Wednesday, September 12, 2007

Is S1 Corp. Being Too Optimistic with EPS Guidance?

In August, financial services software company S1 Corp. (SONE-$8.45) posted a profit of $4.9 million on $52.6 million in revenue for the second quarter ended June 30, 2007 (helped in part by tax credit carryforwards and stock repurchases).

In a ‘feel-good’ mood, management increased its earnings outlook to the range of $0.26 - $0.29 per share from previous guidance range of $0.25 - $0.28 per share.

Revenue estimates were upped, too, now projected between $202 and $206 million, due in part to the launch of a new product, Enterprise 3.5. Earlier, the company estimated revenues to be in the range of $200.0 - $206.0 million.

a research note published last week, analyst John Kraft of DA Davidson maintained his "buy" rating on S1 Corporation, citing management’s success in executing on its restructuring initiatives – introduced back in January 2007, when S1 established individualized branding around products and addressable markets: (i) Postilion, which delivers integrated solutions for self-service banking and a global ATM/payments processing platform; and (ii) S1 Enterprise, a provider of multi-channel, front-office banking solutions.

The financial services software maker’s sales are unlikely to be significantly affected by macroeconomic trends, DA Davidson added.

The 10Q Detective begs to differ.

Last Wednesday, TIBCO Software (TIBX-$7.14) forecasted third-quarter earnings below analysts' estimate as it experienced an unexpected delay in closing some business deals in the last few days of the quarter. Although the late change in business was spread across client markets and was largely due to delays in specific deals, the business software maker admitted that business was especially weak in financial services (due to the ongoing turmoil in the credit and mortgage markets). TIBCO generates about 25 percent of its quarterly revenue from the financial services sector.

Contrary to DA Davidson’s optimism, S1 is not immune to a slowdown in financial services spending, too. Like TIBCO, S1 is dependent on increasing licensing activity and professional service fees with its corporate banking clients for organic growth.

In its second quarter 10Q regulatory filing, S1 said: “A significant portion of our customers are in a consolidating financial services industry, which is subject to economic changes that could reduce demand for our products and services.”

Of concern, too, as of the six months ended June 30, 2007, 42% of Enterprise segment sales, or about $22.94 million, came from one customer, State Farm (about 23% of total revenues).

“Like a good neighbor, State Farm is there.”

State Farm is everywhere. The Company is the leading US personal lines property/casualty company (by premiums), and is the largest private insurer to homeowners in catastrophe-prone states (hurricanes) like Louisiana and Florida. Homeowners represent about 21.2% of written policies.

State Farm Mutual Automobile Insurance Company is the #1 provider of auto insurance (auto policies represent 52.2% of the company’s total accounts). It also is the leading home insurer and offers non-medical health and life insurance through its subsidiary companies.

After an analysis of statutory filings for the property & casualty insurance industry (as of year-end 2006),
Fitch Ratings believes the industry's risk from various sub-prime mortgage exposures is minimal. However, property casualty insurance companies could be exposed to subprime mortgage problems through their investment in residential mortgage-backed securities, asset backed securities and collateralized debt obligations.

State Farm’s property & casualty division earned a pretax operating profit of $6 billion in 2006. Consequently, the Company probably has minimal immediate liquidity needs, and thus is well positioned to weather a 'capital markets storm'.

The 10Q Detective notes, however, that with the fall of barriers between the banking, securities, and insurance industries, State Farm's is now exposed to the housing and mortgage crises. State Farm owns a
federal savings bank charter (State Farm Bank) that offers consumer financial products, including mortgages.

State Farm VP Management Corp. and State Farm Investment Management Corp. (including retail mutual fund operations) reported a combined after-tax net loss of $14 million in 2006.

S1 expects to derive revenues from State Farm of between $45 and $48 million in 2007, representing about 23 percent of aggregate sales. State Farm is free—without recourse—to cancel or reschedule projects at any time.

Given the expected slowdown in financial sector spending—compounded by the Company’s historically long sales cycles—we look for S1 to revisit their earnings/revenue guidance.

Editor David J. Phillips does not hold a financial interest in any of the companies mentioned in this article. The 10Q Detective has a Full Disclosure Policy.


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Best-David J Phillips