lloyd’s.

So going into next year, I don’t see Lloyd’s as a customer the size of what we see at Barclay’s but in the future I believe Lloyd’s will become such a client.

Operator

Your next question comes from Raghavan Sarathy – Dougherty & Company.

Raghavan Sarathy – Dougherty & Company

In the press release you talked about signing contracts with existing customers. Are you working on things that were put on hold before or are these new projects that you are undertaking with existing customers?

Reuven Ben-Menachem

As we said before, the work that we are doing with these two large customers, we were before especially particularly implementing more countries. What I mentioned is that we implemented PLUSpay which is something that was not in evidence and was added to the scope.

Raghavan Sarathy – Dougherty & Company

Given that licensing seems to becoming a bit stronger than probably we expected, how should we think about the fourth quarter license revenue?

Yoram Bibring

I think in general, the business is growing, in growth mode; license is usually growing also because usually growth means you book some new deals hopefully and that’s part of it. I would expect some growth in the license as well.

Operator

Your next question comes from Gil Luria – Wedbush Securities.

Gil Luria – Wedbush Securities

When you talk about the recovery and your markets, could you just parse that a little bit by geography in terms of the U.S., Western Europe, Asia, your large markets? You’re excluding Bank of America which is a deal that you were talking about for the last six or nine months. Where are you seeing more of the recovery? Where do you think that there’s still more recovery to come?

Reuven Ben-Menachem

We are as I said in the script on a global basis, we see activity in Asia. As you know we signed a global contract and we’re active in Australia, but at the same time we are involved in some different steps with banks in Asia Pacific and Asia and we believe that this market is very active for our progress.

That’s one area. Europe is continuing to be a major market for us. As you know we are providing in Great Britain, in London and we have opportunities in Western Europe. And we believe that the high end of the U.S. market is opening as well. So we feel very confident that next year will be a growth year for us and for the industry.

Gil Luria – Wedbush Securities

In terms of currency, could you tell us what the currency impact was on this quarter and if you have it with you, what it was on last quarter?

Yoram Bibring

I don’t have it here for last quarter. This quarter the impact wasn’t much frankly. We are hedged in Israel against our expenses so that didn’t really impact us and our revenues were, the rest of the material revenues are in Euro’s and Pounds and currency went up 3% or they went down 3%, so very, very minimal.

Operator

There are no further questions. I’d like to turn the call back over to Reuven Ben-Menachem for any additional or closing remarks.

Reuven Ben-Menachem

I would like to thank everyone that joined us this morning. Thank you and we’ll see you next quarter.

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