Jack Henry & Associates Inc (JKHY) 2004 Q2 法說會逐字稿

Welcome to the Jack Henry & Associates second-quarter fiscal year 2004 conference call. Today's conference is being recorded. At this time I would like to turn the conference over to the Chief Financial Officer, Mr. Kevin Williams. Please go ahead, sir.

Welcome to the Jack Henry & Associates second-quarter fiscal '04 earnings conference call. First of all, the forward-looking statement. Statements or responses to questions may be made in this conversation which are forward-looking or deal with expectations about the future. Like any statement about the future these are subject to a number of factors which could cause actual results to differ materially from those which we anticipate. Such factors are disclosed in our recent SEC filings. There could also be other factors not included that could potentially cause results to differ materially.

Again, thank you for joining us today as we report our second-quarter fiscal 2004 financial results, which reflect a nice 10 percent increase in revenues, improved gross margins, a very much continued strong balance sheet, increased operating cash flows, and a very solid backlog compared to the same quarter a year ago.

Our total revenues increased 10 percent, with a small dollar decrease in the license revenue, which is primarily due to the timing of delivery of software in our credit union segment this year compared to the prior year. We had another large increase in support and services of 19 percent compared to the prior year quarter, with our continued success in the outsourcing marketplace, our growing ATM and debit card processing business, and additional in-house support fees. Hardware revenues, which is typically driven by software sales, decreased 4 percent, which basically is in line with the decrease in our license revenue.

The three components of our revenue consisted of our license revenue, went down 10 percent or $1.4 million, as I mentioned previously; our support and services went up 19 percent or 12.5 million; hardware sales went down just slightly under $1 million; for a total increase in revenues of $10.2 million.

In regards to our cost of sales, which increased 4 percent in the quarter, our total hardware sales represent 21 percent of total revenue this quarter, compared to 24 percent of total revenue the same quarter a year ago, which means, obviously, as we have said and predicted for quite some time, as hardware is going to continue to become a smaller portion of our total revenue. Our cost of hardware decreased by 12 percent, while hardware revenue decreased by only 4 percent, which obviously had a very positive impact on hardware margins.

Gross margin on hardware revenues this quarter was 32 percent, compared to 26 percent a year ago, which is primarily due to increased sales of IBM iSeries and pSeries boxes this quarter compared to the prior year, which carry very solid margins. We also had increased rebates and incentives from vendors on hardware sales due to volumes and types of hardware sold this quarter. As we have discussed before, our margin can be significantly affected by sales mix, rebates, and incentives when it comes to hardware.

Our cost of support and services increased 11 percent for the quarter compared to the prior year period. This compared to a 19 percent increase in support and service revenue for the same period, which is due primarily to the increases in every component included in this line of revenue, which are installation services, ATM/Debit card switch services, outsourcing, and in-house support revenues.

We continue to leverage our resources, infrastructure, and our general managers and employees continue to be very conscious of cost controls, which our biggest expense and asset by far continues to be our people. Our people costs continue to make just under 60 percent of our total cost of services. Having said that, we continue to have needs and requirements to add employees, and we added 31 full-time employees since this time last year when we put the existing controls in place.

Our gross margin this quarter was up nicely, up to 40 percent compared to 36 percent last year in the same quarter. Our hardware margins as I said earlier have increased 32 percent from 26 percent. Also our support and service margin increased to 33 percent from 28 percent in the same period a year ago. License margins increased to 98 percent compared to 93 percent a year ago, which is primarily just due to fewer third-party licenses being delivered in the quarter.

Our banking segment gross margins increased to 40 percent from 38 percent in the second quarter a year ago; and our credit union segment gross margins increased to 36 percent from 24 percent a year ago, which is an anticipated expansion with the additional products and types of services now being sold in the credit union segment. The expanded margins in the credit union segment is even more impressive considering there was a small decrease in total license revenue in that segment, which obviously carries the highest margins. And this is due to the timing of deliveries, as I previously mentioned.

Operating expenses increased 19 percent this quarter compared to last year's quarter, and as a percentage of revenue increased to 20 percent from 18 percent of total revenue. Our selling and marketing expense increased by 11 percent compared to prior year quarter. This increase is primarily driven by increased commissions on increased revenues and a small increase in personnel costs associated with number of sales staff. As a percentage of revenue selling and marketing remained relatively flat at 8 percent this year compared to 7 percent a year ago.

Research and development expense increased by 49 percent compared to last year; however, as a percentage of revenue there was only a slight increase from 4 percent of revenue to 5 percent. This total increase is primarily due to the increased personnel cost to continue developing new products and improve existing products compared to this time last year. Also this time last year there were several large projects under development which were being capitalized; and at this time there are no large significant developments underway.

Our G&A expense increased 9 percent over last year's quarter, and as a percentage of revenue remained flat at 7 percent. Operating (technical difficulty) 24 percent over prior year quarter, and as a percentage of revenue increase to 20 percent from 18 percent last year, which is a nice increase in operating margins.

The change in other income again primarily is due to interest income increasing about $90,000, which is due to increased levels of cash in our money market account. The effective tax rate remained unchanged at 36.5 percent. The result is an increase in net income of 24 percent to 14.5 million, and earnings per share increase of 21 percent to 16 percent compared to 13 cents in the prior year quarter.

A couple of comments about the balance sheet. The majority of the significant changes compared to last year are obviously a 251 percent increase in cash and cash equivalents, which is tied primarily to timing of annual support billing; and also just some spending was down this quarter compared to a year ago.

Also during the six months ended, we had capital expenditures of 24.9 million this year; and we paid dividends of 6.2 million, which compared to last year is somewhat relatively flat. Accounts Receivable decreased by 8 percent compared to last year, due to our collections department continuing to do a very good job. Change in Accounts Payable accrued expense is primarily due to timing of payments. Our deferred revenue, which is primarily prepayments for in-house support, has increased 25 percent from last year at this time, due to the shift in billing for acquired customers.

Our backlog as increased by 16 percent at December 31, compared to the same time last year. Total backlog increased to 182.5 million, with 60 million in-house and 122.5 outsourced; compared to 158 million last year, with 57.6 in-house and 100.4 outsourced. Total backlog increased slightly more than 3 percent compared to the September quarter, and remained relatively flat compared to June 30, with a nice increase in outsourcing.

After a review of our backlog, sales forecast, and sales pipeline I am currently comfortable with the range of consensus estimates for the next fiscal quarter and this fiscal year, which I believe the consensus for this third quarter is approximately 17 cents and for the year it is approximately 66 to 67 cents. Also in the third quarter backlog should continue to be strong and quite possibly continue to increase for both in-house and outsourcing.

With me today I have Mike Henry, CEO, and Tony Wormington, our COO, here in Monett; and on the phone with us is Jack Prim, our President. We remain confident that we are very well positioned and that we have the right products and services to approach both the bank and credit union markets, from the smallest institutions and de novos to the largest We also believe we have the proper resources in both people and technology for continued future opportunities.

With that, I will open the call up for questions. Jennifer, will you please start taking questions?

(OPERATOR INSTRUCTIONS) Kartik Mehta with Midwest Research.

A couple of questions. The sales of core systems, you said they are a little bit slow but they're starting to pick up a little bit. Just trying to get a little bit more color. Does it continue to be the environment that is out there? Or is it competition or pricing that is making it go a little bit slower than before?

It is a combination of things. On the banking side of the business, it is highly competitive and somewhat more of a mature market. We are also seeing a good bit of interest in outsourcing as compared to in-house alternatives on the banking side of the business.

The credit union side of the business, there are plenty of competitors, but it is a more fragmented market. So we have seen a few more in the way of new footprints there, and there is also more of a preference at this point in time for in-house solutions as opposed to outsourced solutions; although we are offering all of our products in both delivery methods.

So a combination of the environment, and in some cases competition, in cases just the focus of certain market groups.

You also said you're seeing interest from large financial institutions for the core system. Could you, from an asset size perspective maybe, give us an idea of how big those institutions are?

We are seeing those primarily in the over $2 billion market space. I would say up to the 8 to $10 billion market space. Those deals as you might imagine tend to be a little slower in developing and coming to a conclusion. But we are starting to see some interest at that end of the market.

A question on the ATM and debit processing. I am assuming that you are gaining market share there. I was just wondering what type of value add services you might be providing that's allowing you to win market share.

Primarily being able to deal -- again we sell that primarily to our own customers. We would sell our ATM/Debit card services to non-core software customers; but frankly we don't go out looking for that kind of business. But for our core customers there is a convenience factor of dealing with one vendor for both the data processing and ATM EFT services.

There is also an integration factor that allows us to do a little more real-time functionality, in terms of some of the ATM/Debit card processing, as compared to more batch-oriented alternatives that they might have to do if they went with a separate switch provider. So a combination of having one phone number to call for both products and the additional functionality.

The other thing I would there is one of the big drivers in our ATM/Debit services is the traction we're getting on the credit union side. Our ATM/Debit switch revenue went up a little over 40 percent this quarter compared to a year ago; and somewhere between a third and a half of that increase is new expansion in the credit union space. So we are getting some very good traction in that space, which obviously is having a very good impact on the gross margins on the credit union side.

Great, thank you very much.

Pete Swanson with Piper Jaffray.

Kevin, I was wondering if we could drill down a little more on the ATM and debit. Can you give us a level of how much revenue that is as a percentage of the support and service? And also if you could tell us about the outsource as well?

The ATM/Debit piece, Pete, is about 12 percent of that line of revenue. And the outsourcing piece is -- I am doing these numbers in my head -- 27 percent, probably, is that line.

Can you talk about maybe what the organic growth in the ATM and debit, if you were not adding the new credit unions and new banks, what the actual transactions are growing at?

I have no idea, Pete. We don't try to keep track of transactions from existing customers, because it all goes into one big bucket. As far as we are concerned, if they're our core customers it is all organic growth anyway.

That is fair. Just a question on the in-house business. You seemed pretty optimistic about it last quarter on the call, coming out of your users conference. Has there been a change in that throughout the quarter, given where the market is at and some increased competition?

You could sum it up by saying if we were disappointed in anything at all this quarter it would be we are a little disappointed in brand-new in-house footprint. It continues, as Jack said, it continues to be very competitive out there. The deals are out there. We are just a little bit disappointed in those numbers.

We are still optimistic. As you know we had a change in our sales staff and we are picking up steam with that. But it is a little bit disappointing. Everything else, the outsourcing piece is going great; the ATM piece is going great. That is the only piece probably that is a little bit short.

I would just add to that, that a couple of strategies that we unfolded last year have certainly begun to show signs of improvement. The low-end solution on the credit union side that we did with the acquisition of CU Solutions has really begun to get traction in the market. We have seen a good number of new footprints there.

Our repackaged offering of Core Director likewise has been getting good reception in the market as well. The challenge there is that the license fees that are associated with those low-end solutions are pretty small. So it is not going to pay off like a license fee sale to a $5 billion bank would pay off. Again I think that the strategy is proving out and is accomplishing what we had hoped there. It has been a little slower at the higher end of the market.

The credit union business in particular continues to look very strong. Some of the larger deals that we are looking at have tended to get a little more bogged down in the contract review process. They are just taking a little longer to bring to closure than what we were seeing a year ago. But again, very solid on the credit union side.

Banking, again, from a new footprint, outsource is a strong business. It has been a little slower certainly than we would like to see as far as the in-house opportunities.

One thing I would add to that is, to echo Jack's sentiment, that the small credit unions and small banks, it takes a whole bunch of those to make one Silverlake deal or one Episys deal. But by gaining additional footprints, what that allows us to do is get in the door and cross-sell those additional products, which we can make some nice money and nice margins off of, such as our ATM/debit switch services.

Great, thanks a lot.

John Kraft with D&A Davidson.

Just two follow-up on the comment you made on the last question. The sales realignment; have you lost any salespeople? How is that whole realignment going?

The realignment is going very well. We have not lost any salespeople that I am aware of. At the time we made the transition, we may have taken some actions for performance reasons on a couple. But we have not lost any salespeople as a result of the transition.

The salespeople are actually pretty excited about the opportunities that they are engaged with. I think they certainly see the value of the model. Probably a little frustration on their end that things maybe have not come to fruition as fast as we would have liked to have seen. But at the same time feeling good about the pipeline of prospects that they are building up.

Okay. Then Kevin, in the past you have given us some of the product sales for some of the complementary products, like CRM and NetTeller and check imaging. Do you have any of those numbers in front of you?

Sure. For check imaging for the quarter we sold 37 new deals, which is up from 31 in the first quarter. NetTeller we sold 33, which is basically flat with the 34 we sold in the first quarter. And CRM we did not sell any new ARGO deals; but the Synapsys that came from the Transcend acquisition, we sold nine of those in the quarter, which was a very strong quarter for CRM.

Great, thanks.

Bryan Keane with Prudential.

Just the license revenues, they are a lighter like than I was expecting. Is it typically just one or two deals that doesn't close in a given quarter? Or what happened exactly this quarter, that last quarter was a lot stronger there?

I would say we probably had four or five deals that moved out; and we expect to see those ending up closing in the January or early February time frame. Kevin, I don't know if you had anything on that, compared to last quarter. That seems like the year ago to me?

Actually there were some deals that we really thought were going to close in the September quarter that have actually slid into January. But we think those deals are actually going to close this quarter, as Jack said. So that does impact the timing, because obviously we're not going to ship them the day we close the deals anyway. So that is part of it.

Plus just the average size of the deals we have sold have been smaller. We have continued to take quite a bit of footprint in the last two quarters; but as Jack mentioned to somebody's previous question, we have gotten some pretty good traction with our Cruise product in the smaller credit unions and our Core Director repackage in the small banks; and it takes a whole bunch of those to get to the same size as licensed softwares as Silverlake.

But I will point out one thing. Our install revenues are up nicely over this quarter last year and even over the first quarter. So we are continuing to install some software up there and gain footprints which is going to continue to recurring revenue no matter how you look at it.

And the increase you're expecting in the in-house backlog that you mentioned on some of your previous comments, is that also due to just the pipeline and the way you think business will come in?

Yes, obviously we do monthly forecast reviews with our national sales manager and his staff. We have gone through that. Basically we look at that plus pipeline; and we drop that into a model. We make our best guess at what I think backlog is going to be at the end of the quarter, based on timing of closure and when those deals can actually be shipped and delivered.

Finally just I'd be interested in your assessment of the financial community's IT spending budget outlook for '04. Do you see a big improvement, or a vast improvement over the last couple of years? Or have you seen people slowly come back to maybe starting to spend a little bit?

I think that I wouldn't say a vast improvement over past years. I think people have spent money all along; it is just how they have spent it. They have tended to spend some money to make sure the existing systems that they had in place were performing at full capacity; and taking full advantage of investments that they had already made.

We are beginning to see some additional investments. Check 21 legislation is leading to some interest in some of our both in-house and outsourced item processing capabilities. Our continued expansion of item processing sites we think is going to open up some additional opportunities for us in that regard.

But I would not say that I expect to see dramatic improvements in the rate of spending by financial institutions. I think again they are spending where they need to spend money. There are going to be some folks who need to change their core systems; there are going to be others that are going to be more focus on things like Check 21 and image systems; things of that nature.

Probably the other thing that we see heightened interest that is going to continue ongoing is anything that has to do with security and fraud is where banks are going to be spending some money.

Okay, that is helpful. Thanks.

Glenn Greene, ThinkEquity Partners.

Following up on the last question, the deals that, Kevin, you said slipped; and Jack I think you said four to five deals may have slipped. I am wondering what order of magnitude, the size of those deals? Are those larger financial institutions that we're talking about?

I think the ones that Jack was specifically talking about were some larger credit union deals; which all of those were basically almost seven-digit deals. So when you start looking at those size of deals slipping and you get four or five of them, you really feel it in your backlog.

Understood. The gross margin trends. Kevin, you have made a comment previously that the credit union margins can get up to the bank systems margins by the end of the year. Are you still comfortable that they can get up to that 40 percent level?

For the year, no. But by the end of the year, by June 30, I think they can be closing in on it by the fourth quarter going forward. So going into fiscal '05 they should be contributing nicely to the margin. Depending on the timing of some of the outsource deals that we get installed, there is no reason our margins on the outsourced credit union customers can't be at or above what we are seeing on the bank side.

The operating expenses going forward, how should we think about them? Specifically I am talking about the increase in the R&D year-over-year. Is that sort of a trend that we should think about for the next couple of quarters, at least?

Two things. One, if you go back and pull my cash flow statement and take the capitalized software plus R&D expense and add those together; I mean for the last eight quarters it is roughly 5 percent of revenues. If you go back to like last year for the first six monthly, we had capitalized almost $3 million in software because of the large deals I was talking about. This year we capitalized a million.

So yes, I think going forward, unless we have another large development effort going on that we're going to capitalize, and again we are very conservative; it has to be basically a six-digit cost before we would think about capitalizing it. So it has to be a pretty large deal. And as long as we don't have any of those going on, then the R&D expense level is probably where it is going to be.

Okay, thanks a lot.

Nik Fisken with Stephens Inc.

Can you give us an update on ARGO? I know we had some that were in beta that were going live. You said there are no sales, but can you give us an update on how much is left in backlog? Also an update on the US Central conversion that was supposed to happen in January? And just a general update on U.S. Central?

On the ARGO project we have two institutions that are up and live and running today, with both the deposits and the CRM applications. We are closing in on beta with one of the institutions for the lending pieces. And we will be moving into the second institution as well in beta shortly, and expect to get the lending pieces installed. I am talking primarily on the Silverlake side there.

From the OSG or Core Director side we are running both the teller deposits applications live; and we will be moving the lending pieces into beta fairly shortly there as well. From the US Central side, Jack do you want to take that piece?

Yes. Nick, in fact I was up there for a meeting last Friday. It is going very well. Made tremendous progress. This again was a major development effort to make some changes to the system to accommodate the unique requirements that US Central has.

The First Corporate credit union conversion is probably going to be delayed about a month. Combination of reasons for that. Certain amount of scope creep in the deliverable; some things that as we got into it that were decided to add functionality-wise that were not originally part of the original scope. It has taking a little longer. US Central wants some additional test time on those and a number of other functions.

And I think the First Corporate that we have scheduled also wanted a little additional test time for that. So we are probably delaying that about a month. Also given the visibility that a lot of folks will be watching that First Corporate, we want to make sure all of the t's are crossed and i's are dotted. But it is going very well. We feel very good about it.

As far as backlog on the Argo piece, and I don't have the exact numbers with me, but I'm thinking there's somewhere between 2 and $3 million in software still in backlog that will be recognized when we deliver the lending pieces.

We haven't had a sale, and ARGO sale, in a couple, maybe three quarters. Is there something there or has the salesforce reorganization affected that? Kind of walk us through that.

I don't think it is the salesforce reorganization. It is more we were very fortunate to sell three large ARGO deals without anything to show them. I think at our FIS (ph) meeting a year ago, almost a year ago, there was some heightened interest because there was actually now something they could see.

But we actually need to get all of the pieces in, through beta, and basically ready for GEA (ph) so they will have something they can go kick the tires and see that it is really real and feel it. And basically get some feedback form the customers that already bought it, to see what it is doing for them. I think when we get to that point you'll see an increase in selling. But the sales realignment in my opinion has had nothing to do with the ARGO sales.

I would say that system is a pretty substantial financial commitment on the part of an institution. We knew going into this there is a limited number of our customers that are going to be prospects for this solution. I certainly think there is enough of them to make it a worthwhile venture. But it is going to be a fairly unique, or a fairly limited I should probably say, number of folks that this solution will apply to.

Again I think that as some of the folks who had the more pressing needs, as Kevin said, jumped on early on and helped us develop the product. I think the other folks want to be able to touch and feel a little bit more before they commit the kind of revenues that they would have to, to this type of solution.

The other thing, remember, is we have got another CRM solution that surprisingly some of our pretty large banks are taking a look at it, rather than the ARGO solution. Obviously we don't really care which one they buy, as long as they buy one from us.

Lastly, we beat the software license on the credit union to death; but we haven't talked about the banking side. Mike, you said that it was a little light. Were you speaking specifically on the credit unions? Or was it a general comment on banking too?

That was a general comment on banking in-house. We have talked about it for the last four or five quarters that it has been a little light. We have talked about some of those. We have had some deals move both on the banking and credit union side. Again, it is a little bit light; but that is specifically on the banking in-house side. The rest of its numbers are pretty healthy.

I will tell you that the license revenue for banks was basically down slightly, and I mean very slightly, from a year-ago quarter. Credit union license revenue was down in low double-digits from a year ago. So that is what I said. For my credit union margins to increase from 24 to 36 percent quarter over quarter and the license revenue to go down in low double-digits, we are going some good things on that side of the business.

That would tell me that the gross margin should accelerate from here throughout the end of the fiscal year?

I don't know; it depends on how you define accelerate. Like I said, I think we can continue to expand the gross margins on the credit union side; and by June 30, we can have the credit union side up in line with the banking at 40 percent or thereabouts; which obviously is going to have a nice impact on the overall total, because the credit union continues to grow at a pretty healthy pace.

But the overall trend is increased margins. But a lot of things impact that, as far as timing of when you will see those margins up around the banking margins; has to do a lot with new in-house sales, ATM sales, etc. But we have come a long way on the margins, and we believe we can continue to improve them to a point.

Okay, thank you. Congrats on the progress.

Carla Cooper with Robert W. Baird.

Kevin, you made the comment; and I guess I want to make sure I have it right, about the number of installations being up year-over-year. Did I hear that right?

Yes, the number of new footprint installations, Carla?

Yes. Jack, what do you think? That is important obviously because you are expanding it into new banks. Was that sort of what was behind your thinking when you said that?

I am not sure I understand your question. If you're asking where the new footprints are coming from?

Just trying understand, I am trying to put perspective around the idea that the license revenue was a little weaker; but your comment that it seems to sort of be different; a little more positive.

The number of footprints has increased, Carla. It is the size of the footprints. We are leaving rabbit tracks in the snow instead of bear tracks, I guess. We are doing more deals but they are smaller license fees with our low-end credit union solution and our repackaged Core Director solution.

We had a number of the larger Episys deals on the credit union side that slipped, as I indicated, hopefully we believe into the first couple of months of this quarter. It is really more deals but smaller deals that we have been able to continue doing there.

And both those, Carla, is because it is products that we now have that we didn't have a year ago.

We made a real effort beginning this year, a real strategy that we were going to do much better in the small bank and small credit union marketplace. And I think we have done that. We haven't ignored the larger institutions, but we have made a lot of progress where we wanted to make progress (technical difficulty) piece of the marketplace that, although we were playing in, we were not winning very many deals.

Okay. When you think about, Mike, going back to those comments that competition is extremely tough on the in-house, I think you said bank side in particular, have certain competitors changed their tactics? Or do you think this is timing of spending and budgeting?

The banking side is pretty price competitive right now. Not so much on the credit union side, because we have got so much traction on the credit union side. But I will say that pricing is pretty competitive out there. If you take a look at some of our competitors, they are pretty strong competitors with a good balance sheet. So pricing can become an issue, in not just the outsourcing deals but also on the in-house deals. So I would say there is some competitive pricing out there.

Let me just throw a couple numbers at you. One of the banks that will back up the comment that the deals we are doing are smaller, obviously we have had more footprint. Year-to-date compared to a year ago our license fees are basically flat; our installation revenues are up over 20 percent compared to the first six months a year ago. Which means we're doing a whole bunch of installs out there. It is just the revenue dollars from the license fees are smaller.

Thank you.

David Trossman with the tibia security.

Kevin, are you amortizing your Christmas bonuses across all the quarters this year? Or is it tough to see in (technical difficulty) the December results?

It was all in December. That is still a discretionary bonus, David, even though we have done it every year. It is still at the discretion of the Board and senior management. It is kind of hard for me to spread it over four quarters.

Can you give us a rough idea how much that was? I think in the past it has been 2 or 3 million?

Slightly over $2 million with fringes.

Jack, can you give us a quick update on the couple item-processing centers that have opened up over the last 12 months? Where have those been, in the ramp of where you want them to be towards getting to capacity and profitability levels that you want?

Let's see. New Jersey, David, is open, operational, and profitable. Hartford area in Connecticut is open, operational, and very, very close to profitability. The Chicago center was an acquired center; it was profitable, remains profitable, and with a number of prospects that we are working with it that should be able to leverage that even further.

The Atlanta center is scheduled to open in early March; so again we expect a pretty quick ramp up there, but again that one isn't open yet, but is tracking for an early March opening. We are pleased with the progress that we are seeing there.

Couple of other things we have done there, David, is we have moved all the data customers off the Miami facility we acquired back in '99. Those are all being processed out of our Allen facility now. So we are actually leveraging those resources better. The Miami facility is now just a dedicated IP (ph) center. Also the credit union piece is open and running in the Lenexa, Kansas, facility; so we continue to expand on those infrastructure and resources also. That is also profitable.

Thanks for the update.

Pete Heckmann, Stifl Nicolaus.

In terms of some slowness in contract signing, do you think that -- I have been reading a little bit about Fiserv's ITI subsidiary and their beta testing of their platform on an IBM iSeries platform, as opposed to their traditional Unisys platform. Is some slowness do you think attributable to the fact the banks are waiting to see how well that platform works on the IBM platform?

My understanding is they had some beta in the December quarter and they are going to go to general availability sometime in perhaps February or March. Is that one of the reasons you think banks might be slow to make a decision, is they are waiting to sort of the functionality and success of that platform?

Absolutely; we do not believe that has had any effect on us whatsoever. Could not guess what if any effect that will have next year. But no, I would attribute none of that to ITI's move to the iSeries.

Then how do you read that? Is that something that is an endorsement of your platform perhaps? Or will it become a competitive threat in the next year?

I don't think there is any question that the iSeries platform is the most popular platform for banking. IBM is such a great business partner you don't have to sell around, if you are a hardware vendor. It is very strong. It is a very stable platform. I certainly can see someone's interest in the iSeries because of its popularity in banking and many other marketplaces that we don't serve. But there is a lot of them out there, and IBM is sure a great partner.

Can you comment a little bit; we have seen a relatively low level of bank M&A over the last three or four years, to the extent that it may heat up as banks look to copy B of A, J.P. Morgan Chase. Can you talk a little bit about what you are putting into contracts that protects you from bank M&A? Just in general, to the extent that you have a forecast for medium-sized bank M&A over the next year or so, if you can comment on that?

I certainly think M&A is heating up now. De novos are heating up too. We are selling a lot of de novos. We're doing a lot of what we call convert merges with our customers, our customers who are acquiring.

As far as contracts go, if you lose an outsource customer they have to buy out the remainder of their contract, so you have revenue there. On the in-house side, you charge for your software maintenance for a year in advance; but you're going to lose that software maintenance ongoing. So yes, when we lose a bank we are going to lose some money, if you look out over five years in time.

But when our customers acquire we gain lots of revenues on the installation, software, hardware, maintenance side. So yes, if I were a betting man I would say that M&A is heating up and will continue to heat up for the next year or two.

I think large deals like the B of A transaction, that is going to spur a whole bunch of de novos because there will be a whole lot of senior executives that will be out on the streets; and the best thing (technical difficulty) they going to do is start up a bank.

I think in any marketplace when the economy improves you will see companies and banks being a little bit more aggressive in what they are doing out there.

The other thing is typically when a de novo signs up, because there is very little capital outlay, they take everything we have to offer. And they can basically offer products that the guy that just fired them cannot offer.

Talk to me a little bit more about how you price those de novos. Do have the bank in the box solution, where you wrap it all up? And how do you price that? And how do you compensate or price in the fact that you expect some fairly rapid growth from them over a short period of time?

We have done a lot of work on bank in a box to get them up and going very easily; and that has really paid dividends. If I had to point to one thing that is making us much more successful in de novos it is our upgrade of our marketing and sales materials, making it really easy for these de novos to get up and running without much work. It will continue to pay off.

All right, thank you.

We do put minimum payments on those banks. So even if they only open with five accounts there are still minimums in the contract that they have to pay until they get to a certain size and get over that minimum, and continue to grow.

Then as they grow, the monthly payment they pay us obviously grows based on number of accounts and volume of transactions.

Tim Willi with A.G. Edwards.

Kevin, on the software business, the cost of goods sold; I think you said that that dropped fairly notably from prior quarters due to lower third-party licenses. Is that correct?

Yes, obviously we have relationships with ARGO; and through the credit union space there are several third parties that we sell their software. This quarter compared to same quarter a year ago, we just sold more of our own products and we did the third-party product.

Was this sort of an aberration in terms of your own product versus others? Would we expect that cost of good sold to be more in that somewhere between 800 to 1.2 million range like it had been?

I don't know the answer to that. This is kind of like hardware. It is going to shift from quarter to quarter and I don't know there is any real way to predict it. About the only way that I could predict that would be for me to go through my backlog report in very much detail, and try to pick out the exact third party stuff that is going to be shipped and delivered in a specific quarter. That is a little more detail than I care to delve into.

Understood. Second thing, more on the people side; you talked about 31 new hires. I was curious. Is that more in the R&D side? Or is this on customer and sales support, where you're adding the headcount? Or is it pretty evenly distributed?

It is pretty evenly distributed. It may be a little heavier on the R&D side, because we were a little light on the R&D side a year ago, especially with some of the large projects that we undertook. But one of the things that we did a year ago was we went through a kind of a rating project with all of our employees. And we challenged our general managers to get the underperformers either up to speed or out the door. They have done a very good job of that.

We didn't have layoffs or writs (ph) or anything; but we used the slow economic times as a good opportunity to upgrade our people. We have added 31 people, but we have probably had a closer to 300 people because of replacements as we have gotten rid of some of the underperformers.

Okay. Lastly on the salesforce realignment, could you share with us any changes that were put in place in terms of the incentive and compensation systems, as you went through the process of figuring out how to realign the salesforce? Were there changes in terms of how they are getting paid, what their incentives are? Or is it pretty much the same kind of plans that were in place on the competition side?

They got changed a little bit, because we knew that it was going to take the hunters a little time to get some traction. The farmers, they basically already had so many things in the pipeline that they just basically hit the ground running, and it was a nice clean hand-off. We did change the base pay slightly for the hunters, to make it a little more equal and fair for them. But it is not significant enough that you would notice on the bottom line, Tim.

Okay, great.

(OPERATOR INSTRUCTIONS) Pete Swanson with Piper Jaffray.

Just wondering if I could get your comments on the outlook for acquisitions, if that has changed at all recently?

Nope. Our pipeline of acquisitions is healthy, and it remains the same sort of strategy and vision that we have had for acquisitions in the past. So if and when those acquisitions happen, I don't think you'll see any surprises. We're still going down the same acquisition path, and it is a healthy pipeline. That is about it.

Obviously we are not going to go too far out in left-field. Like we said before, we're not going to go out and do an acquisition that makes you all read the press release and wonder what in the world the boys in Monett are doing. There may be a little diversification going on; but it is basically still in the financial institution arena.

Okay, thank you.

It appears we have no further questions. Mr. Williams, I will turn the conference back over to you for any additional or closing remarks.

Again, we want to thank you for joining us today to review our second-quarter fiscal 2004 results. We were pleased with the overall financial performance during the quarter. We continue to expand and improve our products and services. And we are committed to continue building on all of our competitive strengths.

Our executives, managers, and employees continue to do what is best for you, our shareholders. Again, thank you. And with that, operator, would you please provide the replay number?

Thank you for joining today's conference call. If you would like to listen to the replay of this conference, it will be available from 11:30 AM Eastern time today through midnight Tuesday, January 27. The dial-in number in the United States is 888-203-1112; or internationally 719-457-0820. The confirmation code you will need to access the replay is 102011. Thank you for your participation. You may disconnect at this time.