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Bottomline Technologies (NASDAQ:EPAY)

F4Q08 Earnings Call

August 7, 2008 5:00 pm ET

Executives

Rob Eberle - President and Chief Executive Officer

Kevin Donovan - Chief Financial Officer

Analysts

Colin Gillis - Canaccord Adams

Jonathan Maietta - Needham & Company

Brett Huff - Stephens Inc.

Tim Willi - Avondale Partners, LLC

Operator

Welcome to the Bottomline Technologies fourth quarter 2008 earnings conference call. (Operator Instructions)

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

During the remarks, Bottomline will refer to certain non-GAAP results. These non-GAAP metrics include amortization of intangible assets, stock compensations, and acquisition-related expenses. Throughout this call when they refer to non-GAAP, it has that meaning.

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

Rob Eberle

I am delighted to have the opportunity to report on what was a very good quarter for Bottomline. I am joined by Kevin Donovan, Chief Financial Officer, who will provide a detailed review of the fourth quarter financial results and our guidance going forward. We will be available for questions following Kevin's remarks.

The fourth quarter was a strong quarter for Bottomline and a solid conclusion to a very good year. From a financial perspective, we met or exceeded all our financial targets as I will outline in a moment. Not only with the financials for the quarter strong, but I am particularly pleased to report that we continue to focus and have success in closing significant subscription and transaction base deals which represent an important driver for our future growth and profitability. I will highlight two such deals later on my remarks.

Our wins were not limited to these deals, however, as we saw strong demand in all categories, as evidenced by record orders for the quarter. As a result, we entered the first quarter of '09 with great visibility based on record backlog, a strong pipeline and increasing recurring revenue.

Turning to the fourth quarter results, revenue for the fourth quarter was $36 million, an increase of 11% from the prior year. Subscription and transaction revenue, an area of key focus for us, was $8.3 million, an increase of 22% from the prior year. Overall, 64% of revenue was recurring. EBITDA was $3.7 million, up 24% year-over-year, and operating income was $2.7 million, up 32% year-over-year. Both of that were ahead of our forecast, and that drove EPS of $0.11, at the high end of our range. Orders were $45 million, up 27% year-over-year and we ended the current quarter with a record backlog of over $77 million and a strong pipeline. We repurchased $2.3 million of stock, and ended the quarter with over $35 million in cash.

These results in the quarter completed the strong financial year, during which revenues were $131 million, an increase of 11%. EBITDA increased 72% from the prior year to $16.1 million. Operating income more than doubled to just over $12 million. EPS was up 47% to $0.63 for the year, and we generated $16 million in cash and repurchased $11 million in stock. Whether you look at the financial results for the quarter or the year, consistent performance is clear. But what is most exciting to me this quarter are some of the deals that we signed that did not yet produce revenues but will do so in the future.

As I mentioned upfront, we continue to make great progress in building recurring revenue streams. These revenue streams not only will drive future predictable growth and profit, but they will also drive multiple expansions and, accordingly, a higher overall value for shareholders. The two examples I would like to highlight for the fourth quarter are Century Insurance and a major global financial institution.

I will start with Century. We have been in discussions with Century Insurance for just over a year and are delighted to announce that this past quarter we signed a three-year deal for Century to utilize our Legal eXchange, that is our software as a service, or SaaS offering for legal spend management. With over $10 billion in assets, Century is one of the largest mutual insurance companies in the United States, offering a full line of insurance coverages for businesses, families and individuals.

Century was looking for an automated solution to manage external counsel legal bills, obtain better quality of bill screening and review and increase control and management reporting and improve efficiencies and timesaving on the part of claims handlers.

Century will drive tremendous value from Legal eXchange. The system will automate the receipt and processing of all legal invoices from Century's 700 outside law firms across Century's multiple lines of business, yielding significant administrative expense savings. Second, the Legal eXchange incorporates an advanced rules engine that determines if the invoice is the correct amount to pay, ensuring strict adherence to Century's billing guidelines. This technology can save up to 10% of legal spend. And with the [LeX] reporting package, Century can now track statistical elements at a global level and easily drill down into the detailed data from a single application.

We are excited about adding Century as a customer and see their selection of Bottomline as a clear indication of the value of our service. We continue to win market share and today have over 5,500 law firms on our network. From a Bottomline and shareholder perspective, each time we add a customer to Legal eXchange, we add revenue to a relatively fixed-cost basis platform. Over time, it has become a highly profitable model with strong customer retention. From a profitability perspective, Bottomline achieves operating margins of over 25% on its Legal eXchange as operating margins after sales, development, G&A and overhead. That did not happen right away. Rather, it happened over the course of several years. Initially the platform produced a loss, but over time, the margins moved from the loss position to single digits and then ultimately to today's levels. As we bring on other recurring revenue streams from other product sets and offerings, we expect to produce similar market expansion and profitability and customers and revenue scale increases.

I would like to turn now to the new significant strategic relationship we entered during the quarter. Last quarter, we referenced a situation where we were doing work for a large global financial institution and hope to reach final contractual agreement. I am delighted to announce that this past quarter, we did in fact sign a three-year agreement to be the principle technology provider behind a major global payment initiative. While time will tell, this may, from both the strategic and financial standpoint, be the most significant relationship Bottomline has ever entered.

There are many reasons Bottomline was chosen over a competitive field that included some of the world's most prominent, well known technology providers. A few of those include Bottomline's leading position as a trusted provider to the world's largest financial institution, our deep domain knowledge in the space, our strong technical and functional capabilities. In fact, our product set was directly aligned with the market requirement for this offering, and that was proven by actual responses from prospective end user client focus groups. And finally, our cultural fit and the reference checks from other customers of what it is like to work with Bottomline.

The service we will be providing is based on a leading messaging standard for payments but introduces a new, streamlined and less expensive way for enterprises of all sizes to manage payment-related information. The service will be launched and promoted by a major financial institution, an organization clearly established as a global leader in payment information standards.

There is not a lot more that we can comment on at this time on this relationship, and I cannot unfortunately name the organization, but I will make a few remarks on the financial terms. Bottomline will receive a seven-figure annual subscription as well as a fixed percentage of the revenues once certain annual revenue targets are met. As Kevin will outline, as a subscription service, revenue will not be recorded until we go live and acceptance occurs, which we would expect to be by the end of this fiscal year. It is my expectation and hope that on our next call we will be able to talk more freely about this arrangement, but for now, investors can at a minimum know that Bottomline is signing more and more meaningful subscription and transaction deals and continuing to expand on a global basis.

Finally, I am pleased to provide an update on our integration of Optio. As we had indicated on a prior call, we had done a lot of work before the deal closed to prepare for a complete integration of the company. That work has paid off, as the integration is going well and, in fact, is slightly ahead of schedule with everything on track to be completed before the end of our fiscal year. We are delighted with the technology, customer set and talented group of people that have become part of Bottomline. In fact, each rationale for the deal; customers, technology, operating synergies, stronger presence in the healthcare space and the like has so far proven true. There is no question in my mind that the transaction will be strategically beneficial and financially accretive. We are already beginning to see that.

So, in summary, we had a strong quarter from every perspective. We recorded $36 million in revenue and had a 22% growth in subscription and transaction revenue. We saw strong orders during the quarter drive record backlog and clear visibility for Q1. The integration of Optio is going well and is slightly ahead of plan. And finally, we continue to sign attractive deals, including a major new relationship, which will drive future growth, profit and shareholder value. With this success, we enter the new fiscal year confident in our continued ability to execute against our strategic plan.

And with that, I will turn the call over to Kevin Donovan for more detailed review of the financials and our guidance going forward.

Kevin Donovan

We had a very good fourth quarter, highlighted by strong financial results and several large recurring revenue orders, which are naturally not reflected in the fourth quarter results. Financial highlights for the quarter include revenues of $36 million, of which 64% was recurring; orders of $45 million, a 27% increase over last year; subscription and transaction revenue increasing by 22% on a year-over-year basis to $8.3 million; EBITDA of $3.7 million, representing a 24% increase from last year; backlog of $77.8 million, an increase of $21 million from last quarter; and non-GAAP earnings per share of $0.11, the high end of our guidance range.

In addition to what is reflected in the financial statements, we also signed a multiyear subscription order with a major global financial institution, which includes additional revenue share upside. Since this order is subscription based, we did not record any revenue during the fourth quarter on this deal. We expect to begin to recognize the seven-figure annual subscription amount towards the end of fiscal 2009.

I will now provide a more detailed review of the results.

Recurring revenues were $22.9 million in the quarter, a 17% increase over last year. Recurring revenue represented 64% of overall revenue and is derived primarily from software maintenance and subscription and transaction revenues.

Subscription and transaction revenues increased $8.3 million in the quarter and represented 23% of overall revenue. The increase in subscription and transaction revenue was primarily driven by our Legal eXchange offering. Recurring revenue for Legal eXchange was $3.8 million in the quarter, an increase of 33% from last year.

In addition to the strong Legal eXchange revenue growth in the quarter, we also signed a top-15 mutual insurance company during the quarter, which will drive future revenue growth and profitability. Service and maintenance revenues increased by $2.3 million from last year to $20.3 million in the quarter, reflecting increased maintenance and service revenue contribution from Optio.

During the quarter, overall gross margins were 55%, in line with last quarter and last year. Software license and service and maintenance margins were fairly consistent with historical levels. An area of focus for us is our subscription and transaction-based offerings, which create some of the leverage in our financial model. Subscription and transaction margins increased from 46% a year ago to 51% this past quarter. In fact, we generated $1.1 million of overall subscription and transaction revenue growth in the quarter, which produced gross margins of over $800,000 or almost 80% incremental margin. Going forward, we expect to continue expand our subscription and transaction margins.

Turning to operating expenses, non-GAAP operating expenses were $17 million. The increase in operating expenses is primarily the result of the Optio acquisition. As we go forward, we will continue to invest in the sales and marketing and product development areas of the business and expect our general and administrative expenses to decrease as a percentage of revenue over time.

Operating income was $2.7 million in the quarter, an increase of 32% from a year ago. On a non-GAAP basis, net income was $2.6 million, or $0.11 per share, and EBITDA for the quarter was $3.7 million, a 24% increase from last year. Looking at the balance sheet, the company ended the quarter with $35.4 million in cash and short-term investments. The cash balance reflects the cash used the quarter for the Optio acquisition and share repurchases. During the quarter, we used approximately $2.3 million of cash to repurchase 219,000 shares of stock.

Our total backlog at the end of June was $77.8 million, a $21 million increase from last quarter. The increase in backlog was driven by strong order flow of $45 million in the quarter and the addition of backlog from the Optio acquisition. The fourth quarter earned orders were 125% of revenue, which helped drive the strength of the backlog amount.

I will now take a moment and turn to our future financial outlook. We are confirming our first quarter and fiscal 2009 guidance. In the September quarter, the quarter with typical seasonality, we are expecting revenue of between $35.5 and $36 million and earnings per share of $0.10 to $0.11. For the full year, we are expecting revenue of between $150 and $155 million and earnings per share of $0.64 to $0.67. With orders of $45 million in the quarter and a record backlog, we have an increased level of confidence in our future outlook. With similar success in the coming quarters, we look forward to revisiting our guidance and potentially increasing it in future quarters.

In summary, we had a very good quarter, with a 22% increase in subscription and transaction revenue, a 27% increase in orders, a 32% increase in operating income and the signing of a major global financial institution to a multiyear subscription deal. As we look forward, the backlog of almost $78 million provides us with strong visibility towards to the first quarter and full-year revenue outlook.

We will now open up the call for any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Colin Gillis - Canaccord.

Colin Gillis - Canaccord Adams

Can you just talk a little bit about if you are seeing any changes on a geographical basis in terms of the appetite for your products by customers on a geographical region?

Rob Eberle

Yes, that is a great question, and we are, particularly in global banks. And whether that is an appetite that is driven by the environment globally or more emphasis Bottomline has placed on marketing to global banks, I could not tell you, but we are clearly seeing greater and greater demand from global institutions, which not only drives growth, but it also insulates us quite a bit from any disruptions or concerns that might be out there around domestic financial institutions.

Colin Gillis - Canaccord Adams

And then along those lines, are you seeing the size of the typical deals continue to get larger and larger as you are targeting these global banks?

Rob Eberle

Yes, there I would say, first off, yes, the deals are getting are larger, but I think the principle driver behind that is not a market fact. I think it is what Bottomline's now built into the product and the breadth of capability that we deliver with banks. So, where we would have had a module or two and some services in the past, we now can offer a full cash management suite with different payment types reporting global information and balance and transaction and the like, and that is certainly driving a larger average deal for us.

Colin Gillis - Canaccord Adams

Could you give us some color as to how the cross-sell of Business eXchange is into the current basic customers?

Rob Eberle

Yes, what we are doing today, we are not focused today on a cross-sell. What we are focused on is the pilots, and we have gone live with our first customer, which is a Fortune 50, and they are currently up and running, and we are bringing a second customer up live during the course of this quarter. And so, we will drive marketing on Business eXchange. We will begin more aggressively towards the end of the calendar year.

Colin Gillis - Canaccord Adams

Because most of that product cycle decisions are going to be a calendar '09 event at this point, right?

Rob Eberle

Yes, you will not see as we have commented before, the Business eXchange absolutely, I believe, will be a long-term growth driver of subscription and transaction revenues, and the market size and potential for that is significant. But our near-term growth we will see driven more by global banks, more by payment and document offerings. And as we bring on some of the customers we talked about today, the revenues that come from those deals.

Operator

Your next question comes from Jon Maietta - Needham & Company.

Jon Maietta - Needham & Company

Rob, I just wanted to be clear with this Century deal. That is, they are going to deploy it across the enterprise?

Rob Eberle

Well, always on these deals there is a rollout, but this is across multiple divisions for Century. They have got about 650 claims adjusters, and they will all be brought onto the system, so we rarely have ever single enterprise of a major or every single line of business of a major insurer, but we will have the vast majority of Century's business, and nobody else, by the way, so the extent they are not utilizing us, they would be with traditional paper methodology.

Jon Maietta - Needham & Company

And then with this global financial institution, are we just kind of potentially scratching the service here? Is there an opportunity to sell them other solutions over time?

Rob Eberle

Oh, absolutely, yes.

Jon Maietta - Needham & Company

And then just the final question I had was you just referred to the document on automation solutions. I think last quarter you had a couple deals pushed out as you brought Optio on board. Have you seen folks make decisions around that solution now?

Rob Eberle

Yes, we have seen decisions. One of the things we did with the Optio when we brought in Optio, which is in that product set, it had been a traditional software license model. So, we have moved that to the majority of the deals, and certainly the larger deals, we price those over a four-quarter basis. So, we saw a great order flow, but what we like about it is it will drive predictability in the business even though it is in a software license model. So, yes, that team is working well, and that integration's gone real well.

Operator

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

Brett Huff - Stephens, Inc.

Can you give us just a general update on Optio, just vis-a-vis the discussion last quarter on making some choices to retire some of the products and revenue and things like that?

Rob Eberle

Well, we made, yes, those decisions were actually made at the time of the acquisition. So, there was some product sets that Optio marketed that were really a tool set, which would then provide with extensive services an extensively customized platform. A number of reasons that does not work at any scale. First off, you probably are not making money when you take a look at what is the level of services underneath that customization. But worse, when you complete that, you now have a discreet code base with a single customer, so the support costs are very, very difficult on that as well. So, Optio had a focus on that. It is not usual. It is interesting from a technology standpoint. It solves a wide range of customers' problems. But what we do here is we want to drive to a single product solution rather than a customization with multiple code bases. So, that is the big area that we did not market right from the day of the acquisition, and that of course had some fall off in revenues. But for the long term, it is just not a profitable way to conduct the enterprise software business.

Brett Huff - Stephens, Inc.

And more specifically, I think on the last call you had talked about $15 million to $18 million in revs. Is that still what you are..?

Rob Eberle

Yes, nothing. In fact, we are right on target with the rev levels and the like.

Brett Huff - Stephens, Inc.

And then on the new relationship, the new strategic relationship, can you talk about how that may or may not impact your expenses? Do you have to invest alongside that before revenue, etc, etc?

Rob Eberle

Yes, we absolutely have to invest in that before revenue. The investment is one of opportunity cost. So, I will explain that. We end up taking the services cost that we provide are capitalized and will end up then coming back out at the same time as the revenue. So, we do not incur cost, per se, but what we do lose is rather than each piece of revenue that we would have for implementation services that has a margin on it, we lose that margin from a profitability standpoint. So, we lose the revenue in the quarter, and we lose the margin in the quarter, and that is the investment piece. We do not have additional costs coming through, but we certainly would have reported significantly higher revenues in the seven-figure-plus level, and certainly that drives a higher EPS, would have driven. Does that answer the question?

Brett Huff - Stephens, Inc.

Yes. So, I guess just from a P&L point of view, it sounds like this will not be an impact until you really start recognizing revenues sometime later in fiscal '09.

Rob Eberle

It will have a positive impact in fiscal '09 toward the end of the year, and it will have a positive impact going forward from there being a subscription with a revenue shared deal. The negative impact today is services that we are providing that we would normally see revenue and margin on record both on the top line and then drive margin through to the bottom line. We are not able to take those revenues.

Brett Huff - Stephens, Inc.

And then given that it sounds like new business is going really well, and you reiterated guidance for '09, is that just give us a sense of the dynamics behind that because it sounds like revenue opportunities or at least revenue that is likely to roll in probably has gone up, at least from the time you all had a call.

Rob Eberle

That is possible, but what we want to do and what we have always done is take a couple of quarter outlook. We had a great quarter from an order standpoint, but we are headed in, as Kevin said, a quarter that is typically got a little more seasonality. So, we think it is more prudent, as Kevin said in his remarks, to revisit guidance on our September call and to take a look where stand there. We certainly feel confident in the levels we have today, but we do not want to bounce around and raise…we see other companies sometimes raising and then decreasing, and that is not where we want to be. So, we will look at, what is at this point just a couple of months from now and take a look at it then.

Operator

Your last question comes from Tim Willi - Avondale Partners.

Tim Willi - Avondale Partners, LLC

In the pipeline of new business that you signed, or your new orders, have you said on the call yet how much of that would come out of the Optio product set? I got distracted. I know there was a question about Optio previously, but I am just curious to what degree you have seen traction. You mentioned healthcare in the press release, just sort of curious about its contribution in the orders.

Kevin Donovan

We have certainly seen contribution in terms of new orders from Optio. I would say, to echo Rob's comments from earlier, it is as we expected when we did the transaction. So, I would say that it is right in line with where we were targeting it to be.

Rob Eberle

And the only thing I would add, it is a little hard to say it is from Optio. I mean, actually, we really integrated the company fully into our management structure and our management team. So, I know it is an acquisition, but it almost was like a hiring event from that perspective. So, we see it a stronger and bigger team, bigger sales team, bigger market presence. But to point to that or quantify what is Optio and what is not is not something that we either track or have spent a lot of time on.

Tim Willi - Avondale Partners, LLC

Your comments about Optio and going as well as planned, I would assume that that includes renewals of maintenance contracts, et cetera. I did not recall hearing any commentary around that as it pertained to the maintenance renewals and seeing that ramp back up as we went through the year.

Rob Eberle

Yes, no, that is exactly right, Tim. We are seeing maintenance renewals on all of the maintenance contracts that we had acquired through the acquisition. Well, it does not sound like either there is a glitch or there may not be any other questions.

I think we will unless there is another question, we will wrap up here. Thank you all for your time. We had a strong quarter and we are excited about the situation as we enter Q1 with our backlog and the recurring revenue deals we have signed. So look forward to reporting on a strong Q1 in the end of October. Thank you.

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