Bottomline Technologies, Inc. (NASDAQ:EPAY)
Q3 2016 Earnings Conference Call
April 28, 2016 5:00 PM ET
Robert Eberle - President, Chief Executive Officer, Director
Richard Booth - Chief Financial Officer
Cris Kennedy - William Blair
Brett Huff - Stephens
Ladies and gentlemen, thank you standing by and welcome to the Bottomline Technologies' Third Quarter 2016 Earnings Conference Call.
Statements made on today's call will include forward-looking statements about Bottomline's future expectations, plans, and prospects. All such forward-looking statements are subject to risks and uncertainties. Please refer to the cautionary language in today's earnings release and Bottomline's most recent periodic report filed with the SEC for discussion of the risks and uncertainties that could cause the company's actual results to be contemplated these forward-looking statements. Bottomline does not assume any obligation to update any forward-looking statements.
During this call, Bottomline's financial results are presented on a non-GAAP basis. These non-GAAP results include, among others, constant currency growth rates, gross margins, operating income, EBITDA, net income, and earnings per share. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures is available in the Investor Resources section of Bottomline's website, which is www.bottomline.com. Bottomline will be providing forward-looking guidance on the call. A summary of the guidance provided during the call is available from the company upon request.
I would now like to turn the conference over to our host, Mr. Rob Eberle. Please go ahead.
Good afternoon. Thank you for your interest in Bottomline Technologies and welcome to the third quarter fiscal 2016 earnings call. I'm here with Rick Booth, our Chief Financial Officer. Rick will provide a detailed review of the quarter's financial and our guidance and then as always both of us will be available for questions.
We're delighted with the results for the third quarter and our progress against our strategic plan with an excellent sales quarter with strong ARR bookings. We executed strong financial results in the quarter and we are well positioned to drive future subscription and transaction revenue growth.
I'll start my remarks with a review of the financial highlights for the quarter. Subscription and transaction revenues grew 15% to $49.5 million; it is actually 17% growth on a constant currency basis. Revenues overall were $86.2 million, that's up 14% on a constant currency basis, if you exclude our transitioning digital banking business. EBITDA increased to $19.4 million up over $2.3 million from a year ago. Operating income was $16 million or 18.5% of revenue. Cash was a $149 million up $19 million from the prior quarter. And finally, we recorded EPS of $0.40 for the quarter, ahead of our target and expectations, so strong financial results across the board.
Our strategic plan is designed to focus on and drive subscription and transaction revenues growth. A clear highlight of the quarter was our continued strong sales results of our subscription offerings as we booked $16.7 million of ARR, that's up 39% from the same quarter a year ago. In fact we've had strong sales results throughout the year. ARR year-to-date was $50.7 million that's up 73%. Customer’s positive reactions to our offerings is clear. With over half the record ARR is coming from [indiscernible] and other new products, we can confidently see strong subscription transaction revenues growth for years to come. What we're doing is we're building a high growth subscription and transaction and we're doing that without the impact from the recent strong ARR sales that's because revenues begin for subscriptions when a customer is live and for transactions when a customer’s live in transactions occur.
This implementation can take from 90 days to as long as 18 months for some of our digital banking implementations and it can take several years for a customer's usage to ramp to full value. But once it begins, the revenue is predictable, highly profitable, and likely to continue for a decade or more. Our sales results today are giving as visibility to predictable and profitable growth for years to come. It's an attractive model and a very favorable position to be in.
Each of our key growth drivers contributed to our strong sales results in the third quarter with 24 new Paymode-X customer wins, 9 new legal spend management customer wins and 5 new digital banking customers wins. I'll provide some color on what's occurring in each of those key growth drivers.
Starting with Paymode-X, the first thing I'd say is the partnership with [indiscernible]. What I mean by that is they are engaged in working closely with us. Our focus is on providing an integrative platform to optimally automate and monetize business payment. We've began jointly presenting to customers. We're thrilled to be working with Visa and we're confident it will have a big impact on bottom line. We're also seeing real momentum from our bank channel partners particularly Bank of America. Bank of America was not only our most productive channel partner in the quarter they are also taking us into a broader range of verticals. This past quarters wins included a major property manager, double healthcare organizations, a university, double significant municipal agencies and a [indiscernible] franchise.
Paymode-X appealed to organizations of all types. Our ambition to be the way business is paying to get paid is more realizable with each new win. With 24 new payers signed in this quarter we're excited about our progress and even more excited about our future.
Turning to legal spend management. We added nine new legal spend management wins in the quarter. We continued to expand our platforms capabilities and our competitive advantage. This past quarter featured a release which added new [indiscernible] reporting analytic capabilities to our list of industry leading features. We have a leadership position and we are effectively extending that position. Customers are responding as evidenced by a strong nine wins highlighted in the quarter.
Finally turning to digital banking. At the start of this fiscal year we announced we were transitioning to digital banking products after subscription. We did that to coincide with the launch of our new digital banking 3.0 product set. That launch of the new model and product offering has gone quite well with a major platform sale in each of the past three quarters. A key new win in this past quarter was a purchase of our full product suite, payments in cash management, digital account opening and our cyber progress management web payment fraud.
The bank had determined they needed a flexible and digital, so we had a solution to achieve primary bank status with the target corporate customers and to attract and grow this small business relationships available in their footprint. One differentiator for Bottomline was the ability to segment the platform according to the ranging needs the markets banks serves and targets. With the flexibility and complicated user experience with the current system many other banks small and medium sized business customers were placed on their consumer platform. That means they are missing out on fee income and important growth potential. We won because we had the platform best equipped to grow business banking revenues and the most forward looking digital vision
We integrate a combination of payments and cash management, digital account opening and cyber fraud and risk management capabilities distinguishes Bottomline from any other offering in the market. The expansion of our products, we've won more deals, and we'll keep winning more deals all on a subscription model.
Going into the fiscal year, one of our underlying assumptions had been in a number of our large legacy customers with demand traditional software and services. The good news is the move to subscription has been faster, more complete, and far more successful than we would have expected. Everything we sell in our digital banking products at the banks of all sizes is now on the subscription model. There is an impact thought as all revenues is deferred until the customer goes line. But we recorded the expenses of services as they are provided even if we're paid separately for those services. So the more we sell the more class we have and in the short term the worse [ph] our P&L for that product set. With each new deal and with each million dollars of services cost expense now, we're putting in place a multimillion dollar revenues stream that should last for a decade or more.
We plan to get the investment community full visibility to this aspect of our model transition. Transitioning business models are not new, in fact they are pretty well understood. Going forward, we will share our results, guidance and future business model for our transitioning digital banking business separately from the rest of the business. It typically takes three or four years for a conversion to fully play out. We expect that to be the case here as well. The breakout would show the full growth in profit potential of the base business while providing transparency to the timing, profitability and success of the transitioning component and in lines with how we're looking at the business and measuring ourselves as well.
Rick will provide our guidance for the next five quarters in a few moments. What you'll see as the core business is tracking to our key metrics with subscription and transaction revenues growth of 19% and operating margin of 21% by the fourth quarter of FY2017. We expect revenue growth in the transitioning business to lag by a year as implementations are completed and operating margin to lag by three to four years ultimately though yielding similar high teen’s subscription and transaction growth and over 20% operating margins.
Stepping back the big story is we're building a high growth subscription and transaction business while producing significant operating margins. One component of the business is undergoing a model transition while the bulk shows strong growth in profit margin. The strong ARR sales in Q3 validates such strategy and positions us well to produce continued increases in shareholder value. Nothing drives shareholder value like strong subscription and transaction revenue growth. We've demonstrated that this quarter 15% reported and 17% constant currency and that's without the impact of most of our FY2016 sales. We have a market, customers, and products that overtime drive the current level of Subscription growth even higher to make an exciting and rewarding future.
And with that I'll turn it over to Rick Booth for a detailed review of the financials and as always both of us will be available for questions.
Thank you, Rob. I'll cover three topics today. First I'm very pleased to report on the strong Q3 financial and sales results. This quarter represents another significant step forward on our plan. Second I'll provide an update on the revenue model transition of our digital banking business and how that plays out in our financials. And then third I'll provide guidance for fiscal 2017 and the remainder of this year.
First in terms of Q3 results from a financial perspective, Q3 was shaped by really strong sales result and continued strong growth in our subs and trans revenue. This performance helped drive core operating income and earnings per share both above guidance. The highlights include that subs and trans revenue grew 17% on a constant currency basis which brought our total revenue to $86.2 million. We booked $16.7 million of ARR which was up 73% year-to-date, operating income was $16 million or 18.5% of revenue and EBITDA was $19.4 million, or 23% of revenue, and with earnings per share of $0.40 we're ahead of expectation.
I'll now provide a more detailed look into the third quarter financial results beginning with revenue. Subs and trans revenue was up 17% on a constant currency basis year-over-year to $49.5 million which is equivalent to $198 million on an annualized basis. This brought total revenue to $86.2 million. With that growth as a percentage of revenue, subs and trans is now 57% of total revenue, up 5 percentage points year-over-year and recurring revenue is 80% of overall revenue, up 3% percentage point year-over-year.
For services and maintenance, we recorded approximately 900,000 less than the same period a year earlier, but this is consistent with our desire to pursue and provide services only as necessary to implement our solutions and ensure our customers success. In terms of sales performance, Q3 again showed strong sales performance as we added 38 new customers across Paymode-X, legal spend management, and digital banking.
These deal counts are new logos and exclude add-on sales. I'd note that these deals are also getting larger and more valuable. In terms of annual recurring revenue, total bookings for the quarter including add-on sales were $16.7 million, up 39% year-over-year and this brought year-to-date total ARR bookings to $50.7 million, this is up 73% versus the same period a year before. This strengthened level of ARR bookings gives us confidence in our longer term growth. Of course, these ARR figures are estimate and in our model these customers take time to implement to go live and then to ramp into full revenue production. So once revenue is achieved, they provide visibility and consistency to the model as well as the power to drive margin expansion.
As we turn to profit and margins, we finished the quarter with operating income of $16 million or 18.5% of revenue as well as EBITDA of $19.4 million or 23% of revenue. Overall gross margin was $50.4 million or 58% of revenue and subs and trans gross margin was 56%, this was consistent with the year earlier as we invested to support the growth of our subs and trans revenue streams.
From an operating expense standpoint, sales and marketing expense for the quarter was $17.5 million or 20% of revenue and development expense was $10.5 million or 12% of revenue. In terms of cash flow, our operating cash flow was $25.4 million for the quarter and as a result, we ended the quarter with $148.8 million of cash on hand. Before getting to guidance, I'd like to discuss the digital banking revenue model transition from a financial perspective. The revenue model transition itself of course is nothing new, but as Robert discussed, it's happening more completely than even we had expected. The strength of customer response has impacted our fundamental assumptions in two key ways. First, we're selling more large platform deals that we had planned and customers are selecting more elements of our digital banking suite that we had anticipate.
As a result, these customers also take longer and cost more to implement although they're ultimately more valuable. Second, given the strong customer response, we're directing customers to the new platform rather than continuing to customize and modify their existing application. This aligns with our strategy that does not provide what would have been one-time services and software revenues which otherwise would have softened the financial impact of this transition. Financially when we sign a new subscription deal we defer all of the revenue until the customer is live on the solution. But we expense all of the cost of implementing the solution even though typically we've been paid for those services separately and all those costs are expensed well before we can recognize even a dollar of revenue. The combined impact of these factors means that revenue model transition has removed $19 million of revenue from fiscal 2016. This impact comes from two components, the first is the deferred revenue that we would otherwise have recorded that's approximately $2.5 million per quarter or $10 million for the year. This deferral impact was largely contemplated.
Second, and this is the key change to our underlying business plan is the extent to which we are prioritizing the implementations for a new digital banking 3.0 customers over performing legacy services. We had originally expected to perform $9 million of such services, a large portion of which we expected to occur and be recognized in the second half of the year. These are both very positive long-term development, because as a result everything we're doing is aligned to drive future subs and trans revenue. Nonetheless, the accounting implications on the timing of costs and revenue do impact the financials especially in the short term. Transitioning in business model typically takes three to four years to fully play out and we expect that to be the case here as well. To ensure complete visibility, we will break out and discuss the results for digital banking separately as we go through the transition.
As we move on to guidance, I'll note that we have provided a written summary of this guidance including full quarterly breakout which is posted on our Investor Relations website for your convenience and so I won't repeat the details of each quarter here.
For guidance, I'll first discuss our established business model, our base business which includes all revenue streams other than digital banking. As we look to Q4, we expect our base business to generate 15% subs and trans growth consistent with this past quarter bringing total revenue from the established business to $68 million at an 18.5% operating income level. For fiscal 2017, we see strong growth coming from the record ARR books in fiscal 2016. We expect to enter 2017 into subs and trans growth rate of 15% and to see the growth rate accelerate to 19% by the end of the year. This will bring total subs and trans revenue to $165 million and total revenue to $289 million.
From an operating income perspective, we expect to enter fiscal 2017 with operating income of 19% of revenue and to see that ramp to 21% by the end of the year. The transitioning revenue model of the digital banking business will see growth accelerate in the second half of fiscal 2017 as the new platform customers go live. Costs will be higher next quarter and throughout 2017 as we performed multiple implementations with all revenue deferred.
In Q4, we expect revenue of $18 million with roughly breakeven operating margin for this component of our business. In fiscal 2017 by the fourth quarter, we'll have subs and trans growth of at least 15%, but the implementation cost will keep it at breakeven for the fiscal year for this component. But subs and trans growth will continue to accelerate in the subsequent years reaching at least 18% subs and trans growth and 20% operating margins by fiscal 2020. During this revenue model transition to help investors assess our progress we will breakout and discuss digital banking's revenue and operating margin separately in earnings releases and also on these calls, that's the way we're looking at it internally and we believe that's the right way for investors to look at it as well.
On a combined basis, we expect Q4 revenues of $86 million at a 15% operating margin and $0.30 earnings per share. And in fiscal 2017, we expect to deliver consolidated revenue of $363 million with an existing subs and trans growth rate related to 18% and an existing operating margin of 17% of revenue. And I just provided a lot of guidance numbers, but for me the key point is that our guidance demonstrates our confidence in the accelerating growth of our base subs and trans business as well as our confidence that the digital banking business will achieve equally strong levels of subs and trans growth and operating profitability and that will provide measurable progress on a quarterly and annual basis.
So in conclusion we're pleased by Q3's strong financial results including 17% subs and trans growth on a constant currency basis and then 18.5% operating margin. We're pleased with our sales results including the 73% year-to-date increase in ARR. We're confident in the continued growth of our subs and trans revenue and operating profit in our established base business. I'm confident in the banking revenue model transition and then when its complete, we'll see economic strong at our base business.
And with that, we can open the call for questions.
[Operator Instructions] . And we do have a question from the line of Cris Kennedy with William Blair. Please go ahead.
Hey, guys, thanks for taking the question. A lot of guidance there, but just to be clear so $363 million of revenues in fiscal 2017, you said an operating margin of 17%?
Okay. And your prior guidance called for an operating margin of I think 20% to 21%?
That's correct. The way to think about it is the core business is actually going to be delivering between 19% and 21% and exiting Q4 at a 19% growth rate, but what we've realized is that the transition in banking is happening more completely than we had expected and so the investments that we need to make on the banking side are overwhelming that. And that's why we're now providing the breakout so that you can see the two pieces and understand that it's simply a revenue model transition, there's no issue with core business.
Okay, got it. Thanks for the additional color and then I guess just one other question can you just talk about the I guess, the way, the revenue is ramping from some of the signed deals. I think if you go back to December of 2014, you talked about 35 million of ARR, over the last 12 months. Are we seeing that in the income statement yet. Is there any way to frame that?
Yeah, it depends on what product set that would be. We certainly with CAR, each has a different timeframe that they would come in. So in legal spent management or Paymode X transaction based revenue models we're estimating what that is typically with working with the customer and off of their data, off their payment data for example, but that involves an estimate and in both of those product sets, that will take three years to ramp. On digital banking platform, what occurs and what's occurring today and why we will see more impact and more cost is we don't take any revenue until the implementation is completed in the platform's life. That's true by the way, even if it's services revenue.
So even if we are being paid for services and performing those services we will not be recording any revenue. Many others do if they have third parties that are recording, that are providing those services. You might be taking that revenue upfront, but in our case we're not. So in that instance we would see the ARR, but it would be delayed until the point in time that we would start the implementation and what we would see coming through is well would be the services is pro-rated over the estimated life of that engagement. So in short some of our ARR is estimated, it's takes a while to ramp on those products that are transaction based and on the products that are subscription based, it would start with the implementation.
Okay, thanks a lot.
[Operator Instructions] We do have a question from the line of Brett Huff with Stephens. Please go ahead.
Good afternoon, guys.
So I guess while you're separating these things out, but I want to take the core business or base business because it seems like the guidance you're giving for that even separating our digital banking is below sort of your subs, that your original subs and trans guidance for fiscal 2017. So if I recall subs and trans was 18% to 19% and it looks like now the average is going to be 17% on the core business, is that, am I getting that right?
Yeah, we're exiting in 18 and 19, Q3 and Q4 that average it was starting at today's rate of 15, so it will average to 17, yeah.
So, what happened, why did the - did the other core businesses, are they - they're not performing, not growing as quickly as you had expected?
I think they're performing. I think what we're seeing there is the time of the implementation and the time to ramp is just a little longer than we had thought. Because certainly we're going to see that 19% level, we will just see it by the fourth quarter.
Okay. I think the question will be what makes us feel confident that we now have a handle on the timing of the implementation versus the guidance we gave whatever six months ago. I mean what confident should we have that the new expectation is right given that it's moving pretty dramatically from the last sort of guidance you gave us?
Well if you take the core business that the growth rate that we're forecasting or the guidance we're giving today is consistent with current growth. So we posted 15% subs and trans growth in the quarter and 17% on a constant currency basis. We're continuing that for the next two quarters and then it's ramping modestly from there. So I think it's pretty easy to have confidence in that when you take a look at the performance we recorded this quarter.
Okay. And then…
The other way to think about it, Brett is that it's really a small shift in timing in terms of when that growth is occurring. So there still is very, very strong growth ramps going from 15% to 19%. It's just not occurring as much in the first half of the year as we had hoped and that's what then weights down when you do the average across the four quarters.
Okay. And then okay I think that makes sense, okay, that's what I needed.
[Operator Instructions] It does appear at this time, there are no further questions from the phone lines. Please continue.
Well thank you. Thank you for your interest and attention on our call here today. We're actually excited with where we sit today the market demand for our solutions is strong as evidenced by the ARR, the growth in subs and trans, we believe and are confident is the fastest and highest way to drive shareholder value, and with the guidance we've given here in the breakout, investors are going to be able to track our progress as we go through Q4 and FY 2017 and continue to grow subscription and transaction revenues.
So, thank you again for your interest in Bottomline Technologies and look forward to reporting on the fourth quarter in August.
And ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using the AT&T Executive Teleconference service. You may now disconnect.
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