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Longtop Financial Technologies Limited (NYSE:LFT)

F3Q11 (Qtr End 12/31/2010) Earnings Call

January 31, 2011 7:00 pm ET

Executives

Charles Zhang - Head IR

Weizhou Lian - CEO

Derek Palaschuk - CFO

Analysts

Karl Keirstead - BMO Capital Markets

Tim Fox - Deutsche Bank

Joseph Foresi - Janney Montgomery

Evan Xu - Goldman Sachs

Glenn Greene - Oppenheimer

Jon Maietta - Needham & Company

Jerry Huang - Morgan Stanley

Chris Shutler - William Blair & Company

Operator

Welcome to today's Longtop third quarter fiscal year 2011 results announcement. I am pleased to present Mr. Charles Zhang, Head of Investor Relations. (Operator Instructions)

Charles Zhang

Thank you and welcome to our fiscal third quarter 2011 earnings conference call. Joining me on the call today are Weizhou Lian, Chief Executive Officer; and Derek Palaschuk, our Chief Financial Officer.

For today's agenda, management will discuss highlights of the quarter. This will be followed by a Q&A session. Before we continue, I refer you to our Safe Harbor statement in our earnings press release, which applies to this call as we will make forward-looking statements. Finally, please note that unless otherwise stated, all figures mentioned during this conference call are in U.S. dollars on non-GAAP basis.

I would now like to turn the call over to our CEO, Weizhou Lian, and I will translate Mr. Lian's comments.

Weizhou Lian

Thank you, everyone, for joining us. We are very pleased to report outstanding results of our third quarter, supported by a record $43 million in operating cash flow. On the back of this success, we are again increasing our fiscal 2011 revenue and operating income guidance, and I am highly confident we can achieve our revised guidance.

Based on our initial conversations with customers of IT spending in the new calendar year, we continue to be optimistic about our competitive position under the demanding environment. While we are still in the preliminary stage of our 2012 fiscal year budgeting, I believe the 2012 first call consensus of $300 million for revenue and $123 million for adjusted net income is definitely attainable.

With that, let me now give you an update on our quarterly progress as regards customers, products and acquisitions.

On the customer side, we continue to see strong demand from all of our customer segments. We see a clear trend that banking and insurance customers are outsourcing more IT work to Longtop. For example, one of the leading joint-stock banks that has been doing most of its IT development in-house is outsourcing more projects to us after early this year we successfully delivered our operational risk management solution.

We believe the trend is driven by the fact that a number of banks and insurance companies' IT departments cannot satisfy the increasing demand and the complexity of the business departments' requirements. We have a strong competitive advantage to win this business because we can offer them world-class business consulting areas, such as business intelligence and risk management and offer them both customized and standardized solutions.

To give you some specific customer highlights during the quarter.

First, the year-on-year revenue growth rate as a Big Four bank of 39.4% in the first nine months of 2011 is almost double what we expected at the beginning of the year when we guided for 20% year-on-year revenue growth.

Second, the demand at our largest customer remains where it's at, and we continue to gain market share from our competitors for new projects, which is part of the reason the full year growth rate for this customer will be significantly higher than what we anticipated at the beginning of the year. But we have repeatedly said, we don't see any negative change in their IT outsourcing strategy with Longtop.

Thirdly, the strong demand from our fastest growing Big Four Bank customer will continue over the next few years. They have now formally launched their core banking upgrade project, where we will focus their in-house IT capabilities on the core banking upgrade project, and that'd give more auxiliary system development to Longtop, which is their number one strategic software development vendor.

Fourthly, the continued strong momentum from other banks with revenue growing by 80% in the first nine months of 2011, we have established our market leadership in the national joint-stock bank market, where we see increasing product penetration and a stronger Longtop branding. None of our competitors has covered all of the 14 joint-stock banks with such a broad product portfolio as Longtop has.

In the city bank market segment, our focus on the biggest city banks is paying off, as these big city banks expand geographically to become regional banks. This expansion is driving the IT demand, with strong experience and reference cases in Big Four and joint-stock banks market. We are well positioned to capitalize on these opportunities. Meanwhile, we have setup a sales team organically to cover the small city banks and credit union customers.

We are also improving our product R&D, as customers in this market require highly standardized solutions. The major drivers of the small bank market also include increasing competition, banks' consolidations and the emergence of newly approved small city banks.

Firstly, the implementation of our first core insurance project at the re-insurance customers is progressing well. And we are working hard to win our first property core insurance project. We believe core insurance represents the most important market opportunity in the fast growing insurance and IT solution market.

We are investing significantly resources to improve our core insurance capabilities, which is critical for increasing our market share in this segment. With the successful integration of Sysnet, a strong customer-based product delivery capability, we are well positioned in this market.

Finally, I am pleased with our success in the enterprise financial company market, even though this is a small percentage of our revenue. Our investment in developing our standardized financial company core business system has paid off as the solution is winning new customers. The potential adjustable market is also expanding as the government is allowing more state-owned enterprises as well as companies in private sectors to set-up financial companies.

With respect to our product and solution offerings, we continue to execute our strategy of delivering the highest quality services to maintain our leadership position. One of Longtop's key objectives in our next fiscal year is to further improve our product R&D. Product is critical as we penetrate into the small and the medium sizes bank market, core insurance as well as security market.

In the long term, I believe the most important competitive edge that protects us against potential competitors is our comprehensive product lines that we built over the last decade, and we continue to expand, looking into our key solution lines.

The strong demand for our business intelligence solutions is continuing from all customer segments. We believe once again calendar 2010, Longtop will be a dominant number one in China's banking business intelligence market. Our objective is to further expanding our consulting capabilities and standardize the development platform, data models and applications.

We continue to gain momentum from our banking and the insurance customers for our CRM solutions. We are also investing in R&D for channel integration capability that integrates CRM with call centers, internet banking and e-commerce on a common platform.

The demand from Giantstone's is stronger than what we had expected as the scope of the project continues to increase. We continue to invest in our risk management solution offerings with strong interest for our industry-leading operational risk management solution.

Another key initiative for us to better our solution offering is to significantly improve our owned internal training capabilities to have us meet the robust demand for Longtop solutions.

In closing, to update you on the acquisitions, we have a number of smaller acquisition candidates in our pipeline with a continued focus to enter into the securities industry.

With that, I'd like to turn the call over to Derek, our CFO, and look forward to your questions during Q&A.

Derek Palaschuk

Good day, everyone, and thank you for joining our financial review. I apologize for the short notice in announcing our earnings release date. This was due to our internal objective to give our finance staff a proper Chinese New Year holiday by reporting before the holiday which starts tomorrow.

The early Chinese New year only gave us a month to close, which is about two weeks earlier than our normal quarterly reporting schedule. So we wanted to ensure we had our audit committee and auditors' formal clearance before we announced our reporting date. After this quarter, we will go back to a normal reporting timetable.

We are pleased to report a strong Q3 and once again increase our full year guidance. We exceeded our Q3 software development revenue guidance by $5.1 million due to better-than-expect demand from our organic business and Giantstone's revenue being $1.5 million more than we had expected. Due to solid execution and the ongoing expansion of Giantstone's core banking project, we now expect Giantstone to contribute $18 million of revenue in fiscal 2011, up from the $15 million we estimated at the beginning of the year.

Our full year software development revenue guidance has increased from the $216.6 million we gave you last quarter to $226 million, which is an year-on-year revenue growth of 55.6% with organic year-on-year growth of approximately 40%, well ahead of the 30% organic guidance we gave you at beginning of the year. Our revised guidance of $226 million for software development revenue is $22 million more than the guidance we gave at the beginning of the year, and most of this increase has been from our organic business. We expect total revenues in fiscal 2011 of to $249 million, a year-over-year increase of 47.2% even with no growth in our other services business.

With regard to order intake and backlog, excluding Giantstone, contracts signed during the quarter were $65.8 million, a year-on-year increase of 68.7%. For the first nine months, our order intake excluding Giantstone or companies acquired is basically tracking with our organic growth of around 40%.

At December 31, we had software development backlog excluding Giantstone of $57.1 million compared to $59 million at September 30 and $40.7 million in the year-ago period, giving us very a high visibility going into our fourth quarter.

You should not be alarmed when you see the sequential drop in backlog at March 31 as this due to both the short-term nature of our contracts and the seasonality of the contracting process where we signed the least amount of contracts in the calendar Q1.

You will recall that we started our current fiscal year with backlog at March 31, 2010, of only $27.5 million, which is about 13% of our total estimated 2011 software revenue, excluding Giantstone of $208 million. Just as a reminder, our backlog figure only includes amounts where we have executed contracts and does not include any pipeline business. Furthermore, we almost never have had a backlog that has not turned into revenue.

Our primary strategic objective is to maintain our industry-leading position, drive free cash flow and EPS growth, which over the next couple of years will continue to result in small operating margin decline. For example, in 2011, our adjusted operating margins will be around 45%, which is 200 basis points lower than fiscal 2010 and we will deliver a full year adjusted operating income of $113 million, which is $9.5 million more than our initial guidance and a very healthy year-on-year increase of 43%.

Even with the slight margin declines, our cash flow from operations for the first nine months of $75 million is up 50% year-on-year. So we believe our investments are clearly paying off with the strong growth.

Internally, we focus on the operating margin rather than gross margin, because the classification between doing R&D pre-sales and delivery can be judgmental. Our Q4 2011 adjusted operating margin should be around 39% to 40%, which is 100 basis points to 200 basis points lower than the guidance we gave last quarter because of some tuck-in acquisitions we are doing and continued investment for the next year. Even with the slight margin decline, our Q4 2011 adjusted operating income for $25 million is $800,000 more than we gave last quarter and $4.1 million more than we gave at the beginning of the year.

One of the quarter's highlights was the strong cash flow from operations, which was a record of $43.9 million and $75 million for the nine months ended December 31, which is an increase of 50% year-on-year for the nine months. Our December 31 accounts receivable excluding system integration receivables were $84 million, up from $74 million at September 30 and $62.5 million at June 30. The increase was primarily due to receivables from acquired companies and higher business volume.

Our DSO for the first nine months is running at approximately 100 days, and we believe we'll end the year with full year DSOs of around 110 days, which is similar to last year's full year DSOs of 112 days. As our DSO had increased from 93 days in fiscal 2009 to 112 days in fiscal 2010, you'll recall at the beginning of the year our accounts receivable management was a key focus for us, and we have executed on this objective. Longtop's DSO is one of the lowest in the industry in China.

I would like to finish my prepared marks with more details on our net income and EPS guidance for the fourth quarter. We estimate fourth quarter adjusted net income of $22.5 million and adjusted EPS of $0.38 as compared $26.7 million and the $0.45 cents we gave you previously. The reason for the change is that we had assumed based on previous years that Longtop would receive notice prior to March 31 that it qualified as a key software company, which would allow us to an income tax refund of approximately $5.2 million or $0.09 per share which we would have recorded in our Q4.

We now expect to receive the approval notification prior to May 31, 2011, and that we'd record the benefit in fiscal 2012. As a result, our fiscal 2011 effective tax rate would be around 15%. I would add this is not a company-specific issue as the delay had been for all companies in China.

That concludes my presentation and will now ask the operator to open the floor for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Karl Keirstead, BMO Capital Markets.

Karl Keirstead - BMO Capital Markets

It seems, Derek, that the real upside in the quarter came from software development revenues coming about $5 million above your prior guidance. And I am wondering if you might offer a little bit more color as to where this came from and in particular whether Longtop saw any kind of yearend flush out of China Construction Bank that might have contributed to that upside?

Derek Palaschuk

Thanks, Karl. It was really with the Big Four banks. There was definitely more demand than we had anticipated. And if you want to refer to it as a budget flush, you can. Definitely our biggest customer, and that's why Lian and Zong had said looking into next year, based our current budget requirements with them, we don't see any change in their strategy in working with Longtop and that's something that we feel very comfortable about.

And one of the reasons we can't say two years from now is because they're basically working on their current year budget. Also, with our second biggest customer, as Weizhou alluded to, they formally kicked off their work on the core banking system so that there has been be a tremendous amount of demand and again things look very strong going into next year. And you also saw that our order intake was up 68% for the quarter, which is also a fairly good indicator and we're up 40% for the full year.

Also, in other banks, with Giantstone doing very well with its projects expanding in scope, there was also a revenue upside there. And again, these are things that are continuing into the next year. This isn't something that's just going to be quarterly-specific. And then as well as a number of our other bank customers are continuing to increase their spending with us.

Karl Keirstead - BMO Capital Markets

The CEO obviously blessed TheStreet consensus number for fiscal '12, but just to push a little bit on the margins, Derek, you seem to be tracking this year at roughly down 150 basis points to 200 basis points on adjusted operating margins. Is there any reason for TheStreet to believe that your fiscal '12 operating margins might be down by more than 200 basis points or down 150 basis points to down 200 basis points a good guess for your performance next fiscal year?

Derek Palaschuk

As we said, our primary objective is to drive operating income and cash flow growth. And if that comes at a margin decline, because we are investing more in the business and we have such very, very healthy margins we have the resources to invest, we will continue to do that.

Actually if you look over the last few years, if you look from fiscal 2009 to 2010, our margins dropped by about 300 basis points and our operating income grew by 50%. If you look this year, our operating margins have dropped by 200 basis points, and we are looking at operating income growth of 43%. And we think those are very strong numbers, and that's really what our objective is.

When we look into next year, every acquisition we do is going to bring down our margins. While most of our growth is organic, every tuck-in acquisition will bring down our margins. And so we can't really comment on the impact of acquisitions.

But to just get down to your question, it could be 200 basis points to 250 basis points inflation. We think the salary inflation will be 15% this year. It was 10% last year. So with that inflation, we should be able to absorb that in the 200% to 250% margin declines. So basically in line with what The Street has.

Operator

Our next question is from Tim Fox, Deutsche Bank.

Tim Fox - Deutsche Bank

Just one question, you mentioned that Giantstone is performing, sounds like now better than expected, though there has been some recent concerns out there concerning that implementation. Can you talk a little about how that project is progressing with Minsheng Bank and the opportunities for expanding within that client?

Weizhou Lian

We are very optimistic about the opportunities from the Minsheng Bank project. First, the project is progressing very well. According to their schedule, they have tested the system in one of the branches from November 20 to December 20, and the testing result is very satisfying. And they are now delivering the second launch training to 50 more branches, after they have delivered the first round of training before that. And the current schedule is that they are busy looking-forward to doing another real time trial in March.

And hopefully the trial will be finished before March. And then they are going to launch the system, together with older system. So what basically will happen is that the two system will be running at the same time. And after that they will be waiting for the formal approval from the Chinese Banking Regulatory Committee, CBRC. And Minsheng Bank has formally decided to split the whole core banking system into three parts. So they are going to build separate core banking systems for retail banking, corporate banking and investment banking.

So what that means for us is expanding scope of the project. And for us, we are also seeing that Minsheng Bank historically has many, many small software development vendors. So after the core banking system is up and running, we do see the opportunities to consolidate the small vendors by expanding the core banking system to the auxiliary systems. So in terms of the opportunities from the Minsheng Bank project, we do see that the core banking itself is expanding, and also we see more opportunities from auxiliary systems.

Tim Fox - Deutsche Bank

Derek, just one on the margin side, you mentioned you're expecting your operating margin just about 45%. And you addressed obviously the wage inflation concerns. Looking out over the next year or so, what's the wildcard relative to margin side, and what steps might you be able to take relative to pricing or expanding into Tier II, Tier III cities from a delivery perspective to help maintain the strong gross margin profile?

Derek Palaschuk

The only wild card is inflation, so inflation is 15% or less, our margin structure is very stable. So that's really the only wild card that we have. In terms of pricing, there is no pricing pressure. And our prices aren't higher than our competitors, and we're having to bid for a lot of different projects that we do. So pricing isn't something that could bite us.

Also, the banks are looking for very high quality solutions, so that even if people try and undercut us significantly on price, the banks are still going to go with someone with reputation. And also the ability to do projects and manage projects and sell software is really one of the core competencies of our business. And again, so people are trying to come in with very low prices that don't have the expertise aren't going to take business away from us.

And then in terms of our staff is that we will continue to try and hire as many people in cities like Xiamen and Chengdu, Guangzhou. And then one of the main costs is sales and marketing cost, and we've shown a lot of leverage in our sales and marketing. And our sales and marketing is going to go somewhere around less than 9% this year as a percentage of revenue. And that gives us a lot of leverage in our model, because there is companies in industry that have doubled that in their sales and marketing.

So we'll continue to focus on investing in the product, good solutions. And Lian also talked about moving from the larger banks to smaller banks, also in insurance, so all of that will give us a defensible margin. So they aren't really any wild cards out there other than inflation. And demand is not an issue, as you can see from our results. And we think over the next couple of years that's going to be the same thing.

Operator

Our next question is from Joseph Foresi, Janney Montgomery.

Joseph Foresi - Janney Montgomery

I know you had said that maybe pricing pressure isn't taking place, but is there any chance to increase prices here?

If inflation becomes very high then we would have an opportunity to increase prices. And then generally in terms of our pricing strategy is with the Big Four Banks, the pricing is relatively stable and our ability to increase prices isn't very strong. But when you look at our other customers, including the City Banks there is the potential to increase prices. And the other thing we can do is, for our standardized software, that's an area where there is potential room to increase prices.

But historically as a part of our strategy we haven't been aggressive in increasing prices. But that is one of the variables that we do have some control over, if inflation becomes a very big problem. That's the end of the answer.

Joseph Foresi - Janney Montgomery

Maybe you can give us an update on attrition rates. Obviously, if wages are going up, maybe you could just talk about what the attrition rate, how it's been tracking, what you're expectations were for next year versus last year?

Derek Palaschuk

So the attrition somewhere it's been basically stable. It's been somewhere around 20% and that's mainly at the lower level. The attrition at the manager and above level is basically almost zero. And that's been also the case in the last number of year. So our key project managers, and directors and VPs turnover is basically nil.

Joseph Foresi - Janney Montgomery

But you don't expect that to change, because obviously the wages are going up. So I'm just curious as to whether stuff fight some level of potential attrition?

Derek Palaschuk

We don't think so and that's why we're saying that inflation's going to be, we think it's going to be 15% next year. And that's why we're incorporating that into our margin guidance. So we will obviously as a leader in the market, we're willing to adjust the wages of those people to make sure that they don't leave.

And the other thing is Longtop being the leader in the Fin Tech industry, we give a lot of these people a very good opportunity to work on banking, insurance, large projects with finance companies and that's also attractive to the new people that join us.

Joseph Foresi - Janney Montgomery

I think you talked about one of your large customers kicking off the core banking upgrade and you giving auxiliary work. I wonder if you can just walk us through for process. And why you're confident that's going to happen?

Weizhou Lian

The reason we're very confident in the outlook with one of our largest Big Four customers is first of all that they have basically started the core banking project earlier than we originally anticipated and it's been formally kicked off. And the reasons we are confident are: Number one, we're the number one strategic IT vendor. That gives us an opportunity to get a bigger share of their spend. The second is, Longtop has the widest product offering, the most comprehensive product offering in the market and because they need a lot of different products, they can basically have one-stop shopping with us, which is also attractive to them.

The third is, over the last couple of years, we've invested in our consulting capabilities. So we can basically complement our software application development with business consulting, helping them with their planning, and structuring, and that's also very much value-added in the customers' eyes.

And then the fourth is, as he mentioned in his script, we have started bundling some of our products together, like CRM, call center, and the larger banks, where the banks also like this to have basically a more integrated and efficient product.

And then I'll just add one point to that is, if you look at this customer's state of IT development, it's slightly behind our largest customer. And basically, we have done so much work for our largest customer, we can reuse a lot of the experience that we have, and that's also very valuable to this customer that we have been basically proven in a bank of similar size. And that's what gives them confidence in Longtop.

Operator

(Operator Instructions) Our next question is from Evan Xu, Goldman Sachs.

Evan Xu - Goldman Sachs

My first question is could you give us an update for the accommodation dynamics in a core banking system.

Charles Zhang

So first, we see different players in different market segments for the core banking opportunities. For Big Four banks, basically they all do their core banking in-house, except for Bank of China. They have selected SNS product and are doing the implementation on their own.

So for example, ICBC has launched their fourth-generation core banking project last year. And as Lian has mentioned in his script, Agricultural Bank has also launched the upgrade and basically a replacement of their core banking this year, which is early than what we have expected, is also ahead of their schedule.

Our largest customer, China Construction Bank, they have been planning and budgeting for the new core banking system for almost two years, but it seems that the project has been delayed. And we hope they can launch this core banking upgrade later this year.

The Joint Stock banks, most of them are using very old systems which were developed by local vendors, banks like Citibank, Everbright bank, they are all using very old systems. One exception is Minsheng Bank. They have selected SAP product using Giantstone to do the implementation. They have been going through a long, couple of years' implementation process, but we believe they are very, very close to success.

And another bank which is in a unique position is the Bank of Communications, BoCom. They are much, much bigger than other joint-stock banks but smaller than Big Four Banks. They also launched their core banking upgrade project and they are following the Big Four Bank strategy, which is developing the new core banking system in-house.

We believe the big city banks, some of them are trying foreign products but none of them have been successful. And for smaller banks, they dare not try foreign products because foreign products are too big and too complex for them to use.

In terms of competition and opportunities, we believe for the Big Four Banks opportunity is to evolve in the implementation of their core banking. And we believe all the traditional core banking players at Big Four Banks have opportunities, and it's more like implementation outsourcing opportunity rather than selling products and manage the whole project.

For joint-stock banks and big city banks, we do see the opportunity for the SAP plus Giantstone solution, but the sales cycle could be much longer than our other solutions because they need more time to assess the project and also figure out how to implement the system more efficiently. So it could be two years or even longer.

And for medium-sized banks, we don't think it's a good strategy to develop a new product. We are also talking to some foreign partners to see whether we can use their product to address this market segment better. For very small city banks, rural banks and credit unions, our strategy is to use Giantstone's product and the previously acquired Pujian product to adjust them, to cover this segment.

It's our belief that China has entered into a new core banking upgrade cycle. So core banking represents the most important market opportunity in next ten years and we are looking forward to that. And we are also well positioned to capitalize on the opportunities.

Evan Xu - Goldman Sachs

My second question is to redesign a core insurance product, are we required to do some implementation?

Weizhou Lian

In terms of core insurance, basically there are two segments; one is the life insurance and then a second one is property insurance. We acquired Sysnet. They have been putting in a lot of R&D on their next generation car insurance product. Actually they have been doing that product for more than three years. The product is called Pharos. And their objective is to use that product to address both life and property insurance on a common platform. It's a very flexible and process-oriented product and has adopted a lot of new philosophies for core insurance products. We like the product very much, but we believe is more suitable for large-scale property insurance companies.

So now, we are also putting some R&D to develop some more modules around the Pharos product. And also, we are in the process of looking at an acquisition that provides property insurance solutions to small-sized insurance companies. So with that, we will have a very strong product to support our property insurance strategy.

And in terms of life insurance opportunities, even much bigger than property insurance, and our strategy is to develop the product together with the customer organically. As a matter of fact, we have put a lot of R&D in developing that product. That's part of our investment. We will not use a foreign product, because the regulation environment in China is very unique. We believe the foreign product has less opportunity and both the customer and us have very small confidence in foreign products being successful in China. We believe the risk is pretty high to use a foreign product.

Operator

Our next question is from Glenn Greene, Oppenheimer.

Glenn Greene - Oppenheimer

Just want to address the Big Four banks again. It sounds like you are not seeing any issues with your largest bank or any of the Big Four banks at least from what I hear. And I know you have a long-term goal to grow the Big Four banks to sort of 20% CAGR at least since your IPO. And I think you reiterated that at least for the next couple of years on your call.

Is that sort of still the situation or is there anything that you see out there that would provide any rest or give you any caution as it relates to growing 20% or some for the next couple of years on the Big Four banks?

Derek Palaschuk

Glenn, there is nothing negative that we see would cause us to have the Big Four banks grow by less than 20%. And since the IPO, it's been 50-50. And this year, we'll end up a little bit less than 40%. But the demand is very strong and we are well positioned and we feel very comfortable that they are not going to change their strategies toward us.

Glenn Greene - Oppenheimer

I may have missed this, but in the prepared script, you talked about I don't know if it's more outsourcing or a trend toward outsourcing and I don't know if you were talking about a specific customer sub-segment or a specific customer, but what I am really asking is are you seeing an increased trend toward outsourcing broadly?

Derek Palaschuk

When we say outsourcing, we mean your outsourcing their IT Development projects, software to Longtop, that's specifically what we're referring too.

Weizhou Lian

Outsourcing in the prepared remarks, what we meant is actually project outsourcing rather than IT outsourcing. So what drives the outsourcing trend is that the business department is acquiring more business systems rather than pure IT systems. As a result, the trend requires more, even higher, domain knowledge, requires in-depth understanding of their business rather than just IT.

So to give an example, we do a lot of risk management projects for our customers, and it requires the vendor to understand their risk management practices and also have strong consulting abilities. So it's not just IT system. It's more like a business system. And we see the same trend in a couple of areas like private banking, wealth management that all new business for our banking customers and they need our professional advice and consulting to deliver the whole project.

IT is not a key requirement. So we believe Longtop is well positioned in this market, because we have successfully combined the consulting product as well as implementation to meet the customers' requirements.

Glenn Greene - Oppenheimer

Just a number question for Derek, just want to make sure I understand. The tax credit, roughly the $5 million, is going to show up in the first quarter of 2012, which implies actually a negative tax provision for 1Q, is that the right way to think about it?

Derek Palaschuk

That's correct.

Operator

Our next question is from Jon Maietta, Needham & Company.

Jon Maietta - Needham & Company

Derek, I just want to check on something that I think you said in the prepared remarks. I think I heard you say you're working on acquisitions at the moment.

Derek Palaschuk

Correct, we are. What we're doing is a number of tuck-in acquisitions, smaller acquisitions. And Lian just mentioned one related to development of a core insurance system, but we not working on anything big. It'll just be more tuck-in acquisitions.

Jon Maietta - Needham & Company

Would those be tuck-in acquisitions that you would expect to close this March quarter or do you just mean over the course of fiscal '12?

Derek Palaschuk

Approximately some of them, and that's why we only gave our margin guidance. So basically we've already incorporated around $1 million of investment. And that's why we said our gross margin would be 58% to 59%. And basically on each $0.5 million that we invest, there is 1% declining gross margin. So that's related to the tuck-in acquisitions that we'll definitely close. And we are working on a couple of other ones. The reason we are doing it is because we see so much demand out there, we want to expand our product portfolio.

So it is possible that there could be a couple of more, but it won't be anything significant in terms of our cash balance. We have $412 million in cash excluding short-term debt at the end of December. So we wouldn't be required to spend a significant portion of that.

Operator

Our next question is from Jerry Huang from Morgan Stanley.

Jerry Huang - Morgan Stanley

The question is the financial company and the big corporate, so how big is the market in size, how is the penetration and how is the competition?

Weizhou Lian

So we don't have the exact data on basically the market size and the penetration of basically how much the finance companies are spending on their core finance systems. In terms of the market size and potential, last year about 70 finance companies had been approved. When I say last year, that was actually 2009, and about 40 were active.

But what's happening now is there is more and more finance companies being approved, because basically the size has been reduced to RMB50 billion for applying for approval to set up a finance company, so now there's more than 100. In terms of the product, the larger companies such as SinoPec, they were spending tens of million renminbi and for the companies that weren't so large, maybe RMB10 million a year.

And in terms of the competitors, there's a local company as well as historically also iSoftStone has been in this area, the largest finance company's where you see foreign products, because they're just so big. So what we've done is basically three years ago we started developing our first generation for finance system.

And since then we basically went through number of generations and we have a number of customers that are using it now. And the reason that we're quite excited about the market opportunity is because, number one, we've been able to replace some of our competitors, because we have what we believe is the newest generation product.

Secondly, and very importantly, is that because Longtop has experience in banking, insurance and securities, what's happened is that these finance companies have actually expanded their business scope, so now they can do insurance related, securities related international trade, as long as with their traditional assets management liability business.

And Longtop is really one of the few companies or the only company that has this basically cross industry experience. So as they expand their business scope, the system, the core finance systems also have to have more functionality. And Longtop is able to meet that requirement.

Charles Zhang

I think this is last question we have time for.

Operator

Our last question is from Chris Shutler from William Blair & Company.

Chris Shutler - William Blair & Company

Maybe, Derek, you just remind again, these are just couple of clean-up questions. You're talking about 15% wage inflation for fiscal '12. Just want to confirm that the 10% that you saw last year was apples-to-apples with that 15%?

Derek Palaschuk

Yes.

Chris Shutler - William Blair & Company

And the on the software development side, I don't think you gave a headcount number for this quarter, can we get that?

Derek Palaschuk

We had 3,316 engineers. So we had added about almost 250 since last quarter.

Chris Shutler - William Blair & Company

And then the final question is just actually FX rates. What you are assuming in your guidance? Obviously, the renminbi is appreciated about 3% or 4% since your reported last time?

Derek Palaschuk

I don't think it's appreciated quite that much. But basically for the full year it looks like it will appreciate somewhere around 3%, 2.5%. So we're basically assuming a rate of around 6.9 for this next or actually this next quarter will be 6.7. And that's our assumption going into next year as well. So we haven't assumed any further appreciation in the renminbi.

Operator

We will now begin the closing comment. Please go ahead, Mr. Zhang.

Charles Zhang

Thank you, everyone again for joining us. If you have any other questions, please feel free to contact Lian, Derek and myself. Thanks, everyone.

Operator

This concludes our conference call. Thank you all for attending and good bye.

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