Bottomline Technologies, Inc.
Q2 2015 Earnings Call Transcript

Published: 30 Jan 2015

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Bottomline Technologies Second Quarter 2015 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 reports filed with the SEC for a discussion of the risks and uncertainties that could cause the company's actual results to be materially different from those contemplated in the 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, 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, 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.

[Rob Eberle:]

Good afternoon. Thank you for your interest in Bottomline Technologies, and welcome to the second quarter fiscal '15 earnings call. I am delighted to report on what was a great quarter for Bottomline Technologies. I am joined by Kevin Donovan, our Chief Financial Officer, who will provide a detailed review of the quarter's financial results, our guidance going forward, and then both of us will be available for questions following Kevin's remarks. Results for the second were outstanding. Financial performance underscores our ability to execute and confirms our strategic plan. The outlook for our business has never been better. We are committed to building a large subscription and transaction business with expanding profit margins. We are committed to driving shareholder return and we are confident our plan will do so. My commentary in this call will be more detailed in the past and in an effort to give investor a better understanding of several key aspects of our business. Some aspects of our strategy and opportunity were not conveyed as well as they may have on our last call. As a result, there is a significant difference between our true market opportunity business model strength and current and future financial results and investor perception of those same factors. I take responsibility for that and with today's call hope to answer the key questions and clear up the misconception of about Bottomline's business results, trajectory and future. In addition to the Q2 results, I will cover strategic market investments, particularly the total available market opportunity and benefits to be derived, the milestones by which we will measure those investments and our view of the forward revenue opportunity. I will cover our recent Intellinx acquisition, how the technology fits our markets, the purchase price; our transition of the revenue model, our expected future revenue growth and the key milestones. Finally, I will cover profit margin growth, particularly the duration of our investments and the timeframe within which we will see expanding operating margins. Turning first to the financial results for the second quarter, the key results for the quarter were as I indicated at the opening, outstanding. Subscription and transaction revenues grew 23% and are now $170 million on an annualized basis. Our focus is on growing a valuable subscription and transaction business. Revenues overall grew to $82 million. Profitability metrics were each up over 30% from the prior year. EBITDA was up 31% to $18.6 million that represents 23% of revenue. Operating income was up 33% to just over $16 million, representing 20% of revenue. Finally, we recorded EPS of $0.41 for the quarter, ahead of our target and expectations, so strong financial results across the board, particularly on gross margin expansion and profitability. On an annualized basis, we now have $170 million subscription and transaction business, bulk of which is driven by our key cloud platforms, legal spend management, digital banking and PayMode-X. Over the past three years, we have grown this revenue stream at a CAGR of over 30%, which has had a transformative impact on our revenue mix. Continued growth of these cloud-based platforms and the favorable mix will drive incremental gross and operating margins. Our plan is designed to focus on these valuable and leverageable revenue streams. In addition to the financial results, the second quarter also featured strong sales and customer execution. We signed a record 16 new PayMode-X deals under the vendor pay model. We now have 87 payer organizations that have signed under our vendor pay model, with about half of them live, we are just beginning to see vendor pay revenue contribution currently at an annualized rate of just over $4 million and growing well over 100% annually, but that is not the important metric, at least not today and at least not in my view. What is important is the model works. Vendors pay a percentage-based fee for the technology platform, much like a Visa or MasterCard interchange. In return, they receive automation, better information and faster payments. The record 16 deals in the quarter was more than double a year ago. Clearly, we are gaining sales momentum as the vendor pay model becomes accepted and businesses seek to maximize the automation and the value of the payables. We have a network of 295,000 vendors today and almost 40 billion was processed in the second quarter alone. This is a very valuable Bottomline Technologies' asset. We will continue to grow it going forward, but will do so under the vendor pay model, driving dramatically better monetization. We also had strong sales results and legal spend management with eight new deals and digital banking with 11 new deals. We have a strong market presence and an active pipeline in both of these markets. These are areas we have targeted for additional investment and I would like to give investors more color on the details and expected payoff for these investments. On our last call, I outlined three areas for additional investment, PARTNERSELECT, digital banking and cyber fraud. The first PARTNERSELECT is a new offering to extend and complement our legal spend management business. This is a new product and new business model, but it is a sure bet if ever the worst one. What PARTNERSELECT does is it helps automate the very important process of law firm selection, management and evaluation. Platform sits between the buyers, which are our insurance carrier customers and the many law firms vying for their business. Insurance companies pay a small fee, but the bulk of the revenue is from lawyers paying a fee to post the professional profile. For each new case, they are awarded. For the first time, we will be monetizing the 12,000 law firms and tens of thousands of lawyers, who interact with our legal spend management platform. PARTNERSELECT provides a significant competitive differentiator as well as a new revenue stream. The reception to our data platform has been very positive and success in the form of new revenue streams is virtually certain to follow. We have an install base of approximately 250 insurance companies who will benefit from, pay for and most importantly drive lawyer enrollment on the platform. We estimate the total market to be approximately $125 million with the third of the available market represented by our current customer base, so we protect our competitive lead. At the same time, have the opportunity on an additional 40-plus million of cloud-based highly leverageable revenue. The investments we are making are primarily focused on platform, hosting and marketing. In terms of key milestones, the key milestones are signing data customers, Go Live [ph] and enrolling law firms. During the quarter, we signed our second data customer, which is again a key milestone. Going forward, we intend to have a product platform officially GA [ph] by June and our first law firms live by September. In summary, PARTNERSELECT is a low to no-risk opportunity to extend our competitive advantage and tap into an additional 40-plus million of highly leverageable revenue. Turning to digital banking, our investment in digital banking is equally exciting, but somewhat different. Here, we are seeking not to establish a new market, but rather grow and secure our share of a very large market. We are doing some very innovative things with our platform, leveraging our core payment and cash management functionality. We will provide broader capabilities to help the banks' business customers managed their cash flow and business. Second, provide customer engagement capabilities to allow banks to better understand and engage with their customers. In really simple terms, we will be the vendor that helps banks grow revenues, not just make payments. This strategy is unique and well ahead of the competition. We believe we are well positioned to take a much bigger slice of what we estimate to be $1.5 billion total available market opportunity and that is looking at banks between $1 billion and $500 billion in assets. Key milestones are completing the first version of the platform and signing customers. We expect to GA the first version of the platform before the end of June and hope to sign on customers even as soon as the September quarter. We are confident we are significantly strengthening our competitive position and expect that will result in increased market share and revenues. As we get more customer feedback and begin signing deals, we will be in a position to provide more guidance on the revenue upside. The last year, we targeted for investment was cyber fraud. There is no topic more top of mind today than cyber crime, cyber security and cyber fraud. This is the biggest concern for our customers, whether that is banks, large corporate, government agencies, healthcare organizations, you name it. This is the top of mind issue. We have been actively providing fraud detection and prevention capabilities for years, but generally not as discrete products. Cyber fraud risk management is as logical line-of-sight market opportunity for Bottomline. Our customers, particularly our mid-market bank customers have to invest in more preventative technologies and they will do so with us. Earlier this month, we accelerated our plans with the acquisition of Intellinx, an Israeli-based leading provider of cyber fraud and risk management solutions. Intellinx platform has a unique ability to non-invasively monitor, replay and analyze user behavior across multiple channels and instantly flag and stop suspicious activity. The solution creates accountability by recording and analyzing each key stroke and screen view, which reduces risk of theft, information leakage, internal and payment fraud and the cost of regulatory compliance. You could think of it as a digital surveillance camera, with instant alters, session replay and full case management. It is a very powerful technology and it has already been chosen and it is in use by 200 customers globally, including some of the world's leading banks, health organization and government agencies. A simple example of the capability, if Sony had this technology, in all likelihood they would have received alerts that someone was looking at social security information, someone was looking at social security number, someone was looking bonus information and other areas that were outside their normal work patterns and were outside their authorization. They also would have had alerts if that there was data flow, it was unusual or suspicious. Once they had that, once they had visibility into the fact that there was a problem, the session replay capabilities would allow them to recreate screen-by-screen, who was doing what, where was data being stolen, where was the network been accessed, what was happening, much better visibility than you could see from the headlines the challenge they had in discovering what it was. We are excited about the opportunity, the market is huge. I think, everyone understands that, Gartner has estimated the fraud detection and prevention market to be $17 billion, projected to grow to $35 billion by 2019, representing a compound annual growth rate of 20%. Even excluding implementation and services and looking at the market from a pure SaaS technology basis, it is $11 billion, growing to $21 billion. No one debates that the market is large. We have taken a very conservative view at the amount of revenue we will capture, leaving significant room for upside of those estimates. I heard a number of key questions around Intellinx, so I would like to address each. First is, is this a new market for Bottomline? It's not. We offer cash management and payment platforms for banks. PayMode-X processed over a $140 billion in payments last year. Security and fraud prevention are part of everything we do. Cyber fraud and risk management is a natural, very logical line of sight market for Bottomline. Was evaluation right or too high? Evaluation was extremely attractive for Bottomline. Intellinx revenues were $16 million in 2014 growing to 30% for projected revenues of $21 million in 2015. The purchase that equates to three times forward revenues on a cash basis or four times all in, including stock divest over five years. Again, that's an extremely attractive valuation. If the company was expected to do $21 million, why will it only add $10 million to Bottom-line's revenues in 2015? The answer to that is two parts. First, purchase accounting removes some of the revenue. Second, we are converting the model from a perpetual license to a subscription model. It's a better way to sell the technology. It is also better for Bottomline, and it also drives much higher revenue and value. In fact, the conversion of our perpetual software license company to a subscription model, there is a tremendous opportunity to create value. When we are particularly experienced and adapt at. There is a cost, which comes in the form of near-term P&L impact, but enduring that is far more efficient and it is a much better way to establish a high growth subscription revenue stream and paying a SaaS multiple acquisition price. Another question was how we drive return on investment. The answer is simple, one, somewhere. A lot more of the platform, we can do that. Two, well sell it in a subscription model, as I have already outlined. Three, we will be deploying the technology in the cloud. Fourth, we believe that this technology could someday be a standard component in the fight against cyber crime, [ph] every bank, business, government agencies, large or small, domestic or global will require. We can even envision regulatory mandates in some sectors. Bottomline is well positioned to drive higher sales and capitalize on widespread market adoption. What will the revenue be for Bottomline? Well, as indicated, revenue in calendar 2015 will be $10 million. We expect that to grow at 50%, compounded annual growth over the next five years and we will achieve $50 million of revenue, principally on the subscription and transaction basis by calendar 2019. Other question I have got is, finally, what are milestones by which we can measure success. Well, we are actively marketing the platform and training sales teams today. For the sale cycle of six to nine months, we expect Bottomline sales teams to begin closing deals in the September quarter, while we are reporting to investors on our pipeline and sales progress. I hope that clears out the major question around our strategy for cyber fraud and risk management. We could not be more excited about the opportunity. It could not be more timely or in line with our capabilities and direction. I have also gotten some questions about our investments and profitability. We are fully committed to driving shareholder return and are confident the investments we are making will have positive returns and drive shareholder value. The quarter's results particular our 20% operating income and 23% EBITDA margin show the power of our business model and the effectiveness of our execution. We see a six quarter cycle of investment after which the benefits of new and additional revenues will drive expanding margins. Importantly, we will monitor and adjust our investment based on the current and expected results. To the extent the growth and profit we expect to not materialize or do not look like they will be materializing within the timeframe expected, we will adjust our investment. Finally I would like to point out the reasons we have a $170 million subscription in transaction business today and the reason EBITDA and operating income are each up over 30% year-over-year. It is our ability to identify and execute against the opportunities. That is really exactly what we are doing with the targeted investments we are making today. In summary, I would say we had strong financial performance Q2. We took a huge step forward by adding cyber fraud risk management to our products set and Bottomline has never been positioned better to drive revenue growth, margin expansion and shareholder returns. With that, I will it over to Kevin for detailed review of the financials. He will also provide our guidance going forward. Then, again, both of us will be available for questions following Kevin's remarks.

[Kevin Donovan:]

Thank you, Rob. We had a very strong second quarter, exceeding our revenue and earnings guidance, achieving record level subscription and transaction and recurring revenues and growing operating income and EBITDA by 30%-plus. Our subscription and transaction revenue increased 23%, and drove recurring revenue to 76% of overall revenue, demonstrating the continued successful execution of our strategy. Financial highlights of the quarter, include subscription and transaction revenue increasing 23% to $42.9 million, and representing 52% of the overall revenue of $82.2 million. Operating income of $16.1 million was up 33% and EBITDA of $18.6 million was up 31%. Operating cash flow was $12 million and we have generated $60 million of cash flow over the last 12 months. Orders were $94.2 million in the quarter, representing 39% growth with a book-to-bill ratio of 1.15. EPS was $0.41, ahead of guidance and growth of $0.13 from last year and $0.04 from last quarter. In summary, a very strong quarter, one where we exceed all of our key financial targets. I will now provide a more detailed look into the second quarter financial results. Total revenue increased to $82.2 million, driven by subscription and transaction revenue growth of 23% and orders growth of 39%. Even with the significant headwind on currency rates in the quarter, we were able to exceed our revenue guidance. Subscription and transaction revenue, representing 52% of overall revenue was a record $42.9 million. Subscription and transaction revenue is the largest component of recurring revenue, which was $62.3 million or 76% of overall revenue. Annualizing our second quarter results, our subscription and transaction revenue run rate is $172 million and our recurring revenue run rate is almost $250 million, each representing significant scale for these predictable, highly visible revenue streams. We signed new subscription and transaction-based deals across our legal spend management, PayMode-X, financial messaging and digital banking solutions. During the quarter, we closed eight new legal spend management deals and signed 16 PayMode-X deals under the vendor pay model. We have now signed 35 new legal spend management and 45 new PayMode-X vendor pay deals in just the past 12 months. As is always the case, while these new second quarter deals are not expected to contribute much to revenue in the next several quarters, they represent strong visibility into our future recurring revenue growth. In fact, over the past year, we have signed new subscription and transaction deals worth a projected $35 million of incremental annual recurring revenue. These results are a clear indication that our investment in innovation is working and generating strong customer demand for our cloud-based recurring revenue solutions. The revenue growth drove year-over-year expansion in gross margin, operating income and EBITDA. We finished the quarter with record levels of operating income and EBITDA. Operating income grew 33% to $16.1 million and EBITDA grew 31% to $18.6 million. Overall gross margin was $48.9 million or 59%; an increase from 57% last year. Subscription and transaction margin expanded to 55%, an increase from last quarter. The margin expansion demonstrates the leverage in a subscription and transaction model as we captured 84% of the quarter-over-quarter revenue growth and incremental gross margin. From an operating expense standpoint, sales and marketing expense was $16.8 million, representing 20% of revenue, while product development expense was $9.9 million, representing 12% of revenue. The incremental investment in new growth initiatives has begun but smaller than expected in the quarter as the additional hiring began late in the quarter. Operating expenses were also lower than expected, due to the decreased use of our Ukraine offshore development partner. Looking at the balance sheet, cash at the end of December was $187.3 million. During the quarter, we generated $12 million of cash flow from operations. Over the past year, we have generated in excess of $60 million of operating cash flow and $41 million of free cash flow. During the quarter, we used $10.3 million of cash to repurchase 410,000 shares of stock under our current share repurchase program and we have continued to repurchase shares in January. In addition to the strong cash balance, we have a significant backlog. Backlog at the end of December was $142 million, up 14% from last year. In early January, we utilized $66.7 million of cash in the acquisition of Intellinx. I will now provide some additional details on Intellinx and the valuation multiple for the transaction. Intellinx generated $16 million of revenue in calendar 2014. The business was growing 30% and on track to deliver $21 million of revenue in calendar 2015. The cash purchase price was three times forward revenue, which represents a very reasonable valuation multiple. In addition to the cash purchase price, we issued 774,000 shares to employee shareholders. The shares will be used to retain key employees and we will primarily vest over a five-year period. Even if you include the retention shares and the valuation, the transaction was completed at a multiple of four times forward revenue. Now Bottomline expects to record only $10 million of revenue in calendar 2015 in connection with the transaction, due to the transition of the business model from perpetual licenses to subscription and transaction and as a result of the differed revenue haircut on software maintenance. The model change and acquisition accounting impact should be excluded when looking at the valuation multiple, further supporting the transaction at a four times revenue multiple. Bottomline expects to growth the cyber fraud offering by 50% per year and achieve $50 million of revenue by 2019. The transaction will be accretive to earnings in calendar 2016. We are very excited about this new cyber fraud solution and the significant growth opportunities in front of us. Turning to our forward-looking guidance, we are very confident in our strategy and the significant market opportunities in front of us as we continue to drive higher levels of recurring revenue. Looking at 2015 guidance, there are two adjustments that I would like to comment on, first, the headwind on revenue from lower exchange rates. Second, the impact of the acquisition. We derive 40% of our revenue from outside the U.S. the British pound in euro have decreased significantly since our last earnings call, while the Swiss franc, representing a smaller portion of our revenue has strengthen during this time. As a result of the currency movements, revenue will have an incremental headwind of $1.8 million to prior guidance in each of the third and fourth quarters. As communicated at the time of the acquisition, the Intellinx transaction will add $2.1 million of revenue in Q3 and $2.2 million of revenue in Q4 and have a dilutive effect on earnings of $0.03 in each of these quarters. Intellinx was generating profits pre-acquisition and the transaction is dilutive solely because of the revenue model shift and maintenance haircut. Excluding these items, the transaction would have been immediately accretive. Based on these two adjustments to guidance, we are now projecting revenue of $82.1 million in Q3 and $86.2 million in Q4, and EPS is forecasted at $0.30 in Q3 and $0.33 in Q4. With regards to our operating margin, we expect to be at 16% for the next two quarters, reflecting the dilutive impact of the Intellinx acquisition, and then at our previously communicated 18% level, for fiscal 2016. As we complete the investment cycle and begin fiscal 2017, we see operating margins expanding again and are confident that over time, we will be able to achieve our 25% operating margin target. Looking at the full fiscal year, we now expect revenue of $333 million and EPS of $1.41 which despite the currency headwind is an increase over the $301 million and $1.29 reported in fiscal 2014. In summary, we had a great quarter and we have a great opportunity in front of us. We delivered 23% growth in subscription and transaction revenue and 39% growth in orders, while driving 30%-plus growth in operating income and EBITDA. We generated over $60 million of operating cash flow during the past 12 months and our results for the quarter confirm our strategic direction and plan. With strong financial results, increasing customer demand and an expanding set of innovative market leading solutions, we are well positioned for continued future growth in the years ahead. We will now open up the call for any questions.

[Operator:]

[Operator Instructions] The first question is from the line of Brett Huff with Stephens Incorporated. Please go ahead.

[Brett Huff:]

Thanks. Congrats on a nice quarter and appreciate the additional clarity on the investments.

[Rob Eberle:]

Thanks.

[Kevin Donovan:]

Thank you.

[Brett Huff:]

Looking at the security offering, Rob, you mentioned that you would see the cyber security almost becoming part of the existing core set of functionality you might provide a bank. When you guys envision this, would that mean becoming a new module, you would say, hey this is kind of part of our cash management offering and would it be included in the cash management offering or would it be an extra charge or how do think about that opportunity?

[Rob Eberle:]

It’s both and nothing is included. Let me explain what that means. One, we have the opportunity to add the application monitoring capabilities, session replay, the case management and all of that around the cash management application we are providing to the bank. That would be additional cost and additional capability. The second opportunity that you outlined and we have is to provide the bank a platform across the entire enterprise, across other applications for an extra layer of fraud protection throughout. The short answer is we can do both. It is not going to be included and it is always going to drive additional revenue. I guess, I will say one more thing, the first opportunity for us is clearly to have that as an additional feature again for charge against our hosted applications today.

[Brett Huff:]

Okay. My next question is, can you give us an update on the intuit piece of the cash management the SaaS piece? Obviously, when you brought it, it was declining you kept those clients longer than you thought then they kind of came off. I think the last time you told us maybe last quarter, the quarter before, we are growing sort of like-for-like in that particular sub-segment of cash management. Can you give us an update on what the growth rate look like? What are the incremental margins looking like are they are satisfactory et cetera?

[Rob Eberle:]

It's a huge asset for us today, so we have for the most part not with every customer, not with every push, most part we turned around the sentiment, We have been very focused on net promoter score and delighting customers and turning around was a declining business with disappointed customers. We have also been focused on brining new technologies, so if we take a look at that digital banking platform, which will bring new capabilities for businesses for the business customer of those banks to help managed their business and monitor their cash positions in cash flow, as well as new capabilities for those banks to determine what is the customer doing. Activity from this customer suggest that we are not primary wallet share that they maybe going to another bank that we are not getting the revenues opportunity that we have all of those capabilities we will be building into the cash management platform we are deploying with intuit customer. Short answer, turned around, huge assets for us and revenue upside opportunity with the digital banking platform.

[Brett Huff:]

Okay. Then can you give us a sense of , I think it was a record 16 new pay model signed. Were those primarily from the bank channel or were some of those direct?

[Rob Eberle:]

There were some direct, but they are primarily from the bank channels.

[Brett Huff:]

Okay. That’s what I needed. Thank you.

[Rob Eberle:]

Thank you.

[Operator:]

We will go to George Sutton with Craig-Hallum. Please go ahead.

[George Sutton:]

Thank you. My appreciation for the additional details as well. Rob, I think you mentioned rather the vendor pay model that is really the key focus in selling going forward which we expect, but that does that mean the traditional channels will be selling vendor pay specifically and exclusively?

[Rob Eberle:]

It does not. New channels were signing up just in the vendor pay model, Bank of America we have had a longstanding relationship with, so they have the majority of the existing customers and volume in the traditional model and they now sell both models. They had a number of dividend vendor pay model deals in the quarter, but they also sell the traditional model.

[George Sutton:]

Okay. Thank you. Relative to digital banking, you mentioned that you will be in a position to help banks make money with this new offering. Could you be more specific about what you mean there?

[Rob Eberle:]

Yes. Really pretty fundamental, the past, the focus has been on providing the capability. The banks providing the ability for corporate customers to issue a payment to check balance to make a foreign currency, functional capabilities. The banks haven’t brought to their corporate customers much capability that helps them run their business, so these things were bringing to make the platform more attractive to businesses, which means, one bank will attract more customers. Second, their customers will spend more time on the platform. The other side of it, so that's the business operating system, if you will, more capabilities to providing businesses. The second side of it though is using every interaction as a data point to determine what action might they take as a bank to drive more revenue Is the customer transferring balances at the end of the day, which suggests I may not be the primary operating account. Is there an activity or pattern that suggests maybe a customer might lose. Are they juggling payments in a way that suggests that they would be a candidate for a line of credit? There is an e-commerce site that doesn’t focus on each interaction that learns something about the customer and what am I going to do with that information to maximize the opportunity for new revenue. That traditionally has not been a component of how banks and the technology vendors like Bottomline, the technology we provided to banks, have looked at the market. That’s the piece that we are bringing in and building into the new platform.

[George Sutton:]

Okay. Understand, thanks for the clarity. One other thing relative to Intellinx. Will you not offer a perpetual option? Will that not be possible under the new model?

[Rob Eberle:]

We will not offer a perpetual option. There are channel partners and those channel partners have been a big part of Intellinx's past, as big part of their customer, so they will continue to have the ability to sell a perpetual license, but the bulk of the revenues as we go forward, I think, will be driving in Bottomline direct sales and will be driving in subscription and transaction model.

[George Sutton:]

Okay. Perfect. Thank you.

[Operator:]

We will go to Wayne Johnson with Raymond James Financial. Please go ahead.

[Wayne Johnson:]

Hi. Yes, I got a couple of questions. For the PayMode-X, and good results in the quarter by the way, particularly in PayMode-X, but in PayMode-X, but in PayMode-X for new customer sales, how many of those sales of those 11 were through the new Midwestern bank?

[Rob Eberle:]

First off, Wayne, there were 16 new PayMode-X deals. The 11 deals related to our digital banking.

[Wayne Johnson:]

My apologies.

[Rob Eberle:]

The new Midwestern bank just came on last quarter, so we would expect their contribution to pick up in future quarters, but they have just come on board and working with them from a sales training perspective.

[Wayne Johnson:]

Okay. If I understand correctly then you are still selling some of the legacy corporate pay model versus the vendor pay model?

[Rob Eberle:]

The 16 deals, they were all vendor pay.

[Wayne Johnson:]

They were all vendor pay.

[Rob Eberle:]

Yeah.

[Wayne Johnson:]

Okay. Then that’s not the case. It is only vendor pay going forward?

[Rob Eberle:]

Sorry. We have been reporting on vendor pay deals. I think that is certainly more interesting to us…

[Wayne Johnson:]

Yes. It is.

[Rob Eberle:]

I think it is more to, we have not been reporting and I don’t frankly have in front of me what number our channel partner would have had in the last quarter in terms of traditional model deals, but that really is not a significant number. The number we are reporting is vendor pay deals. There were 16 deals. It was more than doubled a year ago.

[Wayne Johnson:]

Right. Those are very healthy results. I congratulate you on those. What distinguishes between the vendor pay and the traditional corporate pay awards when you are signing up the vendors?

[Rob Eberle:]

What distinguishes it? Well, from a payer perspective, in the traditional model, I am paying a fee for each payment that is made.

[Wayne Johnson:]

Understood, that so maybe I didn’t ask eloquently, sorry Rob, but why have two at this point is what I am asking.

[Rob Eberle:]

The only reason we have the two models is continuation with our business partners Bank of America and its part of their offering part of their model and we are happy to continue that given their scale given their significance to us, so that is the reason we have the traditional model still in play.

[Rob Eberle:]

So Wayne when Bottomline sells directly or with any channels partners apart from Bank of America sell PayMode-X, it's exclusively on the vendor pay model.

[Wayne Johnson:]

Okay. Good. All right. Thank you for that clarification. Then, sticking with PayMode-X, can you give us an update on the competitive environment? Have you seen pay around have you see anyone else rearing there head in the B2B payment space?

[Rob Eberle:]

No. I saw that they had some transaction volume that they announced, but we have not seen them from a competitive standpoint. My suspicion is that they are putting pay on the backend of existing Ariva customers but no, we’ve not seen that and you can see our pipeline well our pipeline is healthily and the 16 deals was a fabulous. So we’ve not seen and we’ve also don’t see them and we also do not see, much competitively. I think they provide more customization than we do. We are pure cloud platform and they are focused had been on – the focused has been on some of the big JPMorgan customers that they’ve were able to win but that is a lot of work to provide that customization as opposed to a pure cloud platform that Bottomline drives.

[Wayne Johnson:]

Terrific. Thank you. I appreciate it.

[Operator:]

We will go to Richard Davis with Canaccord Genuity. Please go ahead.

[Richard Davis:]

Hi. Thanks. I was actually in Salt Lake City last week talking to another tech company and they validated what you guys said about Intellinx. Although they had good technology, but the selling effort was not as good as it could be, so the question that I have therefore is, you have good front office kind of revenue generating reference customers and track record etcetera, but I am a salesman for you, I have not sold security before, and I know you sound as the same company, but it is a different buyers, especially larger firms, but just tell me, how are you guys are going to kind of go to market with this? Do you need to do conferences to kind of get that rolled out? What would I be doing if I was a salesman to kind of hit my quota to get that side of the house going? Thanks.

[Rob Eberle:]

Well, you have been doing some work, but you are not going to be alone on that, so I will come around to that second. The first thing I really want to touch on is the buyer, because I think there is a little bit of a misconception around that. If you are selling a cash management platform, everybody that is focused on security in the organization is part of that process, so risk, compliance, vendor management, all of those. In fact, we audit it regularly by those functions, so we know when we interact with those functions. The product group maybe saying this is the capability we want or the Head of Cash Management maybe saying, this is the platform we wanted to have a competitive advantage in attracting business customers, but that sale was not occurring without having involvement from risk, compliance and all those elements of the organization, so we are a very well known vendor, at least, both to our existing customer base as well as with banks generally. Part two of it, is how do we do that? We have done quite a bit of stuff around and we are in the process, we have taken out 50 people in Bottomline, they are cyber fraud and risk management champions. They have learning, the technology, so the model initially at least goes back kind of you can think of this couple of decades ago or decade ago, where you had a sales person that did not know a lot about the technology and brought in the bright young man as the SME, what have you, so we will be having a sales specialist supporting the sales teams, some of those sales specialists will be from Intellinx, some of those sales specialist champions that we are training today, but it’s not so we would ever think we are just going to launch this product out to our sales team and put them out there on their own and say good luck. It is nothing like that. We have got a very comprehensive program to support the sales and get the sales teams ramped and understanding the technology.

[Richard Davis:]

Okay. That is helpful. Thanks.

[Operator:]

We will go to Mayank Tandon with Needham & Company. Please go ahead.

[Mayank Tandon:]

Thank you. Just a couple of questions. First on Intellinx, could you just comment if this was a competitive bidding process or was it not?

[Rob Eberle:]

It was a competitive bid process, but it was not a full banker led. There was banker involved, but it wasn’t the banker. We had discovered the company. There were some other bidders on it, but we were able to prevail not just on purchase price, but principally on the opportunity going forward and the history of Bottomline combining other companies and bringing them into Bottomline was particularly attractive to the senior team and Intellinx, that had a significant stock position and certainly had significant way with the Board.

[Mayank Tandon:]

Great. Then Rob, you commented that you will be making investments obviously related to the acquisition, but you are at the beginning of the six quarter investment cycle, remind us on what are the other investments you are making in the business across your other products?

[Rob Eberle:]

So PARTNERSELECT is outlined, which is the capabilities to help our clients of our legal spend management 250 insurance firms that we have, so that they can better select, valuate and select and assign cases to law firm and the change there is that the law firms will be paying to come on that platform. The second area is digital banking, where we are doing more around the capabilities that will enable our bank customers to provide their business customers as well as capabilities that will help them understand the behavior of their customers and analyze the behavior of their customers to grow revenues and wallet share. Then the third area, cyber fraud risk management, really centers now completely around the Intellinx platform as the case management system, where other things that we will be building out like sanctions in AML and other, compliance components will all be centralized and anchored by the Intellinx platform.

[Mayank Tandon:]

Excellent. Then, I guess where I am going with this in terms of margin expansion longer term, so I think Kevin you said, you expect to get back to 18% margins in fiscal 2016. Then we will see expansion after that? What are the key drivers? Are we going to see more leverage on SG&A or will it be a combination of gross margin improvement and SG&A leverage?

[Rob Eberle:]

I think what you will see is, you will expansion on gross margins, particularly on the subscription and transaction gross margin and you have seen some of that margin expansion opportunity existing in our results today, so subscription and transaction gross margin for the quarter was at 55% and that is up from the low 50% over the last one or two years and we were being in the high 40% levels if you go back, say three or four years. We have talked about in the past, gross margin expansion particularly, on the subscription and transaction line as an opportunity for us. I think at 55%, there is good continued expansion opportunity there. As the business grows, we will also see increased leverage opportunity against our operating expenses, which they are 40% of overall revenue. I would expect that to trend down as well to drive towards that 25% operating margin target.

[Mayank Tandon:]

Great. That's helpful. Thank you.

[Operator:]

We have a question from Chris Kennedy with William Blair. Please go ahead.

[Chris Kennedy:]

Hey, guys. Thanks for the taking the question and increased clarity. You mentioned $4 million of annualized revenue from PayMode-X vendor pay model. Can you talk about kind of the trajectory of that and how that is relative to prior quarters?

[Rob Eberle:]

Well, it has more than doubled from a year ago. The trajectory, I would not want to speculate on that, I wouldn’t want to guarantee that is growing at a 150% or 180% or something, but it has been growing at the size that is growing at a big number. The key to us really isn’t the amount of revenue, because we have just a few customers on relatively early and it takes a while to get one person to sign-up then have to go live, which means they have to have IT resources available to connect with us due to pieces, then we have to sign vendors on and then those vendors have to get paid. The principal thing we are really looking on is model acceptance. Our vendor is going to pay a fee to get the technology, additional functionality, visibility to the payments, earlier payments, better remittance detail and the answer is clearly, yes. Most important piece for us is, does that model work. Can one imply apply that interchange model that has worked so well and so profitably, for Visa and MasterCard cannot be applied to ACH network of significant scale and that’s exactly what we have done and at this level we can see that successful. So we don’t have enough data points to tell you what that ramp, but it has the potential to change the way business is paying, get paid and that’s been our aspiration all along and to monetize that asset that we create as we add vendors and payers.

[Chris Kennedy:]

Okay, great. Then you mentioned the 35 deals over the last 12 months, representing I think about $35 million of revenues or something. Can you talk about when that will hit the income statement? How long does that generally take?

[Rob Eberle:]

Yes, so it was 35 new legal spend management deals over the last 12 months and 45 new PayMode-X vendor pay deals over the past 12 months, so 80 deals combined between the two. The $35 million of incremental annual recurring revenue is comprised of those deals as well as deals that we would have done on our digital banking platform on a subscription and transaction basis, so it encompasses a little bit more than just those 80 deals. We wanted to provide clarity into what we signed up in terms of the deal. The majority of that revenue those deals that we signed over the past 12 months has not come into our revenue results today and it represents future subscription and transaction growth opportunity. That will be clear all $35 million isn’t going to hit next fiscal year, there is a ramp and as Rob talked about it, it takes some time for some of those PayMode-X vendor pay customers to ramp up the full potential, but it’s 35 new annual recurring revenue deals that we have signed that will eventually turn into incremental subscription and transaction revenue for Bottomline.

[Chris Kennedy:]

Great. Thanks a lot.

[Operator:]

We have a question from the line of Irwin [ph] with Stifel. Please go ahead.

[Unidentified Analyst:]

Yes. Thanks. Thanks for taking my question. First off, to what extent can some of your newly acquired capabilities sort of offset your own internal product development, engineering investments, because I would imagine that Intellinx could save you some of the upfront R&D cost compared to creating and launching and internally developed product.

[Rob Eberle:]

Yes. We will not at this point launch and develop an internally developed product. We will develop modules, leveraging our predictive analytics group, for example modules that are focused more on some of the payments areas where we have expertise and online banking, online account origination, but we would not build out a new product. The investment we are making will be shifted from building new organic product to supplementing the Intellinx’s platform to providing the capabilities I mentioned earlier to marry that with our existing cash management platform, so that’s it’s an add-on module for that to monitor that application. Also, then to be bringing the technology to the cloud, so we will be continuing to make investments, but they are centered on the Intellinx platform.

[Unidentified Analyst:]

Got it. Thanks. Is the incremental revenue from Intellinx going to be 100% accretive or just the $10 million contribution in calendar bake into some sort of cannibalization or replacement of some of your own current fraud and risk management solutions?

[Unidentified Analyst:]

No. It is not a cannibalization. That is the incremental revenue that we would see coming out of the transaction.

[Unidentified Analyst:]

Okay.

[Kevin Donovan:]

There is no product cannibalization. It would be interesting to see whether it has any impact on sales teams, so the sales productivity stay the same or the sales productivity increase with this new capability. Our hope of course is that it increases and the structure we’ve put in place with specialists supporting the sales team should also allow it to do that.

[Unidentified Analyst:]

Got it. Thanks. Lastly, a modeling question related to your year-over-year revenue growth. You guys provided the impact on foreign currency on the revenue line, but I was wondering if you guys can do that for the expense side? How much of your expenses are in local currencies? I am curious if there is any expense tailwinds due to the dollar depreciation – appreciation against on that could sort of offset some of the revenue headwinds?

[Rob Eberle:]

Yes. We have expenses denominated in those functional currencies as well, so there is a natural hedge in place, so you would see about a 20% impact on operating income for the revenue headwind, so $1.8 million a quarter, about $360,000. What we believe is we will be able to realize that in increment profit within the existing business, so we did not adjust the earnings guidance or the operating income guidance as a result of that. We will just make that up in the operations of the business.

[Unidentified Analyst:]

All right. Got it. Thanks. That is all I had.

[Rob Eberle:]

Thank you.

[Operator:]

Thank you. I will turn it back to our presenters for any closing remarks.

[Rob Eberle:]

Well, I hope I clarified some of the questions investors have had about or around our direction. We certainly, as everyone can see, had a strong Q2. We could not be more excited and could not have a better fit in terms of cyber fraud, risk management. I think in particularly the question about banks to ask that out, this is a capability we can add right to our cash management platforms. Finally, I would just say we have never been in a better position to drive revenue growth, margin expansion and shareholder return and I look forward to reporting on results of these initiatives on our next call. Thank you for your interest in Bottomline.

[Operator:]

Thank you and, ladies and gentlemen, this conference call will be made available for replay. That begins today at 7 pm. Eastern, running through the date of February 12th at midnight Eastern. You can access the AT&T TeleConference Replay System by dialing 1800-475-6701, please enter the replay access code, 350913. International participants may dial 320-365-3844. The access code is 350913. Those numbers again, 1800-475-6701 from within the United States and international parties may dial 320-365-3844, the replay access code 350913. That will conclude our teleconference for today. Thank you for your participation and for using AT&T Executive TeleConference Service. You may now disconnect.