Jack Henry & Associates, Inc.
Q2 2016 Earnings Call Transcript

Published: 3 Feb 2016

[Operator:]

Good day, ladies and gentlemen and welcome to the Jack Henry & Associates Second Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Mr. Kevin Williams, Chief Financial Officer. Sir, you may begin.

[Kevin D. Williams:]

Thanks, Chelsea. Good morning. Thank you for joining us today for the Jack Henry & Associates second quarter fiscal 2016 earnings call. I'm Kevin Williams, CFO. On the call with me today is Jack Prim, CEO. Also in the room with us is Dave Foss, President. The agenda for the call this morning is Jack will start with some of his thoughts about the business and on the performance of the quarter, then he will give it back to me, I'll provide some additional thoughts and comments regarding the press release that we put out yesterday after market close, and then we'll open the lines up for some Q&A. I need to remind you that remarks or responses to questions concerning future expectations, events, objectives, strategies, trends or results constitute forward-looking statements or deal with expectations about the future. Like any statement about the future, these are subject to a number of factors which can cause actual results or events to differ materially from those which we anticipate, due to a number of risks and uncertainties, and the company undertakes no obligation to update or revise these statements. For a summary of these risk factors and additional information, please refer to yesterday's press release and the sections in our 10-K entitled Risk Factors and Forward-Looking Statements. With that, I'll now turn the call over to Jack.

[John F. Prim:]

Thanks, Kevin. Good morning. We are pleased to report another strong operating quarter with record revenue and operating income. Outsourcing and payments again showed solid growth as did in-house maintenance based primarily on new credit union core system implementations. This is in spite of the continued movement of existing in-house customers to outsourcing with 12 current in-house bank and credit union customers signing to make that transition during the quarter. Despite the recent noise level in the stock market, in our view, business fundamentals remain strong and our clients continue to invest in solutions that can help them drive revenue, reduce costs and improve security. We had solid sales performances with all three brands finishing ahead of plan year-to-date, and sales pipelines remain strong. Last month, we announced a CEO transition that will take place July 1, at the start of our fiscal year, when Dave Foss will assume that role. This is a planned transition that the board and I have been working towards for several years. Dave will bring to the position over 30 years of financial industry experience, including his 17 years of experience at Jack Henry. During his career, Dave has had experience in literally every aspect of the financial institution core processing industry as well as the experience of having built our successful ProfitStars non-core processing business. He is well positioned to take JHA to the next level. I will remain Chairman of the board residing in Monett and working full-time in that role. I'll keep our Enterprise Risk Management group as a reporting entity to ensure that our company maintains its strong focus on and that the board has good visibility to our risk management activities in this critical area. It has been an honor to serve as the CEO of this company for the last 12 years, and I am excited to watch the continued success of Jack Henry & Associates under Dave's leadership. With that, I'll turn it over to Kevin for a closer look at the numbers.

[Kevin D. Williams:]

Thanks, Jack. During the quarter, our license revenue represented less than 1% of our total revenue. The vast majority of our license revenue is now included with bundled services and included in the support and services line of revenue. Our support and services line of revenue continues to drive our total revenue growth and it increased to $320.2 million, which is an 8% increase over the same quarter a year ago and represented 96% of total revenue. To break down our support and services for the quarter

[Operator:]

Certainly. And our first question comes from the line of Peter Heckmann with Avondale. Your line is now open.

[Peter J. Heckmann:]

Good morning everyone.

[John F. Prim:]

Hi, Pete.

[Peter J. Heckmann:]

Kevin, just a few housekeeping things. So, term fees in the fiscal second quarter, how did those compare year-over-year?

[Kevin D. Williams:]

The term fees were up $2.8 million compared to the second quarter last year fee.

[Peter J. Heckmann:]

You said up $2.8 million.

[Kevin D. Williams:]

Yes.

[Peter J. Heckmann:]

Okay. And then I know the acquired revenue was small, but about how much to the base did that contribute in the quarter?

[Kevin D. Williams:]

Less than $1 million.

[Peter J. Heckmann:]

Okay.

[Kevin D. Williams:]

So, our organic revenue growth was still 7%.

[Peter J. Heckmann:]

Got it. Got it. Okay. And then just last question and maybe just a little bit of background. For the second quarter in a row we're seeing the credit union segment continue to really outperform nicely with very, very strong growth but being offset somewhat by a slowdown in the bank side. Can you talk about some of the gives and takes that account for that dynamic?

[John F. Prim:]

Yes, Pete, this is Jack. There were a couple of things. There were a number of larger credit union implementations go-lives that certainly helped and most of those being from an in-house standpoint. The revenue impact, of course, under the new revenue recognition guidelines that we're operating under, so a lot of that's going to show up in the bundled area. But basically, there were a larger number of larger go-lives on the credit union side than what we had on the bank side. The bank side also was somewhat impacted by one of our larger customers being lost in an acquisition. And so there was some revenue impact in the opposite direction on the banking side from that as well.

[Kevin D. Williams:]

Yes, the other thing, Pete, I'd say is we continue to see really strong growth in both outsourcing and payments on the credit union side.

[Peter J. Heckmann:]

Great. That's helpful. Thanks.

[Kevin D. Williams:]

Yep.

[Operator:]

Thank you. And our next question comes from the line of Kartik Mehta with Northcoast Research. Your line is now open.

[Kartik Mehta:]

Hey, morning. Jack, can you just talk about maybe the bank spending environment right now, if you're seeing any changes either up or down?

[John F. Prim:]

Yes. Kartik, it's pretty steady. Different banks are going to be investing in different things, some are doing projects in and around the mobile or online banking implementation or a refreshment. Core systems, there certainly continues to be a movement in that area, somewhat less aggressively on the banking side than on the credit union side and possibly a little less than what we've seen in some previous years. But spending in and around security and related products. So there is no one product I would point to that people are rushing to adopt and it's going to vary from institution to institution as to what their focus area is.

[Kartik Mehta:]

And there is not a lot of talk about mobile obviously. Have you seen any pricing pressure on that or does your model allow you to take advantage of greater clicks that banks are seeing because of use of mobile.

[John F. Prim:]

We haven't really seen any recent pressure. I would tell you that probably 18 months ago we were seeing a fair amount of pressure on some of them, particularly on some of the mobile offerings as some low-cost options became available out in the market. I think we've adjusted accordingly. We have an opportunity to provide for the very price-conscious that want a pretty fully-featured system, but they are more price sensitive. We've got a solid offering there with a low price point on it. For somebody that wants a little more sophisticated mobile offering, we have that option as well, and that's going to be priced a little bit higher. But, as I've said, I think 18 months ago we were seeing more pricing pressure than what we're seeing today.

[Kartik Mehta:]

And then, Kevin, just tax rate going forward, is 34% or 33.5%, a reasonable tax rate to look at going forward because of the R&D tax credit?

[Kevin D. Williams:]

Well, Kartik, like I said in my opening comments, 33.5% is the right rate to use for the third quarter. Fourth quarter it's going to be about 34%, but for FY 2017, it's probably going to be somewhere between 35% and 35.5%, now that they have made the R&D credit permanent.

[Kartik Mehta:]

Perfect. Thanks. I appreciate it.

[Kevin D. Williams:]

Thanks, Kartik.

[Operator:]

Thank you. And our next question comes from the line of Glenn Greene with Oppenheimer. Your line is now open.

[Glenn Greene:]

Thank you. Good morning, guys.

[Kevin D. Williams:]

Hi, Glenn.

[Glenn Greene:]

The first one, just going back on the credit union versus the bank growth, a couple things. So we've had a couple quarters now of credit union growth in sort of this 20% range and I guess there is a few conversions. It's been a nice pipeline of conversions that have been happening. Any reason to think where you don't continue at this sort of like 20% plus growth for another couple of quarters? And then on the bank side, if you could directionally quantify how much of a drag there was from that bank loss, so that we can kind of have a better idea for sort of core growth ex that bank loss?

[Kevin D. Williams:]

Well, Glenn, from the credit union side, yes, I think we should continue to see very good growth for the next couple of quarters. Obviously, when we get in next fiscal year, we're going to start hitting some tougher comps. So I think we're going to continue to see very strong growth in the credit union side at least this fiscal year. On the bank side I'm not sure if I have the numbers right in front of me that tell you what the drag was, but it was obviously a couple of percentage points of revenue in the quarter for not just the one bank but for – there was two or three of them that got acquired or due to repricing that had an impact on payments primarily but it also impacted maintenance and other things.

[Glenn Greene:]

Do you mean two points drag to the banking business or the overall total revenue?

[Kevin D. Williams:]

Banking.

[Glenn Greene:]

And just to be clear on the – you sort of gave the 3Q and the 4Q EPS expectations, including what we've got year-to-date; you're kind of suggesting mid-$2.80s for the year, just to be clear?

[Kevin D. Williams:]

Yes, I think that's where we're going to wind-up, Glenn. I mean we're $1.38 year-to-date. I think third quarter is going to be in the $0.66-ish each range and right now I'm pretty comfortable with that consensus estimate of $0.80 out there in the fourth quarter. I think that gets you to about $2.84 or something like that.

[Glenn Greene:]

And the outsourcing, if I heard it right, it sounded like it decelerated to 7%. Is that for the same reasons that some of those – the bank losses or pricing or...?

[Kevin D. Williams:]

No, actually, Glenn, the outsourcing – if you net out the deconversion fees on outsourcing, it was actually more like a 12% growth year-over-year. So it's pretty much in line with where it has been. The real pressure came in the payments line. If you net out the deconversion fees on the payments line, the payments was only about 4% growth. If you net that out, that's where the real tough grow-over is from the drag from some of the repricing and loss of customers.

[Glenn Greene:]

And then the share buyback, you've been pretty consistent I guess at 1 million shares or so a quarter. Any reason to think you'd change that or perhaps get more aggressive?

[Kevin D. Williams:]

I don't know that we'll get any more aggressive at this point, Glenn, and obviously that's driven by the board, and we have our quarterly board meeting next week. So that will be a discussion at the board meeting just like it is every quarter and we'll decide where we go. But you're right, I mean, we said going into this year that we were going to be a little more aggressive. We bought 2.2 million shares year-to-date, which is about the guidance I gave at the front that we were going to buy for the year. So will we buy some more? Probably, but I don't know that we'll keep the same pace that we have in the first half.

[Glenn Greene:]

Okay, great. Thanks a lot.

[Kevin D. Williams:]

Thanks, Glenn.

[Operator:]

Thank you. And our next question comes from the line of Brett Huff with Stephens, Inc. Your line is now open.

[Brett Huff:]

Good morning, Jack, Kevin and hello, Dave.

[John F. Prim:]

Good morning.

[Brett Huff:]

Quick question on the pipeline, Jack, you talked a little bit about that. As you look forward, and this is kind of I guess tied to a sub question of long-term growth outlook, you guys have been kind of peer leading among your peers for a while on growth, and Kevin you just commented at least for this year that the credit union pipeline looks really good. Can you give us a sense of what are the components of the pipeline that you guys look at most earnestly and how does that translate into how you think about long-term growth I guess combined bank and credit union business over the next few years?

[John F. Prim:]

Brett, I tend to focus more on the total backlog. At this point with license fees representing zero percent of our total revenue, support and services being 96%, hardware on a steady decline, so I tend to just focus more on total backlog, which by and large anymore is almost support and services. But yes, so on the heels of a strong sales quarter, as I mentioned all three brands were over 100%, I think the lowest performance was 105% or 106% from one of the three brands. In spite of that pipelines remained flattish even with closing that volume of business. So I'm not sure if I actually got to the point that you were looking to get to. Kevin, if you would add anything to that.

[Kevin D. Williams:]

Yeah, the other thing I'd add Brett is, one of the things that we obviously continue to focus on is the in to out movement because obviously that's a very good thing for our business long term and currently we're right at the 50% of our existing core customer base that are now outsourced. So we still got a long road ahead of us to continue those conversions. Through the first half, we're right on track to do basically what we did in the previous year. So, I think we did 23% in the first half, we did 46% last year. So, we're right on track to continue that same path, so that's something that I really watch. And then also we continue to look at the payments business and the opportunities we have there, not only just in bill pay, but also in passport and PPS and all of the different payments groups, remote deposit cash where we still got a pretty good runway there. So, those are the sort of things that I kind of look at to look at the future because obviously, as Jack said, those are big drivers, those are all important services and that's what's going to drive us going forward.

[Brett Huff:]

Okay. Any update on the – I can't remember the name of the product, but where you're helping folks outsource more of their – even their front office IT systems.

[Kevin D. Williams:]

Hosted Network Services.

[Brett Huff:]

Yeah, thank you. Any update on that. And you didn't mention that as one of kind of the major growers, but is that still something that could be a part of that growth system?

[Kevin D. Williams:]

I would tell you it's growing nicely Brett. I mean, as we've said originally, this is one that's going to be slow growing things because it's a complicated sale, it's a big decision for an FI to make to give us all of their servers, but it is growing, it's actually ahead of plan and growing very nicely. And is it contributing? Yes. Is it a huge contributor at this point? No. But it's like I said ahead of track.

[Brett Huff:]

Okay.

[John F. Prim:]

I will just add to that, Brett, we're continuing to have increased go-lives, very good success from the institutions that have implemented it. So the reference base is building out there as to the advantage of this approach, and the average contract values that we're seeing continue to increase. So, a lot of good trends happening there. It's just, again, the percentage growth is very solid, but in terms of being to a point where it makes a meaningful impact from a revenue standpoint, not really there yet. But again, with the security environment and the talent acquisition and retention environment, particularly for technically oriented talent that we're all seeing right now, again, we believe that this is a very solid solution that's going to be a nice long-term contributor.

[Brett Huff:]

And then last question, just thinking about margins over the medium term as well, you guys have had good margin performance and nice gross margins this quarter. You guys already have very high margins, kind of where do we go from here and where do the levers, if there are any, that we should be paying attention to?

[Kevin D. Williams:]

Well, Brett, I mean, can some (23

[Brett Huff:]

Great. That's what I needed. Thanks, guys.

[Kevin D. Williams:]

Thanks.

[Operator:]

Thank you. And our next question comes from the line of Dave Koning with Robert W. Baird. Your line is now open.

[David J. Koning:]

Yeah, hey, guys, nice job.

[Kevin D. Williams:]

Thanks, Dave.

[David J. Koning:]

Yeah, I guess just a couple really, the termination fees I know you said would be down year-over-year in Q3, which makes sense. Is that mostly in payments or in outsourcing or a mix?

[Kevin D. Williams:]

It's a mix; it's across the board, Dave.

[David J. Koning:]

Okay. I just wanted to make sure we...

[Kevin D. Williams:]

Last year in the third quarter, we had right at $9.5 million in termination fees and this year we think that's going to be about – under $3 million.

[David J. Koning:]

Okay. But if we just take a few out year-over-year from each like if it's down 6 (25

[Kevin D. Williams:]

Yeah.

[David J. Koning:]

Okay, Okay. And then the other one, hardware, you maybe mentioned this a little earlier too, but hardware was down 14% year-over-year, I know it's immaterial now. Is it like accelerating its declines or should we just expect kind of 5% to 10% declines for a long time?

[Kevin D. Williams:]

I think you can just expect that, Dave. I mean the deal with hardware is, it's hard for us to predict because that's driven by IBM and other hardware providers. And when they come out with new upgrades and what they're going to force the customers to have, and as we continue to move customers from ins to outs, they're not going to be buying hardware upgrades. So it's just going to be a continual decrease in hardware. Now, the hardware margins should stay really solid, because the non-hardware parts of that hardware line of revenue, which is our higher margin business, like our jhaDirect and the (26

[David J. Koning:]

Okay. Good. And then, lastly just, like do the small banks ever ask you about blockchain? I mean, quite honestly, I don't really even understand it very much at all, but is this more of a bigger bank thing that that they're looking at it, or do the small banks every once in a while kind of ask you about it, or I mean is it just a non-issue?

[John F. Prim:]

That's a great question, Dave, and I would say that today small banks are not really asking about it. I fully expect that they will be, simply because there is so much noise in the media about it. We've got a number of folks that are looking at it, and looking at potential applications, which sounds like that's what the whole world is doing right now, is trying to figure out where, if anywhere, the blockchain technology might fit. Its first line of thought tends to be in and around the payments area, because of its original affiliation with Bitcoin. It's possible -certainly some types of payments, they talk about an average potential transaction time, settlement time of around seven minutes. Well, you know, that's pretty quick. If you're talking about something like a cross-border money transfer or a business-to-business payment relative to payment options that are out there today relative to an ATM transaction, relative to a debit card transaction at Target, seven minutes is probably going to be a little long for that to be the best application. And then there is the whole potential other areas of non-payment oriented transactions like land deed transactions, smart contracts and other things. So, there is an awful lot of people trying to figure out where if anywhere this might fit and I would include us in that category at this point. But we're not getting, frankly, questions from any of our customers at this point. But I fully expect that given how much discussion continues to take place around the technology, that that will change and they will want to know more about what it means once they come to understand it a little bit better.

[David J. Koning:]

Yeah, okay. Well, that's great. Thank you.

[John F. Prim:]

Thanks, Dave.

[Operator:]

Our next question comes from the line of Glenn Greene with Oppenheimer. Your line is now open.

[Glenn Greene:]

Thanks. Just a couple follow-ups and that was probably one of the best blockchain answers I have heard in a while. Jack you sort of alluded to that each of your segments was sort of I think trending ahead of quota year-to-date in terms of sales and bookings, could you sort of directionally kind of give us some sense what your sales growth looks like year-to-date across the segments?

[John F. Prim:]

I don't know that I know it on a year-to-date basis, I think there is three brands and I think I have said the lowest was about 105% of quota, one was 120% of quota. And I think the third one was somewhere in between those two, 115%-ish. So, it was a strong sales quota. Now I will tell you that first quarter, two of them were at plan, one was well behind, the overall average was right about 100%. So, we're right around 100% for the first quarter, strong fiscal second quarter and expectation would be 4% to 5% year-over-year.

[Kevin D. Williams:]

Yeah. The numbers Jack has given you Glenn are percentage of quota and I'd tell you that quota for all three brands went up. So, it's a kind of – I don't know that any of us in this room actually calculate that, but I would guesstimate that it's probably 4%, 5% growth over last year in total bookings.

[Glenn Greene:]

Year-to-date. Okay.

[John F. Prim:]

Yeah.

[Glenn Greene:]

And then Kevin, this is a question for you on your favorite topic, the bundled services, but the question really is when does the bundled service accounting turn to a revenue and profit tailwind, meaning I was under the impression that this was sort of a neutral impact and perhaps fiscal 2017, you actually get a benefit from the accounting as you recognize some of that deferred revenue faster than you refill the deferred revenue funnel?

[Kevin D. Williams:]

Well, one of the things I will tell you Glenn and I made sure to point that out in my opening comments. Our deferred revenue went up 7% this year over last year, which is kind of unusual. And my point there is because of the new referrals, we are actually continuing to defer faster than we are recognizing revenues actually through the bundling. So, we are continuing to defer a lot of revenue, could there be some tailwinds come out of that in 2017 as we do some things? Yeah. And I will tell you Glenn with the new referrals coming out and they keep changing the date, it's either 2018 or 2019 now. We are going to have to do some things to try to ramp-up those contracts, get the revenue out and the timing of that – some of that is not up to us, some of that is up to the customers when they'll actually either accept the products or whatever. So could there be some tailwinds in 2017? Yeah, but right now we're still deferring faster than we're recognizing.

[Glenn Greene:]

Okay. Great. Thanks.

[Kevin D. Williams:]

Yep.

[Operator:]

Thank you. And I'm not showing any further questions at this time. I would now like to turn the call back to Mr. Kevin Williams for closing remarks.

[Kevin D. Williams:]

Thanks, Chelsea. First of all, I'd like to remind everyone that we are going to hold an analyst event this year, Analyst Day 2016. We're going to hold that on the afternoon of May 9, and we're going to change the venue a little bit, we're going to have it at the Western Property at the Denver, Colorado Airport. It will be easy for everybody to fly in and fly out, similar to what we've done at Dallas for the last few years. Presentations by all the executives and division presidents will be Monday afternoon, and then we'll follow that with a reception and many tech fairs to highlight some of our products that evening. If you'd like to attend this, just shoot me an email and I'll get you a link to the registration site. With that, I'd like to thank you all for joining us today to review our second quarter fiscal 2016 results. We're pleased with the results from our ongoing operations and the efforts of all of our associates who take care of our customers. Our executives, managers and all of our associates continue to focus on what is best for our customers and our shareholders. With that, I want to thank you all again. And Chelsea, will you please provide the replay number now?

[Operator:]

Certainly. Ladies and gentlemen, this conference will be available for replay after 11