Jack Henry & Associates Inc (JKHY) 2009 Q2 法說會逐字稿

Good day and welcome to the Jack Henry Q2 fiscal year 2009 conference call. Today's conference is being recorded. With us today is Chief Executive Officer, Mr.Jack Prim, Chief Financial Officer, Mr. Kevin Williams, and President, Mr. Tony Wormington.

At this time I would like to turn the call over to Mr. Kevin Williams. Please go ahead, sir.

Thank you Connie. Good morning. and welcome to the Jack Henry Associates second quarter fiscal 2009 earnings call. Statements or response to questions may be made in this conversation which are forward looking or deal with expectations about the future. Like any say about the future these are subject to a number of factors which can cause actual results to differ materially from those which we anticipate. Such factors are are disclosed in our recent SEC filings. There could also be other factors not included that could potentially cause results to differ materially. Again we are pleased to host the call this morning provide a company update or report our financial results for the second fiscal quarter ended December 31, 2008. With that, I will now turn the call over to Jack Prim, our CEO.

Thanks Kevin. We continue to see a cautious outlook by our financial institution customers during the quarter regarding discretionary hardware and software expenditures. In most cases, this caution stems more from uncertainty about the economic environment than from their actual financial performance. While the majority of our customers are delivering generally solid financial performances, they are facing a number of areas of likely future cost increases in areas such regulatory compliance, increased FDIC insurance costs, corporate credit union recapitalization charges, and potential challenges in their customer base as unemployment rates appear likely to increase. We expect the discretionary spending items to remain a challenge until some sign of economic stability are on the horizon. While new inhouse core system sales, year to date, in the credit union segment continue to run well ahead of a year ago period, the average size credit union contracted was roughly half the size from a year ago.

This again, is more a reflection of institutions that happen to be in the evaluation cycle at the moment than anything related to the economy. However, combined with the add on software license impact seen in pretty much all product categories in the bank and credit union segments, we saw a decrease of 36% in license fee revenues compared to a year ago period. Hardware sales were again down compared to year ago period by 14%. The majority of the impact here was related to produce I series and P series servers from IBM. As mentioned on the last quarter call, IBM had a November, 2007, upgrade path deadline for a popular model of their I series, which drove some processor upgrade in the September and December quarters last year with no comparable catalyst in the 2008 quarters. Remote deposit scanner sales were essentially in line with sales of a year ago quarter. And, the number of installed banks and merchant is up substantially. A contributing factor to the hardware sales decline is the continued movement of banks from inhouse to outsource processing. As we have previously discussed, this approach had continued to gain interest primarily in the banking segment where the number more than doubled last fiscal year to 27 and is currently running ahead of this point a year ago. We have also begun to see interest in the credit union segment and last fiscal year we had three credit unions make a similar transition and have already had three sign up in the first six months of this fiscal year.

These transitions result in increased total revenue compared to the inhouse environment and increased recurring revenue on multi-year contracts. They were significant contributors to the 16% year over year growth in the backlog compared to a year ago. I would point out that all the growth in backlog was due to additional booked business and not to delayed implementation. Support services had a stronger performance than would be indicated by the 7% year over year growth. When you look at the fundamental of that business, the year ago period had a significantly higher early termination fees which when factored out would indicate growth of 10% in this line item. The EIT business would have shown growth of 24% on the bill payment , ATM debit and remote deposit component of this line item, rather than the 18% growth when including these charges. We have talked before about the decline in the check 21 image exchange component of the EFT business. And eliminating that component from both periods would indicate total year over year EFT growth of 29% of the quarter, again as compared to 18% growth when including these items.

Our outsource data processing revenues were flat in the quarter when including early termination fees, but were up 8% when excluding them. Our inhouse maintenance showed solid growth of 10% reflecting maintenance revenue on added complementary products. Implementation revenues were down 11% year over year due to reduced convert merge activities. Fewer DNOVO bank implementations and smaller average credit union limitations. These additional comparisons are not intended to confuse your analysis of the business but are offered in hopes it will help you understand the underlying fundamentals of the business which from our view remain very strong. We continue to maintain the strong focus on cost control and this is reflected in our operating expense reduction in the quarter. We will look for additional areas of cost containment which do not damage the long term outlook for the business. Our employees are fully engaged in these (inaudible) opportunities and have offered numerous suggestions of areas where they feel further reductions are possible. We firmly believe that our employees are our most valuable asset and we will continue to look for ways to balance needs and employees, customers and stockholders, as we work our way through this difficulty in unemployment. For that i will turn it over to Tony Worthington for some additional details on the

Thanks, Jack. We continue to remain focused on customer retention and customer satisfaction. The results of our monitoring indicate continued success with our demanding.customer bases to meet the on going demand of our customers for enhancing existing products and services extending depth and functionality as well as developing new solutions to market to our customer bases. As Jack indicated we have a solid and positive performance in our support and service revenue line. 18% growth in the EFT revenue line is fueled by increasing processing volumes and nearly all components of EFT which includes ATM and debit card processing, bill payment processing, merchant capture and check 21 exchange. The ATM and debit card processing volumes increased 11% compared to prior year quarter, our bill payment transaction volumes increased 21% in the same period.

The number of financial institutions installed with our enterprise payment ASP solution for remote deposit processing or merchant casher increased 34% compared to prior year quarter, and the financial institutions merchants installed and utilizing this solution increased 87% to nearly 17,000 merchants in over 67,000 locations. Along with signing and implementing new institutions and their respective merchants we saw solid increases in the volume of transactions being processed. Merchant related transactions increased by 109% compared to the same quarter a year ago,l'll now turn it over to Kevin for a further look at the numbers.

Thanks Tony. As Jack previously mentioned during the quarter just ended, we experienced decline in total revenue of 1% to $190.2 million for the quarter. And, our year to date revenue grew by just 2% to $373.3 million. License revenue decreased by 36% compared to that of a year ago and down 24% year to date. However on sequential basis our license revenue was actually up 12%. And while the banking segment license revenue was basically flat sequentially, the credit union segment license revenue up 63% compared to the September quarter, which this growth was driven entirely by the (inaudible) product sales made up primarily by our fraud sweep products,which is Yellow Hammer fraud, BSA and our EFT fraud. Our net total product which was just recently began offering in the credit union customers are synergy documenting sweeper products and our CRM, all showed very nice growth in the December quarter compared to September quarter (inaudible) .

Our support of services had an increase in every component within that line of revenue with the exception of implementation revenue. For the quarter and year to date invitation revenues decreased 11% and 8% respectively, Compared with the same periods year ago, however invitation revenues up slightly sequentially. Our EFT, or electronic payments business, as Tony talked about was up 18% for the quarter, 17% year to date. Which as Jack mentioned the true core EFT business was higher when considering the impact of the decrease in early termination fees and the impact of the change in check 21. Also EFT would be essentially flat to slightly up sequentially considering these same issues. Out link data processing up 1% for the quarter and 4% year to date; however, outlink was also impacted by a decrease in the one time early termination fees just like EFT for the year-over-year comparison, and another decreasing component in out link revenues, traditional IP services people switched to branch and telecapture.

Sequentially out link was up 5%, without any consideration of termination fees. Obviously, we like to see the continued decrease in one time early termination fees as this is good for the long-term health of Jack Henry to keep customers, even though it can make for tough comparables. Also, as you remember, this significant fluctuation dates back almost a year when we announced the March quarter of fiscal '08, and the one time termination fees dropped so dramatically sequentially from that quarter. As I believe we said then combined one time termination fees were just over $4 million in December quarter a year ago and this is compared to just $400,000 in the December just ended or $3.6 million decrease. For your modeling purposes, we'd like to provide the early termination fees that happened in last March and last June quarters, in the March quarter of fiscal '08, we had early termination fees of $615,000 in the June quarter $1.8 million respectively. Obviously there is no way to predict what these will with for the next two quarters but gives you some basis for modeling going forward. Our inhouse maintenance grew 9% for the quarter. 11% year to date compared to last year, in-house maintenance grew sequentially 3%.

Harbor (inaudible) decreased by 14% for the quarter and 19% for the year compared a year ago, due to weaker sales and INT series upgrade and sorters for check imaging compared to the prior year. However, hardware was up 14% sequentially compared to September quarter due to slightly stronger I&P series sales which is typical in the December quarter and also we had a very good quarter in our forms and supplies business which the December quarter typically is driven by tax forms for year end by the financial institution customers. Our gross margins dropped for the quarter to 41%. And year to date to 40%. Compared to last year up 44% for the quarter, and 42% year to date. Gross margin; however, improved slightly sequentially as we had a slightly stronger license quarter and our associates were able to control costs even more compared to the first quarter of the fiscal year. Gross margins in both our banking segment and credit union segment slowed for the quarter. And, year to date compared to last year, banking went from 44% to 40% for the quarter, and. from 42% to 40% for the year.

While the credit union segment went from 45% to 43% for the quarter. And from 43% to 42% for the year. However gross margin for both segments were up slightly sequentially which is a good sign considering the economic environment we were in this past quarter. Total operating expenses decreased 8% for the quarter and for the year, operating expenses increased by just 1%. Operating expenses were down 3% sequentially. This is accomplished by very good cost controls primarily in personnel costs, reduction in travel related costs, and reduced use of outside consulting contractors and professional services organizations. The only operating expenses that went up sequentially was G&A and that was entirely due to the cost associated with the banking national (inaudible) meeting during the December quarter. Our operating margin decreased to 22% for the quarter from 24% last year, and decreased slightly to 21% year to date compared to 22% last year; however, our operating margin increased sequentially from 19% in the September quarter to 22% in the second quarter just ended.

Net result was a decrease in operating income of 10% in the second quarter, and 6% for the year compared to the prior year. Again though; however we managed to increase our operating income by 17% sequentially. As we discussed in prior earnings call the R&D credit was extended again for two years, which created a catch up for the prior 12 months in this quarter, thereby reducing the affective tax rate for the quarter to 32.1%, from 36.8% a year ago. And, the impact for year to date was to reduce the affective rate to 34.3% this year, compared to 36.6% last year. The affected tax rate is estimated to be approximately 35%, for the remainder of the fiscal year at this time. Our EBITDA decreased this year to date to $109.9 million from $114.2 million last year, Or a 4% decrease. Depreciation amortization was $31.9 million this year, compared to $30.0 million last year or 6% increase in D&A. Our EBITDA margins decreased year to date to 29%, compared to the prior year of 31%. For guidance going forward. Obviously the economic conditions continue to be a challenge, and as Jack mentioned, we understand that most of our customers are faring pretty well, but there is definitely an extreme caution in the base, which makes it much more difficult to forecast or predict discretionary sales to customers which obviously relates to our software and harbor business.

Therefore, based on what we know today, our worst case scenario would be the remainder of the year tracks right along with the first half and we see virtually little growth in (inaudible) EPF from the prior year. But, in this case we would continue to be very profitable and generate (inaudible) cash flow. The other end of the spectrum, and the best case scenario, would be if we close some of the larger deal we've been talking about, (inaudible) larger credit union in the last quarter or so and the economic environment stabilizes. Which, we could then (inaudible) to be somewhere closer to our original annual guidance (inaudible) going into the fiscal year. Reality though is most likely we will wind up somewhere in between. But, that obviously depends on a number of factors. However, we will continue to manage our expenses and strive to maximize shareholder value regardless of where the year winds up within that range.

Couple of comments on cash. We did purchase 1.1 million shares of treasury stock this quarter, and 2.6 million shares year to date. Since May of 2005 we have purchased 13.9 million shares for the treasury and continue to have 6.1 million shares remaining under the current authorization. Also year to date our cash use for acquisitions was down $46 million, compared to last year, as the M&A market continues to be a challenge. Our CapEx is down compared to prior year by 7 million to $14 million. Capitalized (inaudible) up slightly by 1.2 million. For FY '09, it now appears our CapEx will be somewhere in the low to mid $30 million, which we downed from our original projections, as both some of our large projects we have underway have incurred delays, and we, like our customers are evaluating capital expenditures. Backlog was up-- was at $277.9 million, with $61.4 million in-house, and $216.5 million outsourcing at December 31, which represents a 16% increase over that of year ago with outsourcing up 21% compared to a year ago. Again remember there are no transactional revenue represented by our EFT debit processing, bill pay or remote deposit capture within the backlog numbers trying to be conservative and estimate the transaction revenues. With that, that ends our opening comments and we will now open the call up for questions,

(Operator Instructions) We will take our first question from [Tim Fox] from Deutsche Bank.

Alright, thanks. Good morning. My first question was around your EFT business. I was just wondering-- we've been hearing some noise about the decreases in overall volumes from some of the other providers out there, if you could just give us a little bit of color about how your volumes are trending, particularly in the credit, debit and ATM transaction space. Do you expect there to be any pressure on the overall transaction volumes going forward or do you think that's going to be relatively stable in the client base?

We seen some decrease in the transaction volumes in the last quarter and prior quarter, we think that's somewhat due to the current economic environment, but we expect to see transaction volumes to be pretty stable moving forward at this point.

One other thing, Tim, we continue to add additional product into that product suite with the EFT and debit switch solution that we can get additional transaction fees on top of like fraud center and some other things, plus we're putting products out there to help drive the use of debit cards. So, , I think all those will help at least solidify the constant growth within that line of

Just a follow up on that, as far as penetration, about how many customers do you have on that particular switch product at this point and do you see opportunities for share gains over the rest of this fiscal year?

Don't have that number in front of us, can I get that number and then try to give it to you later but I don't have it.

Tim, I think it's somewhere around 700 total core customers that are on our switch product. It may be slightly less than that. There is some additional opportunity there, and as you pointed out , this is clearly becoming more of a commodity gain. so what we have to push is the high level of integration, the high level of customer service we provide and the suite of products that we're now (inaudible) our products, So, is there some potential market share out there? Absolutely. As you can see from the numbers we've done pretty well in gaining some market share in the credit union space and we think there is more opportunity

Okay. Just lastly on the hardware side. You talked a little bit about some of the tough compares given the programs that were run last year. What point do the hardware comparisons get easier for you throughout calendar 09?

I'm not sure they get a whole lot easier, Tim, because if you remember this time last year, we were just-- especially in the June quarter there was another IBM initiative that was going on out there and then also, the remote deposit cash or scanner sales were just flying off the shelf a year ago, and those slowed a little bit. We are still selling a very good share of them. But to say we are going to continue to grow -- and again those scanners have become more of a commodity.

When you've got merchants that can go to Office Depot and buy them off the shelf at significantly less margins than what we are willing to sell them for, there is going to put some pressure on that. Then the ongoing -- are banks going to branch and telecapture away from the traditional-- our foresight products and things like that so the size of the hardware continues to go down significantly. So, I thing the hardware comparisons are going to continue to be a challenge for the rest of this year.

Okay, I'm going to sneak one more in, if I may. You obviously done a nice job on the cost control side, just wondering, how much room do you have left, do you think, around the cost control area, if things do deteriorate a little bit more in the near term. Do you have some more levers available to maintain that margin?

Yes, Tim, this is Jack. There certainly are things that we can do, again our outlook on the business is we feel like this is a temporary economic headwind. How temporary, your guess is as good as ours now, but we are trying to be very cautious that we don't take actions that damage the business for the long-term. There certainly are other steps that we can take that are certainly more short-term in nature without some of those ramifications. There are more things we can do at this point. We kind of lined them up and looked at them and sort of have those in the back of our minds depending on what we see happening in the business going forward. There is definitely additional things we can do if we need to.

Very good, thank you.

Thanks, Tim.

Next question from John Kraft from DA Davidson.

Good morning, guys. Jack, just to reconcile something that you mentioned then also Tony discussed, the remote deposit scanner sales you said were flat, and then Tony talked about pretty impressive growth metrics for a number of merchants and installations and all that, is that simply just a timing issue where there were some big orders made by some of these banks ahead of implementations, or are you seeing a tick up in other scanner vendors selling in to that customer base?

Great question, John. These things tend to be all over the board. What I would have expected to see in the quarter was continued reduction compared to the same quarter a year ago in scanner sales and to my surprise they ended up around the same number. I think some of it is that we come out with some promotions that involve the leasing of the device. Which again it wouldn't seem like a 3 or $400 scanner would be a significant item, but a lot of times for these merchants, the bank trying to figure out how to put it in to a business to be able to not have to come up the up front capital can be good thing.

I think we've seen some good response to a leasing approach which from our standpoint is really treated as a sale, but through a third party vender we are able to put the scanner out there on a lease basis. I think that has helped. I think that we are-- we've made some good inroads with some other nonfinancial institutions that provide merchant acquiring services and other things that need a remote deposit solution and have elected to partner with our solution so that's probably driving some of the scanner business as well. Awfully hard to predict. All the trends that I would look at would say that the scanner sales should continue to fall off somewhat, even as merchants continue to grow, simply because of the available alternatives for them to acquire those scanners.

Those leasing revenues would be in the hardware line, right?

Well, there aren't leasing revenues to us. We are doing that through a third party, so it's treated as a hardware purchase to us the leasing component is actually on somebody else's books.

Okay. Then Kevin just to clarify, your guidance, your worse case scenario, what did you say about economic conditions that they would continue to worsen or that they would stay fairly stable?

Well if they would stay where they are today, which in my opinion is pretty bad, I think that's worse case, John. Kind of the guidance that I'm giving out there is obviously in the second half this year, there is relatively no early termination fees in the support and services line impact. So, if you back out just termination fees from the first half and apples-to-apples, our support and services have grown 10%, year to date , actually, if you want to (inaudible) back up the impact of check point one, which is going to get smaller and smaller, our support services actually went up 11% for the quarter and year to date. So, having said that, I think the second half of the year our support and services line of revenue should grow at roughly 10% or there abouts.

So what I'm saying is worse case if the economy stays where it is, and we continue to have challenges on this discretionary spending and we continue to be at equivalent levels down in software and hardware that we have the first half of the year then we are going to wind up about the same place we did last year. I don't think that's obviously where we are going to wind up. What I'm just trying to give you-all some guidance is worse case, this is where we wind up. I think obviously it's going to be better than that. I think best case is we close a few of these large mystery deals we have been talking about. The economy stabilizes, we hit the easy comparables because of the no termination fees and obviously we grow somewhere to the guidance I gave, last earnings

John our crystal ball is that it's cloudy as anybody else out there right now related to the economy and what is going to happen with some of these discretionary purchases. You keep thinking that surely the last shoe has dropped at this point but just to give you an example, here in the last week, week and a half, there is this discussion credit union segment around one of the large corporate credit unions that's had some difficulties similar to some of the things the big banks have had and there is going to have to be a recapitalization plan to shore them back up. These guys right now are not eligible for TARP fund.

So that's going to be basically an assessment of all the credit unions. Well I had a conversation recently with a large credit union, $2 billion credit union. They're estimating the charge to them based on what they know right now to be somewhere between 8 and $11 million for their piece of this component. That's a big credit union, wouldn't be that much for everybody, but you take a $100 million credit union that's potentially looking at a $400,000 unplanned, unbudgeted expense to shore up a corporate credit union. As it stands right now the final guidelines are not out on that, but as it stands now, that's a charge to income. It's not-- they can't capitalize it, they can't do it over multiple years, maybe that will change by the final stage, but my point is here is more to you than the last week and a half that in the credit union segment that's got some fairly significant ramifications, for some of these folks. We don't know how to predict are we there yet? Have we seen the last bit of bad news, as far as seeing things stabilize.

Okay, that's fair, that's fair. Let me ask one last question. Something a little bit more positive,hopefully. On the bill pay side that transaction growth number was strong, do you have-- and I don't know if you would track this, but do you happen to know, off the top of your head roughly what the penetration-- bill pay usage penetration is within your end user customer base?

Meaning the penetration rate of their customers, if a financial institution offers bill pay what percentage of their customers are using it?

Yes.

I would quote that number wrong, we do have that. I can tell you it's pretty low, I think there is definitely room for upside to that number. In fact, we discussed a number of promotions that we could work with our customers to offer for them to be able to spur additional bill pay adoption, within their customer base. Sort of the-- come up with generic statement suffers and things like that, that can be bank or credit union branded that they can use for that.

We have not moved forward with that because, quite frankly, even for the banks and the credit unions that understand the value that having a customer on bill pays brings, in terms of stickiness and typical average balances compared to customers that don't use it, et cetera. I think people are reluctant to go out there and try to stimulate the demands for a service that's going to cost them more money to offer at this point in time, even given the positive ramifications of what happens when a customer does use bill pay. But, I would say, I believe there that our penetration is low, probably low by industry standards, and I do believe there is good upside opportunity there at the appropriate time.

Plus the other thing, John, that I mentioned in opening comments was we are starting to see (inaudible) our net offering which obviously has a refresh look and feel that we are selling in to the credit union space, there is nice opportunity there to cross sell our bill pay offering, because its all integrated in one look and feel which is considerably different than the typical credit union has today. We think there is some-- not only as Jack mentioned additional opportunity in our customers customers base to get penetration there, we think there is a significant opportunity in the 700 credit unions that we have to cross sell that product. Because, up until two quarters ago we didn't even really offer our bill pay offering in to the credit union space.

Okay that's helpful, thanks, guys.

We will take our next question from [Tim Willie from Avondale Partners].

Thanks. Good morning. Couple of questions about the backlog, if I could. First, and I know this is probably hard to give an exact number. But as you've seen let's say over the last four to five quarters very strong growth in the out sourcing backlog, is there any way that you could frame how much license revenue that you think you may have cannibalized from customers that may have stepped up and licensed an additional product or two from you that no longer would be doing that, that might be hitting that license line item right now?

That's a tough one. I'm sure Tim that will is some of that. I believe that it's relatively small percentage because I think what we are finding when folks make the election to move from an out source deliveries they typically sign up for several additional products that they've had their eye on but just were unwilling to come up with the license fees to do it. So had they stayed in that in-house environment, my gut feel is they would have continued to hold off on making those capital outlays for license fees to move forward with products that they needed.

I'm sure there is some of that, I think that there clearly is some cannibalization of hardware over a two to three year period, at some point they would have needed to do a capacity upgrade or possibly to replace a outdated box all together. There certainly is cannibalization on the hardware side. On the software side, I don't know how to quantify it, but my gut feel is it's a relatively small number.

Especially in this environment. Because I think it would have continued holding off in this environment if they were already holding off.

And the second question related to the out sourcing backlog, can you give us a feel for-- within that support and services line item, you have the out sourcing services category that you disclosed. It would seem that with pretty substantial ramp up in the year-over-year growth rates of the out sourcing backlog, that there should be some pick up in the outsourcing services growth rate. So I'm just curious if that logic is true, and if there is any way you can sort of frame where that may begin to flow into the income statement given that we are now about three to four quarters into a pretty strong up tick in your outsourcing backlog.

Well first of all Tim remember last year at June 30th we talked about that we had 27 banks that had made that decision to go (inaudible) outsourcing.. And 14 of those were in-- basically in June. So not all of those are even converted yet. As Jack mentioned we are ahead of the pace last year halfway through the year for the total year last year, but I doubt if any of those have converted yet. So it's going to be a slow ramp. But to your point, is it going to drive additional increase in our outlink line of revenue? Absolutely, because as we talked about what we charged them is going up even we we had a program in place, because, as Jack mentioned, on average they are taking additional three or four products, there will be a slow up tick.

And will you be able to see it? Yes, but it will probably be a year from now, and you;ll start seeing it in a quarter or a year-over-year base, you probably won't even see it sequentially, that flows in so smoothly as we convert those customers. And one of the points that is a caution, remember this will eventually put a little headwind on our in-house maintenance line of revenue as the customers switch over because it's going to take away from tin house maintenance and take all of that revenue plus the additional up tick and put it in to the up link line.

Keep in mind the impact on the backlog from one of these transactions is a little different than the impact on the P&L when they actually implement, when it goes in to the backlog you are seeing the full five year value of that contract or in some cases seven to ten year value of the tract, versus when they do get moved over you're seeing one month or three months in a quarter, of that amount that actually rolls into the P&L, so it would take quite a while to see for example, a 16% increase in the outsourcing line item.

But, also remember that the outsourcing backlog number is an extremely conservative number, Tim, because what we put in there is the minimum. So, as the banks switch over from in-house to outsourcing and as they grow and they grow the number of accounts we are going to charge them more on a monthly basis, which revenue is going to grow but we don't go back and readjust the backlog.

Understood. Question on your commentary around worse case scenario, around guidance versus more realistic. When you sort of say flattish with last year are you talking just dollars of net income or are you talking about earnings per share?

EPS, primarily.

EPS, how are you thinking about share buy back? Given again the balance sheet is in pretty good shape, there still seems to be a pretty good predictability around the vast majority of your business.

We've bought back obviously as I mentioned in opening comments, we bought back quite a few shares, we've bought back 2.6 million shares so far this year. At the last board meeting, our board is pretty conservative too, and they wanted us to be just a little more cautious as we move forward with buying back stock, and I think for two reasons, Tim, one, just the unknown in the economy out there, and secondly, we also think that in the current environment that the M&A activity is going to come back. We think there is going to be some properties that are going to hit the market this year. And we want to definitely have dry powder so we can go after those in the event that happens . But, having said that, if our stock price would take a significant dive, would we be back in there with both feet?

Thank you.

(Operator Instructions) We will go next to [John Maetta from Needham and Company].

Thanks very much, Hey Kevin, hey Jack, hey Tony. Kevin, just a follow up again on this worse case scenario for the seventh time. What's the greatest delta in terms of the close rates that you apply to the pipeline to kind of get from the worse case to a more normalized scenario? The greatest variable around the perpetual license line? Maybe talk about the puts and takes that would be helpful.

I think the biggest variable, John, is clearly license and around the some of the mid tier opportunities that we are continuing to pursue. We got very good predictability in the support and services line item. That is unlikely to have any kind of dramatic change in the next two quarters that would make a significant difference to the numbers. But a large credit union, a large bank license transaction, those would be the kind of things that would get us back up in the range where we expect it to be.

Or as Jack commented, I mean if John, if we could just go a month without more bad news out there to where the banks you feel like the last shoe had dropped and didn't have to be quite so cautious. I think there is, I hate to use this word, but I think there is some growing demand out there for products that people had put on the back burner. And I think once they get a little more comfortable with the economic environment I think that right there in itself, even without the mid-year deal could get us back in to a more predictable type range and then if you throw the mid-year deal on top of that, that would be the best case scenario if the economy stabilizes and we get closure on a couple of those deals that put us right back to where we were at the beginning of the year.

Yes, Understood. That makes sense, okay. Kevin, what gives you a sense as to-- that there may be pent up demand out there. Is that an increase in conversations that folks in the field are having, is some of that actually in the pipeline and maybe you have deals where they haven't been signed off but in the process?

Well, I think that it's a number of things, John. Obviously our salespeople are saying there is delays out there, we are aware of some deals that-- deals that actually had board approval, and before they signed contracts they decided to delay them. This is not what you would consider normal slippage or whatever, this is actually just true delay, they know they want to product, but they are going to wait a while and see what happens to the economy before they are ready to either sign the contractor, or in some cases the contract is (inaudible) they don't want to (inaudible) yet. There are those indications out there, and I think as Jack and Tony and I have talked I think a lot of this, that's part of the it. The other part is I think there is just a lot of people out there that aren't even looking now because of the uncertain any the economy.

Although the paradox though, John, is that the sales teams and banking credit union and profit stars would tell you they are seeing increase sales activity in terms of customers prospect that are evaluating solutions, surprisingly to me, an increase in new core sales activity. We never seen the core sales activity in the credit union business slowdown. Yes, we'd like to get a couple of bigger ones but we will take what is available right now.which has been rough-- credit unions roughly half the size or smaller than what we saw in the year ago period. But that level of new core sales evaluation activity has not slowed down. And continues to look very good.

But with some exceptions and some banking territories if you are working in Michigan Ohio territory it's probably a little slower but we are seeing surprisingly good new core system evaluation activity and our profit stars group has got, good activity as well. Its perplexing. You got at least as much if not more activity than we probably had a year ago. But as (inaudible) said, we are seeing some delays that tell us some of these things to push out. It really kind of reeks havoc with the forecasting methodology, the things that you developed over the years, frankly, all bets are off right now in terms of trying to apply those.

Okay. Thanks, guys.

Thanks, John.

We will take our next question from Gil Luria from Wedbush.

Good morning, Gil

Good morning. You talked some about existing banks making decisions and the pipeline and then you got in to a bit of depth around that. Can you talk a little bit about the trends you saw in the last calendar years in terms of the DNOVO activity if you've seen that stable or going up or down? And in the flip side of that in terms of attrition, do you try to follow what the FDIC is doing and their watch list? From my understanding so far, we haven't seen as much attrition as maybe people thought at the beginning of this crisis, are those trends working in your favor or part of a drag right now?

Good question. But it's a combination of things. The DNOVO activity definitely slowed down. I would estimate that it's down 40% from what we would have been seeing a year ago this time. You actually got some states where it's been reported that the FDIC is not going to issue insurance for new charters in the south, the southeast, and the west. But as far as they defined it. Whatever they are consider southeast and west, they've indicated that they are not going to issue insurance for new DNOVO charters, we had regulators just in some case say we think we got enough banks right now that they want to see stabilization before they get back to approving the DNOVO charter.

We think it's down and it's likely to continue to be down for sometime. Attrition, again, we've had very high retention rates and continue to have very high retention rates. We, like everybody else, have some banks that are on the government watch list and we pay attention to that, but frankly there is not much you can do about it. Kind of look -- let's look at the absolutely doomsday scenario, if we, in the six states where most of your real estate problems are concentrated, if every single bank that we had in every single one of those states got closed it was still a relatively modest impact on -- it certainly wasn't good news, but it was a relatively modest impact compared to what would be the absolute doomsday scenario. So again, it certainly is a bit of a headwind. I think you are right on, Gil, that the-- some of the initial estimates of banks closings were way overblown. I don't, again, don't have a crystal ball here, but if you look back at what is normal-- forget this economic environment normal attrition, -- not attrition but consolidation in the banking industry has been year in and year out, it's run 2%, for about the last five to seven years. Will it likely pick up with some of the bank failures? Yes probably, but at the same time that that picks up, you got banks that might have sold their bank under that normal 2% attrition where everybody's bank stock has been so depressed in price that they are going to pull off the market until times turn around. So, if I had to guess, I would guess that the shrinkage we might see for the next two years might be 3% instead of 2%. But, again, that's -- your guess is as good as ours at this point.

Gil, we also think the [DNOVO's] will come back and we think they will probably come back stronger than they were a year ago. Because we think about the large banks that have merged together in the last two years, I don't have to name them, you know them, and there is a significant number of loan officers on the street which are typically the ones that start new DNOVOs-- so I think as soon as the regulators get loosened up and FDIC gets a little more comfortable, I think the DNOVO market will come back stronger than ever and we will be right there to take advantage of it. As we talked about before, the DNOVO is down, we are still closing a few-- you're really not going to see much impact in our financial statements even if we don't get DNOVO's for nine to 12 months because there is virtually no revenue in the first nine to 12 months after you sign one anyway.

In terms of that activity in those six real estate bubble states, is that more or less than 10% of your overall business?

Well, okay, here is what we did, this is total doomsday, I hesitate to even throw this number out there because I'm sure it will show up in somebody's call report. or first call. But what I did is looked at all of our customers in those six states and we said, okay, if every bank shut down-- which we all know is not going to happen, but if every bank and every (inaudible) in those six states shut down, that represented about 10% of last year's total revenue. So let's say 20% of those banks get shutdown, it's 2% of our revenue. (OVERLAPPING SPEAKERS)

20% percent of the banking market. 20% impact is more likely scenario than 100%.

A lot of times those banks get bought by out of region banks and continue to survive and those can be your customers too.

Which that has happened all ready last year.

Last question. When we talk about the discretionary items that your customers are passing on right now or pushing out decisions, we are not talking about core and probably not talking about fraud, what product categories fall in to that bucket of products that banks are taking a little longer to make decisions right now?

Gil it would be things like CRM solutions which they would like to have, but could live without, it would be things like our synergy, documentary solution. Most banks today have some type of a document imaging solution. They might be looking for more of an enterprise offering like our synergy product, but again, as times are tight that would be an expense they could hold off on for a while. So, I think in a lot of cases this replacement of existing technologies with more modern types of technologies, fraud continues to be pretty strong as well, but I think those would be main ones. Kevin, there are others that are obvious to you.

I think what I say, Gil, in some instances, fraud can be discretionary for some things. It depends-- a lot depends what bank it is, what geographic area they are in, so if you've got a bank that just got hit for a $60 (inaudible) scheme and they could put y(inaudible) that would have caught it and stopped it for $60,000, that probably moved from a discretionary to a must have automatically. But, if you got a small bank that's never had a fraud issue, which every bank has a fraud issue, but no significant that's probably going be a discretionary item. If you look at the 100 plus complimentary products we have-- for every bank out there depending on where they are at and what make up they are is going to dictate what products are discretionary and what ones are must have.

Thank you.

(Operator Instructions) Next to [Brett Huff] from Stephens inc.

Good morning, guys. Couple of quick housekeeping things, did you go over the recurring revenue number for this quarter?

Don't know if I mentioned or not, Brett, but it was 74% for the quarter, 74% year to date.

Thanks. A question on pricing pressure, it sounds like maybe banks switching on cores and things like that has slowed down, but have you seen any change in pricing pressure this quarter versus last quarter?

No. I can't say that we have. Again, it's been a competitive environment for as long as I can remember and it remains so. But in terms of anything certainly, in the way of a what would appear to be a new promotion or campaign or a policy from one of the major players we really haven't seen any change.

Okay. I want to make sure I understood, Kevin, you mentioned specifically talking about license and I didn't know, I think it was year-over-year, you mentioned it was-- license was flat in the bank segment, but up 63% in the license for credit union was that right?

That was in the December quarter compared to September quarter sequentially.

That was sequentially.

Banking license relatively flat and credit union was up significantly. And again, that goes right back to some of those (inaudible) products which is a document imaging. broad solutions, the new net teller offering and those type things.

And that's partially because you're now-- those are new offerings to that particular base, right?

Well, it's not it's not -- net teller is a new offering for that base, we just came out of (inaudible) -- it's going well, the CRM solution we just got done with the integration of the product and so the (inaudible) part is doing well, synergy document imaging has been going well, we actually got a new partner in there, that's making that an even stronger offering, in the credit union space. I think more than anything is our sales guys on that side of the house are just getting a lot of momentum and they have got some excitement.

Okay. And then, just to get a better understanding for the kind-- , you are talking about mid tier deals in the pipeline. I thought it was mostly credit unit you but might be bank too, could you a) comment on that and b) give us a sense on how big is big on these deals and how many are in the pipeline-- in any range of the pipeline. If you can give us comment on

Yes, it's a combination of both bank and credit union deals. Primarily, Brett, what we are talking about there is the -- north of a billion dollars, typically one to five, one to ten billion dollar kind of an asset range. Numbers three or four probably in some stage of evaluation at this point.

The key to that, Brett, is when they get to that size they are typically looking at going in-house. So as software hardware and services hitting all three lines of our revenue.

Deal of that size, any sort of broad guidelines on how much in general that would bring in in revenue?

It could range in software from a billion dollar size to brand new software from a million and a half up.

Last question, you mentioned that there were still some things you thought you would do on costs. It seems like the COGs line maybe benefited more than R&D this quarter., Where do you see the lowest hanging fruit where we should look for additional saves, COGs or OpEx and if you can give us more detail which of those sub line items?

Well, I think there is continued leverage in our selling and marketing, -- obviously we need all of our sales organizations on the street doing what they are doing to keep the pipeline full and drive business. As our recurring revenue, as your first question referred to, continues to grow, there is very little commission tied to those recurring lines of revenue, which-- that is where we can get some leverage, from the R&D, we've said all along we continue to move upstream in to the larger banks, larger credit union which is are more demanding customers, I don't know if you will ever see much leverage on the R&D line.

I think there is some additional leverage potentially on the G&A line as we move forward. We went through a couple of three years there basically holding G&A lines completely flat, dollar for dollar and then we put the new back office in and they kind of jumped up there for the last couple of years, but I think there is some opportunity to leverage there on the OpEx line going forward. Just to back up. On your, previous question on the license revenue, the real key to that is what they are buying. Because if all they are buying is silver lay, you've got one thing, but if they are buying silver lay and ten other products you can have basically a GAAP of a million to $3 million on a billion dollar size bank.

Okay. That's all I needed, thank you.

We will take a follow up question from Tim Willie from Avondale Partners.

Thanks for the follow up. Kevin, one question for you, tax rate, I think you said 35% for just the back half of the year. But that -- I think that all shakes out to about 35% for the full year, is that correct.

Yes

How would you think about that, I guess for '10. Do you expect to get the credits again, is there anything you're doing with tax planning that would change that rate dramatically, that you're aware of now?

Well, I understand, Tim, when they renewed the R&D credit retroactive to January 1 but as a two year renewal. So, we'll automatically get the first half of next fiscal year R&D credit. So, our effective tax rate next year will probably be, we haven't ran all the numbers yet, somewhere around 36% for the year.

Jack, and Kevin, Tony, all three of you if you have a thought that you could share, how could you compare what we are going through now with what was going on in sort of the post Y2K bubble tech.com collapse of '01-'02, not only in terms of holding back on decisions and obviously there was a lot of pressure on license and discretionary spending, but also the mood of the customers, I mean , Jack, you made comments that point to a surprising amount of activity on the sales front versus what you think in this environment. How do you recollect that things were back in the last downturn, was there just as much activity and people still looking but not making decisions or was there just really no activity anywhere during that time

Well, Tim, I would say that there appears to be more uncertainty around where are we in this cycle than there was in the post Y2K. A lot of the slowdown post Y2K was not that big of a surprise. Should have seen that coming. Lots of valuations ramped up and implementations ramped up ahead of Y2K, every reason to believe there would be slowdown, post Y2K, and there was, I think it probably slowed a little longer than we expected it to. But I think everybody kind of said, hey, we kind of understand what we are up against here and we just got to work our way through it. I'm not sure people yet understand completely what it is we're up against. There is this confidence issue-- , I said from the beginning of this thing that the lack of clarity was a bigger issue for the majority of our customers than the actual performance.

And of course with hundreds of thousands of people being laid off and those kinds of things, now we've got some issues that find their way to roost in our customers as well. My sense is -- Tim probably has a better recollection of this than I do in the post Y2K timeframe, but my sense is that there is probably more system evaluation activity going on now than there was in the post Y2K Quite frankly, some of it may have to do with the fact that lots of systems got implemented in 1997 and 1998 that was ten years ago. So people may be (inaudible) saying that maybe was the right horse to ride in '97, '98 but maybe ought to be looking at what the right partner is for me out there today. Kevin, I don't know if you can shed any light on

No, that's absolutely right. Everybody that got ready through Y2K and then they went into the quiet period where nobody can do anything by mandate from the FDIC, and they came out of that and we came out, Tim, if you remember the March quarter of that year we came back and had a record year. There was hardly any core deals in there. That was all add on products that people had delayed. Getting through Y2K and when everybody was surprised and the lights came on on January 1st and the world was still here, everybody decided business is getting back to usual.

Where to Jack's point, they don't know when the lights are going to come back on, because they don't know when business is going to go back to being usual here like they did there. There was one moment in time, once we got past that point it was like (inaudible) get back to business. I don't even know when that point is-- that measurement point is in this situation we are in today.

Great, thank you.

And, at this time we have no further questions in the queue I would like to turn the conference over to your presenters for any additional closing remarks.

Thanks Connie. First of all I would like to let everyone know the dates of our upcoming annual Analyst Day, which will be held on May 11th and May 12th. The event held in Dallas, Texas, again this year and we will kick it off with a mini tech fair and dinner on Monday evening to highlight some of our newer and hotter products just like we did last year. Then on Tuesday you;ll have the opportunity to hear from most of our (inaudible) GMs and all of our national sales managers and the executive team here today. The Tuesday event should conclude about 3:00 p.m. that afternoon, so please build your schedules accordingly and a registration link will be sent out sometime in the next 30 days or so for you to sign up for the event.

Now (inaudible) the call. We would like to thank you for joining us today to review our second fiscal 2000 quarterly results we are obviously not pleased with the discretionary revenue during the quarter year to date. However, we are extremely pleased with the efforts of all of our associates to help control costs during the current economic environment. Remain confident we are well positioned and aware of the right products and services to approach the financial services market. We also believe we have the proper resources in both people and technologies for these continued future opportunities. We continue to expand and improve our products and services and we are committed to build on all of our competitive strengths. Our executive managers and all the members of our team will continue to focus to do what is right and best for shareholders. Again, thank you for joining us this morning and with that Connie will you please provide the replay number?

Thank you. This does conclude today's conference. If you would like to dial in for the replay, that number is 888-203-1112. Using the confirmation code 8651481. If you're calling from international it is 719-457-0820. That conference will be available today at 10:45 a.m. Central Time and will run through February 11th at 11:45 p.m. Central Time, thank you and have a good day.