Jack Henry & Associates, Inc.
Q3 2018 Earnings Call Transcript

Published: 2 May 2018

[Operator:]

Good day, ladies and gentlemen, and thank you for standing by. Welcome to Jack Henry & Associates' Third Quarter FY 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session; instructions will follow at that time. As a reminder, this conference is being recorded. I'll now turn the conference over to your host, Mr. Kevin Williams. You may begin.

[Kevin D. Williams:]

Thanks, Lydia (00

[David B. Foss:]

Thank you, Kevin, and good morning, everyone. We're pleased to report another quarter with record revenue and earnings. As in the past, I'd like to begin today by thanking our associates for all the hard work that went into producing those results for our third fiscal quarter. Total revenue increased 9% for the quarter and increased 8% excluding the impact of deconversion fees from both quarters. Organic revenue growth was 7% for the quarter. We again had a very solid quarter in the core segment of our business. Revenue increased by 7% for the quarter and also increased by 7% if you exclude the impact of deconversion fees from both quarters. Our Payments segment performed extremely well, posting a 12% increase in revenue this quarter and an 11% increase excluding the impact of deconversion fees. Of course, Ensenta is a contributor to this growth. But even if we exclude Ensenta, we saw more than a 5% increase in revenue through our traditional offerings. We also had a very strong quarter in our complementary solutions businesses, posting an 11% increase in revenue this quarter and a 10% increase excluding the impact of deconversion fees. Our combined sales team had another nice quarter, again finishing ahead of quota. As I mentioned in the press release, it also appears that the team is on track to exceed quota for the year. This was a well-balanced sales quarter with the sales teams posting solid numbers for several of our new solutions, including Banno, Debit Processing, the new Credit Processing Solution and Treasury Management. We also had a record number of Symitar into out signings at 13. Regarding our new first data PSU debit card offering, we now have 34 customers converted and live on the new platform. As with any conversion, we've encountered a few minor bumps, but I'm very happy to say that all of these customers are referenceable at this point. And as planned, we will begin to slowly ramp our conversion volume later in May. With regard to the recently enacted Tax Cuts and Jobs Act, we provided a very high level review of our plans in the last call, including plans to return a portion of the savings to our shareholders. Shortly after that call, we announced an increase to our quarterly dividend of 19%. We also discussed our intent to use a portion of the TCJA savings to offer a voluntary incentive plan which would provide a large subset of our longer tenured employees the option to leave the company with a significant financial reward. We projected a Q4 expense of around $8 million as a result of this program. As we have discussed with many of you in the past, our voluntary turnover rate runs well below the industry average. This tends to provide great stability in our workforce because once people join our company, they are generally inclined to stay. We saw this same behavior reflected in the results of this special incentive program in that even though we felt we had forecasted conservatively, many fewer people took advantage of the program than we had expected. Our Q4 charge therefore will be much closer to $5.5 million than the originally projected $8 million. We don't intend to offer another program like this, but as we move through FY 2019, we'll be announcing several other programs intended to benefit our employees, including an improved 401(k) offering and improved bonus structure and other changes designed to help us continue to attract and retain strong talent. Sticking with the topic of attracting and retaining the best talent in the industry, most of you are well aware of the fact that we regularly win Best Place to Work Awards around the country and in various publications. Yesterday afternoon, we were notified that this year we have again won as a Best Large Employer in the Forbes Magazine annual review. Last year, we were recognized as number 92 on the list of Top 500 Large Employers and number seven among the 26 technology companies. This year, we have moved up to number 12 overall and number 2 on the list of technology companies with Google as the only company scoring higher than Jack Henry. Obviously, we're extremely happy with these results and thankful that our employees have such a positive opinion of our company. As I'm sure you're all aware, we'll be hosting our Annual Analyst Conference in Atlanta next week in conjunction with the Jack Henry Banking Strategic Initiatives Conference for our largest core banking clients. We look forward to seeing many of you next week in Atlanta. With that, I'll turn it over to Kevin for some detail on the numbers.

[Kevin D. Williams:]

Thanks, Dave. This high level of the service and support line of revenue, which includes our license, hardware, imitation (06

[Operator:]

Our first question coming from the line of Brett Huff with Stephens. Your line is open.

[Brett Huff:]

Good morning, guys.

[David B. Foss:]

Good morning, Brett.

[Kevin D. Williams:]

Good morning.

[Brett Huff:]

Two questions. Number one, can you talk a little bit about the demand environment? Dave, you touched on it, but your two peers have been – last couple of days have talked a little bit more enthusiastically about acceleration of demand, particularly sales over the last couple of quarters. And just wondered how that matched with what you all are seeing if there's a meaningful difference here in the last six months?

[David B. Foss:]

No, we're seeing the same thing. I think on the last call, if I remember right, I pointed out that our pipeline was larger than it's ever been in the history of the company. And so I would say we're seeing the same things. In fact, I have a couple of charts that I'm going to show you guys at the Analyst Conference next week from a recent study that came out on that very topic. But I would echo that. I think demand is strong. The sales pipeline is solid. The sales team has exceeded quota every quarter so far this year, which is remarkable as far as I'm concerned. So, things are good on the sales front.

[Brett Huff:]

That's helpful. And then the other question is, we're pretty focused and intrigued by the new card issuing processing product that you guys are developing. Two questions on that. One, is it still about a year-and-a-half out before we start getting some margin sort of moderate – a margin impact moderation as we kind of close down some of the other two switches, number one? And then number two, I think you said 34 live. Can you give us a sense, are the banks bigger than you thought? Is the volume coming on faster than you thought and kind of how are the economics playing out relative to what you expected?

[David B. Foss:]

Yeah. I think so, 34 live. We have, I think, 19 more that will be live by the time we get together next Monday. So, I can give you another update at the Analyst Conference on Monday, but it's a broad mix. So as with any project like this, it's probably logical to you that we wouldn't start with our largest customers. We would start with a few smaller ones. But so far, other than the first four, after that, it's been a good mix as far as volume, a good mix as far as number of cardholders. And these conversions, I should knock on wood when I say it, but they really have gone flawlessly and I think a big reason for that is because the consumer, there's no impact to the consumer. They don't have to issue new cards. It's really a seamless conversion for the consumer, so progress will continue. We'll continue to give you updates on progress and a little more information on volumes as we get farther down the road. But so far, it's been extremely successful and the timeline at the beginning of your question, it's still in the ballpark. We'll see again as we start to ramp up how quickly can we ramp, can we do more than we thought every month, will we end up doing fewer than we thought, so we'll give you more guidance on that as time goes by as well. But right now, it's progressing extremely well and I'm very optimistic about the future of that project.

[Brett Huff:]

I guess one – sorry. Sorry. Go ahead, Kevin.

[Kevin D. Williams:]

Yeah. On the margin side, the other thing that I've talked about before is the timing of when we can get all the customers off one of the platforms because obviously when that happens, we'll be able to take a significant amount of cost out and that's not going to happen at the same time. So, we're not going to get all the customers off both platforms at the same time. So, there is going to be one quarter that's going to get a nice bump in margins because we're going to be able to take a significant amount of cost out for that one and then when we get all of the customers off of the other one, you're going to see a very nice bump in the margin. So, as Dave said, the timing is still about the same. We've been doing pretty good at maintaining our margins in the payments side because I will tell you, we've taken on a lot of costs for the additional labor to help with these migrations. And so far, we've managed to kind of offset those margins. We haven't seen quite the deprivation that I thought, but we got more cost coming on. And again, it comes down to the timing of when can we start getting new credit card customers on the new platform because that's new revenue that we've never sold before, so the faster we can start getting some of that and seeing that, which I'm not giving you any guidance there, but that will help also offset those margins as we move forward over the next 18 months or so.

[Brett Huff:]

And I guess one more question while I have you, the other interesting product that you guys, I think, have rolling out or you have a bunch of them, but the other one that we're focused on is the enterprise fraud product with the corporation SAS. I think that's targeted at larger banks and I'm wondering how are those conversations going, anything live there and are you seeing anything surprising in terms of – if the medium- and smaller-sized banks are also perking up on that.

[David B. Foss:]

Yeah. It's a good question because you're exactly right. So, we have a handful live. I think we have two or three live right now, but you're exactly right. We originally thought this was only going to be appealing to the largest banks in our core base. Knew there might be some interest in the credit union side of the house, but really no interest among smaller, either banks or credit unions, and it's been very different from that. There is a lot of demand around midsized and larger banks and a number of our credit unions. So that one I think is going to turn into a broader success than what we maybe originally thought. So, we've already signed 10 so far. We have two or three lives and we're pretty optimistic about that opportunity in the future.

[Brett Huff:]

Great. That's all I had, appreciate it.

[David B. Foss:]

Thanks, Brett.

[Operator:]

Thank you. Our next question coming from the line of Joseph Foresi with Cantor Fitzgerald. Your line is open.

[Joseph Foresi:]

Hi. Can you talk about the deceleration in 4Q? What's causing the slowdown? And any color on termination fees and I guess some other color on 4Q?

[Kevin D. Williams:]

Well, term fees we expect to be flat in Q4. The slight deceleration in total revenue is just kind of comparable to Q4 last year. We try to be cautious with our guidance and we feel pretty solid. That 5% to 6% growth in Q4 is pretty much in line and we'll probably right on over into FY 2019, Joe.

[Joseph Foresi:]

Okay. And then just as we talk about FY 2019, I know you gave some color on the cash flows in I think 4Q and 1Q, but maybe could talk about your expectations for cash flows versus net income next year and also on the DSO side?

[Kevin D. Williams:]

Well, as far as cash flows, we have – we peaked in our cap software a year ago, we saw that came down a little bit last year. It's going to be – if we're on track, could be down a little bit this year. I think it's going to probably come down a little bit more next year. We don't have huge internal software developments going on. So, those are going to contribute to increased free cash flow. And then, obviously, the impact of the lower tax rates is going to drop straight to free cash flow as well. So, I think in FY 2019, tentatively, again, there's still a lot of moving parts, but I think in FY 2019 our free cash flow should get back up above our net income.

[Joseph Foresi:]

Got it. Okay. And then the last one for me, you mentioned the pickup in demand. Where we would most likely be able to see that? Would that come through your digital products, standard products or both, whether it be the insourcing to outsourcing move? I'm just wondering if there was an area where you thought you're most likely to see some upside, which area would that be in? Thanks.

[David B. Foss:]

Yeah, that's a good question. And it really is across the board. I will tell you so, for sure, digital, and we've talked about that a lot. We have an outstanding digital offering and the strategy that the customers are really zoning in on. So, digital is an opportunity. We do have – we've talked for many years about the in-to-out opportunities, customers moving from in-house to outsourcing. That's been a steady performer for us on the banking side for many years, but the credit union side there wasn't that much demand in the past. We've seen an uptick there. I highlighted it in my opening comments and then several of these new products that we rolled out. There was a reason why we focused on some of these new solutions like treasury management and like the card offering and certainly demand in those areas as well. So I'd say it's across the board as far as ongoing demand.

[Joseph Foresi:]

Great. Thank you.

[David B. Foss:]

Yeah.

[Operator:]

Thank you. Our next question coming from the line of David Koning with Baird. Your line is now open.

[David J. Koning:]

Yeah. Hey, guys. Nice job, again.

[David B. Foss:]

Thanks, Dave.

[David J. Koning:]

Yeah. Hey, and so, I guess, on the payments side, you mentioned – I think you mentioned 11% growth ex-term and over 5% ex-term and Ensenta. I think the last couple of quarters were 4% to 5%. It was on a really tough comp last year too, so you accelerated on a tougher comp. Is there something you're doing specifically or is there something environmental? It seemed like Visa and MasterCard both accelerated really nicely in debit and maybe you're feeling some of that as well?

[David B. Foss:]

I don't know that it's – so I've talked about it before that our EPS business, which is our Enterprise Payment Solutions, the ACH origination business, as surprising as it is to me, in 2018, that business continues to grow and continues to perform well. So, obviously, that's a win. I think the growth in the card business was a little ahead of probably what might have been logical to expect and so that's continuing to perform well. Bill Pay is a steady performer for us, so there's no spike in any particular area. I wouldn't tie anything in particular to anything that's happening with debit with one of the card associations, but it's just across the board.

[Kevin D. Williams:]

The one thing I would throw out, Dave, and we talked about this a lot in the previous calls, two or three calls ago, that when we announced this, the PSCU-FDC arrangement to our larger customers, I mean, we stopped a lot of those customers that were in an RFP process. So I think just the fact that we stopped losing customers because of the new platform makes it easier comps going forward for the payments line.

[David J. Koning:]

Got you, yeah. Okay. Great. And then, I guess secondly on margins, they've held up well this year and you've kind of talked about you know ex-term fees they were pretty flat year-over-year, which is good especially given the development costs and some of the new onboarding with the double debit processing system. When is like the inflection point where margins actually like start to go up again year-over-year? Is that like six months out? Is it like late fiscal 2019? How should we think about that?

[Kevin D. Williams:]

Well, there's a couple of things, Dave. First of all, you've got obviously all the development, but also the additional head count that we've brought in to assist with the migrations for the move to the new payments platform. And those costs are going to be around for the next 18 months or so. At that point when we get all the customers off one of the platforms, we will shut down our platforms, we'll be getting rid of or displacing a lot of development people and a lot of the migration staff. So, you're going to see a really nice pop in margins there. The other thing that we're having to kind of grow over is all the development we've done on all these products in the previous three or four years for the treasury services, the ERMS solution and all those. So, depreciation and amortization are both up quite a bit, and so we've got the cost that's rolling out there, but yet we still – now we're just getting the sales going and so we're going to have to ratchet up the live customers on those to even offset the increase in amortization and depreciation. So, that's going to happen slowly over the next probably three or four quarters that we'll be able to grow over that. And that should give a little relief on margins or at least help to maintain the margins where we are to offset the increased costs for the move on the payments platform. And then when we get to shut down the payments platforms, that's when you're going to see a huge increase in margins because, again, that's over 20% of our total revenue right now that you're going to see a significant pop in margins.

[David J. Koning:]

Okay. Okay. Great. And then just the final one. What did you say for full-year EPS for fiscal 2018 again?

[Kevin D. Williams:]

For fiscal 2018, well, we're going to finish this quarter at $0.93 to $0.95, which will put us full year with the impacts of TJCA in the $4.69 to $4.71 range.

[David J. Koning:]

Okay, on a GAAP basis, but normalized it's more around $3.50 or somewhere around there I think?

[Kevin D. Williams:]

Yeah.

[David J. Koning:]

Yeah. Okay. Great. Well, thanks, guys. I appreciate it.

[Kevin D. Williams:]

Thanks, Dave.

[Operator:]

And our next question coming from the line of Peter Heckmann with D.A. Davidson & Company. Your line is open.

[Peter J. Heckmann:]

Hey. Good morning, gentlemen. I had a couple of questions. This is maybe a little bit looking out a little longer term. On a theoretical basis, how do you feel about selling to FinTech disruptors, some, I'm reading a lot in American Banker as well some of the other publications about some of these new companies coming out offering a lightweight core maybe offering payment capabilities. On a theoretical basis, are you marketing to those or you view that as something that impacts negatively your target market of regular banks and credit unions?

[David B. Foss:]

Yeah. That's a good question, Pete. It's a fine line that we walk in that discussion. We're committed to the idea that we are not going to set ourselves up to be a competitor with our traditional customers. So with that in mind, where are those opportunities where we can maybe partner with a traditional customer to enable them with a FinTech. So, we are not – we are open to the idea instead of two negatives here. I'll say, we're open to the idea of working some of those partnerships. We have some of those discussions ongoing today, but we're very careful about the point of not positioning ourselves to compete with our traditional customers. And by the way, to your point about the lightweight core and being nimble and gathering online deposits, that's actually a topic in my discussion for next week because we are – we will be offering that type of solution to our customers with products that are solutions that we already have at Jack Henry. So, we're well-positioned to compete in that space with what we already have.

[Peter J. Heckmann:]

Okay, that's helpful. And then just a followup on Ensenta, I've read through via description of what Ensenta does and I've read through some of your material and I guess I'm still not completely clear on some of the additional capabilities that Ensenta brought to Jack Henry and maybe you give us some examples of other areas where it either solidified a lead or added new capabilities.

[David B. Foss:]

Sure. Yeah. So if you think about our traditional Enterprise Payments business, we were very strong in commercial deposits, working with commercial customers, particularly on the banking side of our business. So, we're the most widely installed solution in that space. We had some penetration on the Credit Union side and we had some penetration for consumer deposits, but we were not industry leader in that space and the reason we weren't the industry leader is because Ensenta was. So, if you put Ensenta together with our EPS platform, we have the industry leading solution for commercial deposits, consumer deposits, mobile deposits, essentially across the board. Additionally, Ensenta brought to us a technology for working in the ATM environment that we didn't have and the shared branching environment on the Credit Union side for processing payments. Neither of those were huge part of their business, but it broadened our suite which of course is what we're always looking to do on the ProfitStars. This is a ProfitStars solution by the way. So, we're always looking to broaden that offering on the ProfitStars side to try and fill as many holes as we can for those customers who do business with ProfitStars and of course many of them are non-core Jack Henry customers. So, we have to have a best of breed very broad offering to be competitive in that space.

[Kevin D. Williams:]

They also brought us some best of breed risk solution.

[David B. Foss:]

Yes. Right. Yeah, risk management technology around payments that we – we had a very solid offering, but they had a better offering. So, that augmented that piece of our story as well.

[Peter J. Heckmann:]

Got you. Okay, that's helpful. See you Monday.

[Kevin D. Williams:]

Yeah. Thanks, Pete.

[David B. Foss:]

Okay.

[Operator:]

Thank you. At this time, I'm showing no further questions. I would like to turn the call back over to Mr. Kevin Williams for closing remarks.

[Kevin D. Williams:]

Thanks, Lydia (30

[Operator:]

Yes, sir. Ladies and gentlemen, thank you again for participating in today's conference. This conference will be available for replay beginning today May 2, 2018 at 11