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Internet Banking Leader Falters in Competitive Fray

Internet Banking Leader Falters in Competitive Fray By SHELLY GARCIA Senior Reporter Warnings that performance will fall short of fourth-quarter expectations, fears that fierce competition will continue to take a toll on customer retention and a budding price war in the Internet banking industry have pummeled the share price of Digital Insight Corp. Shares in the Calabasas-based company lost more than 30 percent of their value since Oct. 25 when Digital Insight executives announced that competitors were picking off clients, a situation expected to continue into the fourth quarter and, perhaps, beyond. “We remain concerned over top line growth given the competitive landscape that will likely pressure pricing and customer retention in the near term,” wrote Jeffery B. Baker, senior research analyst with US Bancorp Piper Jaffray in a report reducing the rating of the company from an outperform to a market perform. ” We believe it will be at least three quarters before we get a good read on management’s ability to retain existing customers.” Digital Insight develops and sells software applications and related services that allow banks, credit unions and other financial institutions to offer their customers Internet banking services. The company is widely considered a leader in an extremely segmented competitive field. Ironically, the third-quarter announcement that sparked Wall Street’s bear run on the company included the news that Digital Insight beat the street’s earnings estimates for the period and, for the first time, landed in the black on a GAAP basis. For the quarter ended Sept. 30, Digital Insight earned $1.7 million or $0.05 per diluted share on revenues of $33.9 million. That compares with a loss of $9.9 million or $0.34 per share on sales of $24.5 million in the third quarter of 2001. But along with the good news, Digital Insight delivered a troubling admission in its third-quarter conference call to investment analysts. The company let the ball drop on some of the current clients whose contracts had come up for renewal, and Digital Insight lost a number of those clients as a result. “In hindsight, we took these customers a little more for granted,” said Digital Insight Chairman and CEO John Dorman. The announcement led to a trading free-for-all. On the day after the company released its third-quarter earnings report, shares in Digital Insight fell to $9.03 with 5.6 million shares traded. The day before, the stock closed at $13.57 with 250,000 shares traded. On Friday, Nov. 22 shares in Digital Insight were trading at XX Check on Friday. About 8,000 financial institutions signed up for Internet banking services between 1997 and 1999, when the business was just taking off, and this year those contracts, which typically run three or four years, began to come up for renewal. The cycle created a feeding frenzy among suppliers of Internet banking services, with each trying to nab competitors’ accounts. While Digital Insight, widely recognized as the leader in the field, put its resources behind pursuing new accounts, its existing clients were being courted by the competition, in some cases, successfully. About 23 Digital Insight clients switched sides in the third quarter. “What’s significant is the average size (of those clients) was up significantly,” Dorman said. Because of the increasing popularity of Internet banking services, the average number of potential end users lost with each client has grown to 30,000, up from about 10,000 last year. Digital Insight’s fees for service are based on the number of end-users each client serves. Digital Insight has moved to shore up the losses. The company hired a former EDS executive to head up a newly created post, senior vice president for Internet banking services, to develop customer satisfaction and retention programs; it is adding sales and support personnel and tweaking its compensation programs to offer stronger incentives to its workers. At the same time, the company said it anticipated continued fallout in its client base through the fourth quarter and the early part of 2003, and lowered its guidance for the last three months of the year. In the past, the company typically retained about 90 percent of its client contracts, but in the third quarter, and through the fourth quarter, Dorman said the retention rate was expected to be in the low 80-percent range. Officials expect fourth-quarter revenues between $34 million and $34.5 million and pro forma net income in the range of $0.11 to $0.12 per share. Officials did not provide guidance beyond the fourth quarter, but said they anticipated swift improvement in the situation. “We’re confident we can turn it around quickly,” Dorman said. On the street, analysts were less sanguine. With so many contracts coming up for renewal and so many smaller competitors anxious to gain a foothold, some believe it is only a matter of time before a price war drives down profit margins. Stephen A. Laws, an analyst with WR Hambrecht + Co., cited the recent loss of two accounts to Corillian, a Digital Insight competitor, as a reflection of what may come. “The recent success of Corillian’s Voyager SE platform in winning business versus Digital Insight is a discouraging trend, in our opinion,” Laws wrote in a recent research report. “While we don’t know the details of the contract, we believe Corillian is competing more aggressively on price to win business from Digital Insight.” Not only is Digital Insight likely to have a tough time holding its pricing, it is also likely to face even more competition in the future. Besides the many competitors currently in the market, some see a push by other types of banking companies to add Internet solutions to their offerings, a development that could put Digital Insight, which only offers Internet services, at a disadvantage, they say. “There are simply too many ‘Internet-only’ banking vendors in the market,” said Baker, “and we believe further consolidation remains inevitable.”

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