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CyberSource Corporation (CYBS)

Q4 2006 Earnings Call

January 25, 2007 4.30 pm ET

Executives

Steve Pellizzer - CFO

Bill McKiernan - Chairman and CEO

Analysts

Franco Turrinelli - William Blair & Company

Colin Gillis - Canaccord Adams

Wayne Johnson - Raymond James

Gil Luria - Wedbush Morgan Securities Inc.

Robert Dodd - Morgan Keegan & Company

Gary Prestopino - Barrington Research Associates

Tom McCrohan - Janney Montgomery Scott

Glenn Greene - ThinkEquity Partners

Nick Farwell

Presentation

Operator

Good afternoon. My name is Robert, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the CyberSource Fourth Quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions). Thank you.

I will now turn the call over to Mr. Steve Pellizzer, Chief Financial Officer. Sir, you may begin.

Steve Pellizzer

Thanks Robert. Welcome to the CyberSource's fourth quarter conference call. I am Steve Pellizzer, Chief Financial Officer of CyberSource. During this call, we will discuss our financial results for the fourth quarter of 2006. If you have not received the press release summarizing our fourth quarter results, it's available at www.cybersource.com.

Participating in the call with me today is Bill McKiernan, our Chairman and CEO. These prepared remarks will run for approximately 20 minutes and then we will open up the call the Q&A.

Before we get started, I need to alert you to our Safe Harbor provisions. During the course of this teleconference, we will make certain forward-looking statements regarding our business and results of operations. Statements made today that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including without limitations; statements regarding the company's expectations, objectives, anticipations, plans, hopes, beliefs, intentions or strategies regarding the future.

Such forward-looking statements include those relating to the company's financial performance in the fourth quarter and the full year, ongoing profitability of the company, BidPay being an excellent long-term investment, strength of the company's European business, the company's European business doing well, the strength of the balance sheet, financial guidance, including without limitation those regarding revenue, transaction volume, gross profit, operating expenses, net income, earnings per share, deferred tax assets and cash balance; company's opportunities in the eCommerce market, growth of eCommerce, achieving $1 billion transaction in 2007. We wish to caution you that such statements are just beliefs or predictions and that actual results might differ materially from those projected in any or all of the forward-looking statements. These statements are also subject to risks and uncertainties including but not limited to the following; changes in customer requirements, potential financial risks relating to the company's global acquiring business, changes in general economic conditions and eCommerce in particular, changes in legal requirements and litigation arising from time-to-time, unforeseen technical difficulties relating to the Internet in general or our technology in particular, potential system failures including without limitation, disruptions intentionally caused by third parties and the intense competition in our industry, and the need for rapid technological change associated with such competition.

Further CyberSource's past financial business, operations and stock performance are not necessarily indicative of CyberSource's future performance. Listeners are referred to the documents filed by CyberSource with the SEC, specifically Form 10-K filed on March 10, 2006, covering the one year period ended December 31, 2005 and our quarterly reports filed on Form 10-Q from time-to-time. All of which include these and certain other important risk factors.

Now, let me introduce Bill McKiernan.

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Bill McKiernan

Thanks Steve. Good afternoon and thank you all for joining us. It's a pleasure to welcome you to our earnings call. CyberSource had a very strong fourth quarter. We generated record revenue of $20.9 million, a 40% increase over the same period last year and a 20% sequential increase over the third quarter. These results were again driven by strong growth in our transaction processing and merchant acquiring businesses.

Transaction revenue was up 45% year-over-year. Transaction revenue excludes software and professional services and represents 92% of our revenue. We had another record quarter in transaction volumes as we processed over 255 million transactions, a 32% increase over the same period last year. In December alone, we processed over 100 million transactions and averaged 3.5 million transactions per day. The value of the transactions we processed was over $9.9 billion for the quarter, a 31% increase over the same quarter last year. The value of transactions where we acted, as the acquirer, was $246 million, up from $115 million last year, or a 114% increase.

CyberSource global acquiring generated approximately $7.8 million of revenue for the quarter, up 108% year-over-year. We now have approximately 1,400 customers using our acquiring services, double the number we had a year ago and global acquiring now represents about 37% of our total revenue.

During the quarter, we processed transactions in 64 different currencies, reflecting the global nature of the eCommerce. Our system availability during the busiest quarter in CyberSource history was 99.995%. We are very proud of our system reliability and scalability, as our infrastructure consistently handled the volumes throughout this past holiday season.

With the sixth consecutive year, we have received an award for excellence in customer satisfaction, and customer support. We recently were informed that we have won the ACE Award from CustomerSat Corporation for achievement in customer excellence. The award was based on the results of monthly surveys of our installed base.

During the year, 80% of surveyed customers ranked us eight or higher on a 10 point scale. These impressive scores are one more reason why CyberSource continues to win new customers.

Our financial results this quarter on a GAAP basis include a reduction in our allowance against our deferred tax asset. This resulted in a benefit in Q4 of $9.9 million. The allowance was reduced again this year because we believe we will be able to recognize the benefit of our past NOLs, due to the ongoing profitability of the company.

Including the reduction in the tax allowance, CyberSource net income on a GAAP basis was $12.5 million or $0.34 per share, versus $5.2 million or $0.14 per share in 2005. Because 2005 results did not include significant charges, like stock option, compensation and non-cash tax expenses, we provide non-GAAP measures, which may provide investors with additional meaningful information. Steve, will provide a more detailed explanation of GAAP versus non-GAAP in a moment, and we also reconcile GAAP and non-GAAP measures in our press release available on our website.

At any rate, non-GAAP net income was $3.3 million or $0.09 per share in Q4, up 50% from $2.2 million or $0.06 per share in the prior year. These results include approximately $900,000 in losses attributable to BidPay or about $0.02 per share. We continue to believe BidPay represents a great opportunity for CyberSource. Person-to-person payments, is a huge market and we believe BidPay has an opportunity to capture a meaningful share of that market.

In our core payments business, we signed over 1800 new customers in the quarter, a very strong performance given that the fourth quarter is typically a time of year when merchants minimize changes. The majority of these customer additions are the result of our small business program, but we also added a solid group of enterprise and mid-market customers during the quarter. These additions bring our installed base to over 18,000 customers. Among the enterprise customers signed this quarter are ABES of Maine, an electronics retailer; Iron Mountain Information Management; Shell Global Solutions; Sonoco Products Company and the Smithsonian Institute. Existing customers that added new services or renewed agreements during the quarter include Air Canada, BBC Worldwide, Curves International, Eastman Kodak, Home Depot and Seagate. Our European business continues to perform well and posted strong results for the quarter. During the fourth quarter European based customers generated over 39 million transactions and represented about 10% of our revenue.

Q4 [accounted] a very strong year for CyberSource, revenue for the full year 2006 was $70.3 million up 39% over 2005. Net income on a non-GAAP basis was $10.5 million, up 54% over the prior year. Earnings per share on a non-GAAP basis were $0.29 up 53% over 2005. For the year, we processed over 850 million transactions worth over $34.5 billion.

Now, I will ask Steve Pellizzer to provide additional details on our financial results for the quarter and financial guidance for 2007.

Steve Pellizzer

Thanks Bill. As Bill mentioned our fourth quarter revenue was $20.9 million, $1.1 million higher than our previous guidance of $19.8 million. Transaction processing revenue was $19.3 million, $1 million than our guidance of $18.3 million; included in transaction processing revenue was approximately 175,000 generated by BidPay.

Global acquiring revenue represented approximately 30% of total revenue, it is important to note that our global acquiring revenue may also include fees generated for gateway services, as it is becoming more common to quote the customer, a bundled price for services provided. Enterprise software revenue was 800,000; 100,000 higher than our guidance of 700,000. While professional services revenue was 900,000 or 100,000 higher than our guidance of 800,000.

During the fourth quarter, we added approximately 1,800 new customers on a gross basis and approximately 1,600 customers on a net basis. Our gross profit on a GAAP basis of $9.9 million was 500,000 higher than guidance of $9.4 million. Operating expenses on a GAAP basis for the fourth quarter were 9 million compared to guidance of 9.3 million.

During the fourth quarter, our GAAP results include approximately 1.3 million of FAS 123R expense, most of which was recorded in operating expenses.

As Bill mentioned, our financial results on a GAAP basis include a reduction in our allowance against our deferred tax asset. This resulted in a tax benefit in the quarter of 9.9 million.

GAAP net income for the fourth quarter was 12.5 million, while fully diluted earnings per share were $0.34 as compared to guidance of 400,000 or $0.01 per share.

As we noted last quarter, our guidance for the fourth quarter did not account for any reductions in our valuation allowance against our deferred tax asset. Non-GAAP net income was 3.3 million or $0.09 per share as compared to guidance of 2.5 million or $0.07 per share.

Our balance sheet continues to be very strong. Our cash and short-term investment balance increased to 54.9 million. The company used 1.3 million to repurchase approximately 136,000 shares of its common stock during the fourth quarter and generated approximately 700,000 in cash from employee stock option exercises. Cash flow from operating activities was 1.6 million during the three months ended December 31st, 2006, compared to 1.3 million during the same period last year. In addition, our DSO was 39 days, well below our internal target of 50 days.

Now, I'll give you some detailed guidance for the first quarter and fiscal year 2007. In light of SEC Fair Disclosure, this forecast, which is made in good faith and is based on all the market information we have available today, will be the only numbers that the company will comment on going forward or until updated by the company. We also assume no duty to update these numbers at any time.

We expect revenue in the first quarter to be $20.6 million. We expect transaction and support revenue to be $19.3 million, which includes 400,000 expected to be generated from BidPay. We expect professional services revenue to be 700,000 and enterprise software revenue to be 600,000. We currently estimate transaction volume in the first quarter to be between 245 million and 250 million. We expect gross profit to be $9.3 million, and we expect operating expenses for the first quarter to be approximately $10.4 million. We currently expect a net loss in accordance with GAAP and a loss per share of $300,000 and $0.01 per share on a weighted average share count of 37 million shares. We expect non-GAAP net income for the first quarter to be $1.4 million, and non-GAAP earnings per share to be $0.04, based on a weighted average share count of 37 million shares.

For the full year 2007, we expect total revenue to be between $90 million and $95 million. We expect to record gross profit of between $44 million and $46 million. We expect total operating expenses for 2007 to be between $40 million and $43 million. We expect to record a tax provision of approximately 40%, most of which is non-cash and will be applied against our deferred tax asset on the balance sheet.

Net income in accordance with GAAP for the full year 2007 is expected to be between $3.5 million and $4 million. Earnings per share in accordance with GAAP, is expected to be $0.09 and $0.11, based on a weighted share count of 38 million shares. Our guidance does not take into accounts any further reductions in our valuation allowance against our deferred tax asset, which could result in a tax benefit during the period of the reduction. We will continue to evaluate whether a further reduction in the allowance is appropriate.

Non-GAAP net income for full year 2007 is expected to be between $13.5 million and $14.5 million. Non-GAAP earnings per share is expected to be between $0.36 and $0.38, based on a weighted average share count of 38 million shares. We are forecasting a cash balance in excess of $65 million as of the end of the year, excluding any cash that maybe consumed under the 2007 $10 million stock repurchase program or non-recurring items. We expect capital spending for 2007 to be between $1.5 million and $2 million.

With regards to BidPay, we expect to generate revenue of between $3.5 million and $4 million in 2007, and expect to record operating losses of between $1.7 million and $2.2 million. We expect BidPay to generate operating income beginning in 2008.

I will now return the call to Bill, for his concluding remarks.

Bill McKiernan

So, by any measure I think CyberSource performed very well this year. While investing over $0.04 per share in BidPay during the year, we were still able to grow our earnings per share by 53%. We believe our value proposition continues to gain traction in the market. Our goal of managing the entire payment process for our customers from acceptance, to risk, to reconciliation and reporting is clearly resonating with customers. However, our penetration of the overall payment processing market is still relatively low. While we have excellent relationships with many of the largest eCommerce businesses in the world, we still have a huge opportunity to capture a larger share of the fees they currently pay to process payments. For example in Q4, we provided merchant acquiring services for only about 2% of the dollar volume that flowed through our gateways.

Our acquiring business, which did about $23 million in revenue this year is a very small share of a multi-billion dollar domestic acquiring market. We know there was a huge opportunity for us to expand our business in this area. And therefore, we will be investing heavily in this business in 2007. We also believe we have the right executive team in place. We have added a lot of strength to the team in the last nine months, with Scott Cruickshank from Chase Payment Tech; Carolyn Brackett from FDC; Kirsten Fry-Sanchez from FDC; and George Barby from VISA.

This year, we will be investing in building out our channel offerings. Our international payment capabilities, our risk capabilities and delivering on our vision of managing the entire payment process for our customers.

I am confident we can deliver on this vision. In 1996, we established a BHAG for the company. A BHAG is a Big Hairy Audacious Goal. The concept of a BHAG is to create a goal that is about 10 years out and that is so audacious as to be almost unattainable.

One example of the BHAG is President Kennedy saying in 1961 that the United States would put a man on the moon by the end of the decade. At the time he made that statement that was almost absurd.

At CyberSource, in 1996, we looked out 10 years and said that our BHAG would be that by 2007 we would process 1 billion billable transactions. We picked this goal because that year FDC had processed about 5 billion transactions and we figured that in 10 years we should be able to do about one-fifth of what FDC was doing.

At the time we set this BHAG, we were probably processing a few thousand transactions a day. And most people had no idea what the Internet even was. We memorialized this BHAG in [lucid] cubes and gave the cubes out to all of our employees at that time. I still have mine.

In 2006, this past year, we processed 854 million transactions. In 2007 we intent to process over 1 billion billable transactions. In 2007, we intend to achieve the BHAG that we set out 10 years ago.

So with that operator, we'd be happy to take any questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Franco Turrinelli.

Franco Turrinelli - William Blair & Company

Bill, Steve, good afternoon. Congratulations.

Bill McKiernan

Hey, Franco.

Steve Pellizzer

Hey, Franco.

Franco Turrinelli - William Blair & Company

We should have a BHAG of doing this conference call in less than half an hour, how is that? Bill, could you comment a little bit on -- obviously there has been a lot of press of PayPal and Google certainly encouraging a lot of eCommerce volume through some of the promotions that they ran. Did you really see or can you think that you detected the impact of those competitive efforts in terms of the overall volume that you experienced?

Bill McKiernan

As you can tell from our results, Franco, we had a very strong quarter by any measure. Our volumes grew up substantially. Our revenue was up substantially. So, I don't think we detected any loss of share to either Google Checkout or to PayPal. However, having said that, both of those companies we view as formidable competition, so we certainly do keep our eyes on them.

Franco Turrinelli - William Blair & Company

I was actually wondering Bill that, [it's more than] the market share you'd see the effort promote a higher level of awareness of online purchasing or maybe a higher level of willingness to purchase online, particularly with some of the shipping cost promotions that were out there?

Bill McKiernan

I'm not sure that those promotions had that big of an impact. I think eCommerce is still gaining momentum. I think every holiday season we see a big spike as more-and-more people use it for the first time and those people who have used it in the past increase their usage during the holiday season. And then generally what we see is that, unlike traditional retail, where you've got a spike in Q4, and that sort of drops off into the first quarter. I think what we see in eCommerce is that all of those people who had good experiences in the fourth quarter continue to use the Internet to buy things. So, our hope is that we will see that trend continue through 2007.

Franco Turrinelli - William Blair & Company

Indeed. I have a couple of net -- picky financial questions. So, let me -- let other people jump on board now, I'll come back if there are no further questions. Thank you.

Bill McKiernan

Thanks Franco.

Steve Pellizzer

Thanks Franco.

Operator

Your next question is from Colin Gillis.

Colin Gillis - Canaccord Adams

Hey, Bill, hey Steve. Congratulations on a great quarter.

Steve Pellizzer

Thanks Colin.

Bill McKiernan

Hey Colin.

Colin Gillis - Canaccord Adams

So, would you say -- you've established the model works to leverage your best-in-class gateway to capture more acquiring business right now?

Bill McKiernan

No question. And it's not just leveraging the gateway, Colin, it's leveraging the whole approach to manage payment and providing risk services, reporting, reconciliation, tax calculation, export control, all through one single connection into CyberSource. And our view is that overtime by providing this holistic managed solution to merchants that will continue to capture share in the acquiring space.

Colin Gillis - Canaccord Adams

Is there any color, you could give to us in term of like, what the number of the merchant adds in the acquiring space you are looking for? Where that could go down the line?

Bill McKiernan

As I said, in my prepared remarks, the merchant acquiring business is multi-billion dollar business. If eCommerce in the U.S. is about $200 billion market, I assume that merchants are paying on average about 2.5% of the value of those transactions in payment fees. So that's about a $5 billion market and today our acquiring revenue is $24 million or something. So we've got a lot of room to grow in that space.

Colin Gillis - Canaccord Adams

Do you have any stats as to the percent of merchants that you turn away, that you decline for risk reasons?

Bill McKiernan

Yeah, I mean that's a -- it's a pretty, I think a relatively low percentage. I mean I would say we are taking on between 80% to may be 85% of the accounts that we look at from an underwriting perspective.

Colin Gillis - Canaccord Adams

Have there been any losses yet, like related to actual purchases as opposed to just customer costs?

Bill McKiernan

No, I mean losses have been relatively low. We had one -- I think it was actually last year, that was 50K and under. So they have been -- this year was actually even better than last, it has been pretty clean from that perspective.

Colin Gillis - Canaccord Adams

Okay, great. And then just finally, are there any 10% customers in the gateway right now?

Bill McKiernan

No.

Colin Gillis - Canaccord Adams

Okay. Great. Thank you.

Bill McKiernan

Thank you.

Steve Pellizzer

Next caller?

Operator

Your next question is from Wayne Johnson.

Wayne Johnson - Raymond James

Hi, good afternoon.

Bill McKiernan

Hey Wayne.

Wayne Johnson - Raymond James

I just a got a couple of quick questions here. Can you give us an update, I think you may have alluded to this earlier, but an update nonetheless on where CyberSource stands in the hiring process of sales for the different services and products?

Steve Pellizzer

Sure. You could tell us by just looking at how we sort of ended versus my guidance from an operating expense perspective, we were slightly under, and that's because we still have some positions out there that we are looking to fill.

Wayne Johnson - Raymond James

Right. And what -- could you tell us, like numerically how many and what kind of titles this would be?

Steve Pellizzer

I don't want to go into title, but numerically it's probably about 15 heads that we were under at the end of the year, and they have concentrated mostly in sort of the product developments, as well as in the sales area. And this is the area that we are going to continue to focus on even throughout 2007, you know Bill mentioned some of the investments that we are going to be doing in the prepared remarks and that's going to take some additional product development resources. And then we are always looking at sales and looking at sort of the market opportunity that we see in making sure that we right size the organization.

Wayne Johnson - Raymond James

Right. Okay.

Bill McKiernan

And Wayne, these are non-executive hires; we feel really good about the executive team that we have in place and its people at the Director and below level.

Wayne Johnson - Raymond James

Okay. And if you mentioned this, I apologize for asking upon the BidPay side, did you talked about subscribers at all?

Bill McKiernan

Yeah, let me give you some metrics there. So, I think, on the last call we talked about having about 120,000 registered users, that's up to about 254,000 right now. From a seller standpoint, we had about 20,000 last quarter, that's up to over 32,000 now. We had about 500,000 active listings at the time of our last call and that's about 750,000 now. So the business is gaining traction, clearly we still have a lot of work to do there, but we feel good about the progress we have made, given that it was just re-launched in June of last year.

Wayne Johnson - Raymond James

Right. That sounds great, and thank you for giving us the revenue and other metrics for '07 and that seems up or clears up some of the other questions I had on BidPay itself. But going to the merchant processing side, you mentioned expanding the channels, looking more internationally and also fueling out the risk side. What did you mean by on the risk side? Are there are product updates that are coming or what was that -- are you alluding to?

Bill McKiernan

Yeah absolutely, our decision manager product that we enhanced in 2006 is really getting a lot of interest in the market and we have got some plans to continue to enhance that through the year. So, there is -- there is a lot of opportunity for us to offer more value to our customers.

Wayne Johnson - Raymond James

Okay. You mean adding more or selling more services per customer or providing them with upgrades that could generate more revenues?

Bill McKiernan

Well it's probably -- it’s both, and it's selling our services to more customers by adding additional functionality, additional features and make the services that much more attractive to a larger customer base.

Wayne Johnson - Raymond James

When you guys are adding these new customers? Whom do you compete against the most and what are the two or three reasons most frequently mentioned the reasons as to why CyberSource is able to win in a bake-off situation.

Bill McKiernan

Yeah, when we -- when we show acquiring services, we are typically up against the larger merchant acquirers out there and certainly Chase Payment Tech is probably the largest in the card, not present space. And often when we win there, we win because we bring not only the payment acceptance piece, and we do that on a global level, but also some of the risk management capabilities that we have, that frankly no one else in the market has. We just recently won an account, where we were actually priced slightly higher than the competition, but because of our risk capabilities they chose CyberSource over the competition.

Wayne Johnson - Raymond James

Okay. Great. Thanks very much.

Operator

Your next question comes from Gil Luria.

Gil Luria - Wedbush Morgan Securities Inc.

Good afternoon and also congratulations on the great quarter.

Bill McKiernan

Thanks Gil.

Steve Pellizzer

Thanks Gil.

Gil Luria - Wedbush Morgan Securities Inc.

You had a very substantial amount of merchant adds, probably more than typical for the fourth quarter, considering most merchants who would usually be in business at this point. I was wondering whether that's -- did you convert a reseller from a competitor? What's -- what drove that very substantial customer adds?

Bill McKiernan

Yeah Gil, I think more than anything its continued traction in the channel. As you know, Carolyn Brackett joined us in 2006 to head up our channel effort. She is our VP of Channels and Alliances and she is really doing a great job getting out there and promoting CyberSource to both financial institution partners and also technology partners.

Gil Luria - Wedbush Morgan Securities Inc.

Great. Now, in terms of your merchant acquiring, I think you said 7.8 million of revenue in the quarter. Is that apples-to-apples with previous numbers that you've said or you are now also including the gateway to those customers which you previously did not?

Steve Pellizzer

It's apples-to-apples, but as I mentioned in the prepared remarks, one of the challenge going forward is, as we price this payment solution to merchants, it's getting more common. The merchant just wants one price. They don't want a separate price for the gateway and a separate price for the gateway and a separate price for the merchant account. So it's more difficult to breakout the component that's related to the gateway versus the merchant account. From a methodology perspective we are calculating it in the same way, it's just going to -- as we continue to grow, get a little bit more difficult in comparing that.

Gil Luria - Wedbush Morgan Securities Inc.

And finally on BidPay, obviously you believe the potential there is very large. But for now its still investment mode, it sounds like next -- this year there will be also an investment mode. Is there a point where you put yourself -- put for yourself where you decide that its not worth investing any more and you just can't afford or is there something that you are committed to for at least a couple of more years?

Steve Pellizzer

Well, I think we are absolutely committed to it for this year, and again, we have high hopes for it. I think the person-to-person space is a huge market, and there will be a meaningful number two competitor to PayPal there. Right now, BidPay is probably the number two player, but it's not a number two player in a meaningful way. I think what's important to keep in mind with BidPay is that, when we bought it in March from FDC, what we got was not a going concern, it was not a business, it was a -- literally a box of assets that we got from FDC. It came in a box, accompanied by a security officer from FDC and a commercial plane from Denver to Mountain View and it contained all bunch of CDs with some software and customer names and things like that. And so we had to totally rebuild that business from hiring to re-architecting the systems to re-launching it. And so given that, we feel pretty good about where it's evolved to after six or seven months.

Gil Luria - Wedbush Morgan Securities Inc.

Got it. Thank you very much.

Bill McKiernan

Thanks Gil.

Operator

Your next question comes from Robert Dodd.

Robert Dodd - Morgan Keegan & Company

Hi guys. Just one on BidPay and then one on gross margins. On the BidPay, we asked you before and on the last call I think you told us about eBay conferences and things like that. But could you give us an idea about your plans to market that blend out to both sellers and consumers and just what the general approach is there going forward?

Bill McKiernan

Sure, our approach Robert, is really to focus on the seller community. We want sellers to put up the BidPay logo on every one of their options, and so that's how we target the marketing and we tend to focus on the power sellers and we're involved with PESA which is the Power eBay Sellers Alliance, and that group represents the leading eBay sellers and we attend their conferences and sponsor their events and things like that. So, the fact that we grow in that seller community on BidPay from 20,000 to 32,000 in the last quarter, we feel good about that. But having said that, we still have plenty more work to do clearly.

Robert Dodd - Morgan Keegan & Company

Okay. And then on the -- your guidance for gross margin implies 49% gross margin for next year, which would up from the level in Q4. Given if the acquiring in BidPay were to grow faster, I would have assumed gross margins would compress sequentially versus going up. Can you give me an -- I mean are you expecting the gateway business to be the faster growing next year or can you give us an idea, which way you are thinking on gross margin?

Bill McKiernan

I mean, we are definitely factoring in higher merchant acquiring revenue which would result in a lower margin. But offsetting it too is BidPay. The BidPay investment this year had a drain on gross profit, had a negative gross margin. Now it will continue in the beginning of 2007, but we expect that to eventually turn the corner and be driving some positive gross profit. And so that's what we see in terms of impacting the margins.

Robert Dodd - Morgan Keegan & Company

In the last -- I have a couple of follow-ups on that. Can you give us an idea, I think in Q2 and Q3 you gave us an idea what the BidPay negative impact on gross profit was. I think there was $100,000 in Q2 and $700,000 in Q3. Can you give us an idea what it was in Q4?

Steve Pellizzer

No. I don't know but I have that readily handy.

Robert Dodd - Morgan Keegan & Company

I will follow-up with you on that, I guess. I mean just one other would be what's the stock comp projection for 2007? I could probably calculate given all the other numbers you have given us but --

Steve Pellizzer

Yeah. The FAS 123R expense, it was about $1.3 million for Q1 and about $5.8 million for the full year.

Robert Dodd - Morgan Keegan & Company

Thanks.

Operator

Your next question is from Gary Prestopino.

Gary Prestopino - Barrington Research Associates

Hey, guys. How are you doing?

Steve Pellizzer

Hi, Gary.

Gary Prestopino - Barrington Research Associates

Most questions have been answered, but I just -- in your guidance that you gave for Q1 obviously, I think you are looking for a down quarter. And just wondering is a lot of this investment that you are talking about plus the losses in BidPay? Is that more front-end loaded in Q1 and Q2? And then maybe at the back half of the year, you are kind of thinking that BidPay -- the losses decreased dramatically and may be even begins to become a breakeven situation?

Steve Pellizzer

That's correct. The investment is very much front-end loaded in terms of the hiring that we need to do some of the build out that we talked about. And yeah, the trends for BidPay, the expectation is that at the end of 2007, we are getting close to breakeven and then turning profitable in 2008.

Gary Prestopino - Barrington Research Associates

Okay. And then the other thing is on the acquiring side. It looks like the amount of customers that you had on an acquiring basis was stagnant again with Q3. Was there some pruning there or did you have some people -- some customers leave?

Steve Pellizzer

Yeah. There was some churn in the merchant acquiring line. But we are still sort of looking into what happened there. We added about 150 and saw a churn of about 110, 120. We believe that may be due to one of our partners that [had set] some accounts there some issues that they are having on their end but it is something that we are investigating.

Bill McKiernan

Although, I will say Gary that not all accounts are created equal and the terminations that experienced were small volume accounts and you can see that reflected in the revenue and transaction volumes we saw from the acquired customers where the --

Gary Prestopino - Barrington Research Associates

Okay. And then last question, more strategic. With the strategy of penetrating the channels and alliances and all that, since you have been active now, what about nine months, since Scott joined 12 months? Do you find that the word is getting out among some of your larger target markets of what you are doing, and maybe you're getting some of these entities that are coming directly to you and saying we want to work with you, for your integrated solution?

Bill McKiernan

I think that's definitely true, Gary. What we're seeing among a lot of the financial institutions is an increased desire to work with CyberSource and also a recognition on their part that, the gateway is getting more complicated and their need for things like risk management and risk services is increasing, and so to the extent they can partner with someone like CyberSource and get all of that from one partnership and thereby enhance their own offering to their customers. That's becoming a pretty compelling value proposition for them.

Gary Prestopino - Barrington Research Associates

Thanks Bill.

Steve Pellizzer

If I could actually just interject to answer Robert Dodd's earlier question with regards to BidPay's gross profit. In the fourth quarter, it was a gross loss of about 700,000.

Operator

Your next question comes from Tom McCrohan

Tom McCrohan - Janney Montgomery Scott

Hi, good afternoon.

Bill McKiernan

Hey Tom. Welcome to the call.

Tom McCrohan - Janney Montgomery Scott

Thanks very much. I have one question that's real simple, because I am [ramping] up on your guys. What do you expect the percentage of revenues to -- by the end of '07 for global acquiring? I think it was 37% for the fourth quarter. What could we anticipate for that number to be by the end of '07 if you have a goal?

Steve Pellizzer

Yeah, I don't have a specific percentage that I can provide. We are certainly seeing that percentage grow ratably if you look at sort of the last eight quarters or so, since we introduced the acquiring back in the beginning of 2004. We've seen sort of a couple of percent increase every quarter. So, my expectation would be that we continue to see that increase, hopefully even accelerate a little bit, because as Bill mentioned, we see that as sort of a big opportunity for us going forward.

Tom McCrohan - Janney Montgomery Scott

Fantastic. Okay. Thanks very much.

Bill McKiernan

Thanks Tom.

Operator

Your next question is from the line of Glenn Greene.

Glenn Greene - ThinkEquity Partners

Thank you. Hi Bill, Steve.

Bill McKiernan

Hey Glenn, how are you?

Glenn Greene - ThinkEquity Partners

Good. How are you doing?

Bill McKiernan

Good.

Steve Pellizzer

Good.

Glenn Greene - ThinkEquity Partners

Couple of quick questions. Just one, the first on the acquiring market, if you can just discuss what pricing trends you are seeing as you are kind of bidding for new business and if there is sort of any change in your long-term thinking on gross margin profile for the acquiring business?

Bill McKiernan

I think, pricing in the acquiring space has always been very competitive, and so what we try to do is focus on the value-add that we can provide. Outside of just the pure acquiring fees. And so that may come down to our ability to acquire more payment types than other processors, doing it both domestically and internationally. So, acquiring, (inaudible) for international payment sides, but also providing connections to support electronic checks or PayPal or Bill Me Later. And then also on the risks side, clearly, highlighting some of our capabilities to help merchants manage the fraud risk, inherent in faking eCommerce transactions. So, we tried to move the discussion away from a pure pricing discussion to one where we can talk about how we add value to their entire business.

Glenn Greene - ThinkEquity Partners

Okay. So, you are still comfortable with 20% gross margins for the long-term there?

Bill McKiernan

Yes, we are.

Glenn Greene - ThinkEquity Partners

Okay. And then on BidPay, if I heard right it sounds like for the year you are thinking about 3.5 million to 4 million in revenue in the first quarter. I think was 400,000. So it's a pretty healthy ramp throughout the year, I was just wondering sort of what assumptions are behind that, how you are thinking about in terms of sellers or users or whatever metric, to sort of think about how -- how does that build throughout the year?

Bill McKiernan

Yeah, I think it's based on extrapolating what we've seen in the first six months of running the business. And clearly, there is steep ramp there. But again we are optimistic given the size of the market opportunity and the traction, frankly that we have got to date.

Glenn Greene - ThinkEquity Partners

Okay. Thanks guys.

Operator

Your next question is from Nick Farwell.

Nick Farwell

Good afternoon. Thank you very much. I just have a few follow-on questions if I may, with respect to the transaction, gross profit margin Steve, was declined, if my math is correct declined about 200 basis points. Can you give us some delineation between mix BidPay and whether average price per transaction on the gateway side, what impact that might have had?

Steve Pellizzer

So as I mentioned, BidPay, we had a gross loss, if you look at that gross profit line, it was a negative of about $700,000 in Q4.

Nick Farwell

Right, I didn't --

Steve Pellizzer

So that's obviously contributing to that. From a -- just a high level, we continue to see merchant acquiring grow as a percentage of total revenue and transaction revenue. So that is trying down the margin, but actually helping the average transaction price. We did see slight decline in the average transaction price in the fourth quarter, but we expect to see that rebound in the first quarter of '07.

Nick Farwell

Is that just a seasonality of volume at that quarter?

Steve Pellizzer

Yeah, I mean, we also saw healthy volumes as you know in terms of just transaction volumes in the fourth quarter. And so part of that could be some of our smaller merchants may have ran more volumes and may have a monthly minimum associated with them, in which case you get the same revenue, but there is a higher transaction volume. So there could be some of that that is playing into it as well. Certainly the growth that we are seeing too on the merchant acquiring side is in there.

Nick Farwell

And then if -- just simply interpolating, which I may not be doing (inaudible), did you think your gross profit margin loss for BidPay in the third quarter was also $700,000?

Steve Pellizzer

No, I just mentioned Q4; I don't actually have Q3 here with me.

Nick Farwell

You recall were it might have been, perhaps somewhat less or --?

Steve Pellizzer

I would imagine it was a similar number.

Nick Farwell

Okay. Because if in fact you look at the two percentage point differential again being very simplistic, that's roughly $400,000 and if you -- $700,000 is BidPay and if the delta between third and fourth quarter was a $200,000, that means actually your gross margins improved sequentially. Despite mix and despite your average price per transaction, perhaps declining modestly?

Steve Pellizzer

Yeah, and that could be the case, I mean we do tend to see in the fourth quarter, the margin seems to improve with the increase in volume that we see.

Nick Farwell

Yeah. And then also in professional services you had a rather significant increase in your gross profit margin, which is always encouraging. But to see that margin go from 48 to 52, on a little shy of $200,000 in incremental volume, but 130 of that falls to the bottom line that's huge incremental margin. Is that -- is there just year-end true-ups, is it better utilization or is there something going on in the income statement line that might account for that.

Steve Pellizzer

No, I mean it's nothing unusual from an accounting perspective. It really just depends upon the nature of the project. If you look historically, I think margins from professional services generally are in the high 40s to low 50s. We have certainly been in the low 50s before, so I don't think it's that unusual. But it was a strong performance by our professional services team.

Nick Farwell

Were there some incentive payments at year-end or you completed a specific project or several projects that helped that number?

Steve Pellizzer

No. I mean, we record on a percentage of a completion basis. So, it's really just dependent upon the type of the projects. I mean some projects, are priced better than others from a margin perspective and it really just depends upon that mix.

Nick Farwell

You ever do incentive projects where at the end of the project, if you come in below whatever the estimated projection might be, you get a piece of that action that shows up you may not pick it up in percentage of completion, but when the deal is completed it's picked up in the income statement.

Steve Pellizzer

Yeah. No -- I don't recall ever seeing a deal with that kind of structure.

Nick Farwell

Okay. And I wanted to ask a little more about traction at BidPay and that is -- I thought I heard you say you thought you might achieve breakevenish sometime during the second half of the year, so you are going into '08, hopefully, with a profitable business?

Steve Pellizzer

Yeah it's really achieving breakeven sort of at the end November, December of '07 and then going into to '08 on a profitable basis.

Nick Farwell

Okay. And to go back to the merchant acquiring business, you commented that the attrition was roughly 110 or 120 versus the incremental new customers of 150, because you said that your total customer account remained at 1,400 is -- did I understand that correctly?

Steve Pellizzer

That's correct.

Nick Farwell

Okay. Was there any attrition on your part or these were all traded either by your partner or your accounts walked away for some reason because of -- [admonished] in for service?

Steve Pellizzer

Yeah.

Nick Farwell

Some other factors.

Steve Pellizzer

We didn't terminate there are many if we did at all, so it's more attributed to the other side.

Nick Farwell

And then the lastly I want to ask there has been a tremendous amount of absorption of talent or sources certainly in engineering space or for engineering space here in Silicon Valley due to Google, I mean they are basically having anyone to remove. And to what degree does that suggest to you, you may want to consider or maybe perhaps already doing this, adding to your resource base outside the Silicon Valley either domestically or offshore and are you?

Steve Pellizzer

Yeah. That is something that we have begun to do both offshore and even we have built our presence in Salt Lake City where some of our BidPay personnel and we are looking at even moving some other disciplines within the organization there as well just because of the cost savings.

Nick Farwell

Is part of this tracking behind your headcount projections, a function of just not having made that resource allocation to either Salt Lake City or other communities? And you are just sort of taking that process through?

Steve Pellizzer

No, I would say that the reason we were behind in terms of Q4 is because we had still all of the [records] that we had open, it was necessarily based on rethinking a new strategy. We sort of have begun the evolution of looking outside of Mountain View in the last few quarters, so that's not a new focus necessarily.

Nick Farwell

Thanks very much. I appreciate it.

Steve Pellizzer

Thanks Nick.

Operator

Your next question is a follow-up from Franco Turrinelli

Franco Turrinelli - William Blair & Company.

Hi Steve, and Bill, I actually had a few follow-ups if I may. The first is, just help me on something on the non-GAAP adjustments, if you would. The reported income tax benefit was 10,987, but the reversal of the valuation allowance that you are showing us in the reconciliation was 10,948. The delta would imply that there is still a tax benefit on a non-GAAP basis of about 39,000. Am I doing that math correctly or am I missing something?

Steve Pellizzer

No, you are doing it correctly. In the fourth quarter, in addition to the reversal of the valuation allowance, there was also a true-up to the provision, where we ended up basically booking a benefit in a way of a provision as well, because we had overbooked the provision in the previous three quarters. So, there is just kind of a true-up that's going in the fourth quarter in addition of the reversal.

Franco Turrinelli - William Blair & Company

Right, good clarifies that thank you. On BidPay, you have given us some really helpful metrics here and again I want to add my appreciation of that. But help us understand a little bit, what is it that's going -- obviously what's going to get you to breakeven is usage of the product and therefore volume of payments using BidPay. But in your mind, what do you have to do to get to that volume? Is it really just adding more users or is it somehow driving usage amongst those that I have already registered?

Steve Pellizzer

Well, I think right now, it's more about getting more sellers to promote BidPay. Getting them signed up and getting them to put up the BidPay logo. At the current 32,000 registered sellers, we still got a very, very small percentage of the whole eBay seller community. Now, clearly we want the right 32,000 too because eBay like any business, they have a nuclear sub-sellers who do a disproportionate amount of their business. So, that's who we're targeting.

Franco Turrinelli - William Blair & Company

Okay. So, you think Bill, that for at least it's really adding sellers and getting and those sellers to promote the product.

Bill McKiernan

Right.

Franco Turrinelli - William Blair & Company

Okay. So, Bill don't do anything silly like offering enough free shipment or $10 sign up on this.

Bill McKiernan

No, no. We are not desperate.

Franco Turrinelli - William Blair & Company

Alright, well moving swiftly on. Steve is the acquiring business 20% margins right now.

Steve Pellizzer

You know it fluctuates by quarter, but yeah I mean for the most part it is. And it's dependent upon also the mix that we see between the domestic acquiring and the international acquiring. International tends to have slightly higher than 20%, the domestic tends to be slightly lower.

Franco Turrinelli - William Blair & Company

And what should we think about in terms of where this quarter was, did you already say whether or not there was a good domestic, international mix or a bad international, domestic mix?

Steve Pellizzer

I didn't say, and I think the blended is about 19% for Q4.

Franco Turrinelli - William Blair & Company

I am sorry, the blended gross margin is about 19%.

Steve Pellizzer

Correct.

Franco Turrinelli - William Blair & Company

Sorry, but can you make it as simple as good and bad, but we haven't mentioned that the bears they go into the Super Bowl yet and we have good recs and a bad rec. So, we think of things in very simple terms in Chicago right now.

One final thing for you, and I am going to mention this on the conference call not to in any way embarrass anyone but just today its on the record. There is a typo in your guidance in the press release, and in the second bullet which is for the full year 2007. Your press release currently says, the GAAP net income for 2007 is expected to be between $3.5 million and $4 million, or $0.9 to $0.11 per share and I think we all know that means $0.09 to $0.11 but that's not currently what the press release say. So, just for your own purposes you might want to correct rather at least have this under record, so to speak.

Steve Pellizzer

Thank you.

Franco Turrinelli - William Blair & Company

Alright, thank you.

Bill McKiernan

Thanks, Franco.

Operator

At this time there are no further questions. Gentlemen, are there any closing remarks?

Bill McKiernan

Yeah. Thank you, operator and thank you, everyone for joining us.

Operator

This concludes today's CyberSource quarter four earnings conference call. You may now disconnect.

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