Jack Henry & Associates Inc (JKHY) 2015 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Jack Henry & Associates second-quarter 2015 earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded. I would now like to introduce your host for today's program, Kevin Williams. Sir, you have the floor.

Good morning. Thank you for joining us today for the Jack Henry & Associates second quarter FY15 earnings call. I am Kevin Williams, CFO. On the call with me today is Jack Prim, our CEO. The agenda for the call this morning will follow the way we typically do. Jack will start out with his thoughts on the performance for the quarter and some other comments. I will provide some additional thoughts and comments regarding the press release we put out yesterday, and then we will open the lines for Q&A.

I need to remind you that the remarks or responses to questions concerning future expectations, events, objectives, strategies, trends or results constitute forward-looking statements, or deal with expectations about the future. Like any statement about the future, these are subject to a number of factors which could cause actual results or events to differ materially from those which we anticipate due to a number of risks and uncertainties, and the Company undertakes no obligation to update or revise these statements. For a summary of these risk factors and additional information please refer to yesterday's press release, and the sections in our 10-K entitled risk factors and forward-looking statements. Now I'll turn the call over to Jack.

Thanks, Kevin. Good morning. Today's earnings call will be a bit of a challenge to present because of a number of one-time events that occurred in the quarter, including the gain on sale associated with the disposition of a non-strategic product group, the retroactive reinstatement of the research and experimentation tax credit, and a one-time adjustment to revenue based on a new interpretation of revenue recognition policies by our outside accounting firm. Kevin will attempt to provide some clarity that will allow for an effective apples-to-apples comparison to the prior-year quarter.

The noise in the numbers of this quarter obscures at a glance a solid operating quarter, in particular without the accounting revenue adjustment. And let me repeat without the accounting revenue adjustment, we had a quarter in which organic revenue growth was just under 8%, with support and service revenue up 10%, led by a 15% growth in our outsourcing business, and a 10% growth in our payments business.

The growth in these businesses offset what would have been a decline of 14% year-over-year in license fees, and we maintained strong gross margins in spite of this lower high-margin component of revenue. Business fundamentals remain strong, and in a solid and still improving economic environment, our clients continue to invest in solutions that can help them drive revenue, reduce costs and improve security. We had solid sales performances across all three brands, with strong core and complementary sales in the banking and credit union segments, and a strong outside the core based performance by the ProfitStars team.

In reference to the previously mentioned revenue adjustment, for our in-house clients we have historically recognized revenue as the software is delivered and implemented by the client, which we believe most accurately represents the intended financial arrangement. We have recently received guidance from our accounting firm, that if even a single small software product on that contract is not implemented, we should defer all revenue on the agreement.

I would point out that we have followed substantially the same recognition policies for many years, adjusted as necessary to accommodate new accounting guidelines as they have emerged. There have been no recent changes to our policies, and none during the five-year period that was reviewed. We have not received a satisfactory explanation for why previously acceptable recognition policies have now been called into question.

While we are confident that our policies have been fully compliant with GAAP and more accurately reflect the intentions of the arrangements with our clients, we are modifying our policies to comply with this new interpretation. These adjustments related to license fees and associated implementation fees are included in the earnings release.

The review of software maintenance is ongoing, and unfortunately could not be completed by the time of our earnings release. The first time a question related to maintenance was posed to us was Monday night at 11 PM.

As I said earlier, it was a noisy quarter with a number of puts and takes. But when you net that all out, it was a solid operational quarter with continued strong organic growth and margins. With that, I'll turn it over to Kevin for some additional details.

Thanks, Jack. As Jack mentioned, all the numbers disclosed in the press release that I am going to talk about were adjusted for the revenue recognition adjustments disclosed in the press release. The total impact of the adjustments in the current quarter was to decrease revenue by $1.2 million, and it decreased operating income by $0.6 million, compared to the adjustment made to the second quarter last year. Which again, we are going to restate proactively quarters going forward, so the prior-year historical numbers be adjusted each quarter.

The adjustment to the second quarter of last year was to increase revenue by $2.4 million, and it increased operating income by $1.5 million, which obviously this changed the comps a little. Without these adjustments as Jack mentioned, our revenue would have grown 8% compared to the 6% reported, and our operating income would have shown growth of 6% versus the 4%.

Our support and service line of revenue continues to drive our total revenue growth. It increased to $299.6 million, which is a 9% increase. To break that down between the components, our implementation revenue was at $26.9 million for a 16% increase. Our electronic payments was at $121.5 million for a 10% increase. Our outsourcing, our OutLink data processing was $67 million, a 15% increase. And in-house maintenance was $84.2 million for a 1% increase. The recurring revenue, which is based to the payments OutLink and in-house maintenance, grew at about an 8.5% growth for the quarter and represented 79%.

As Jack mentioned, our margins continued to be strong. Our consolidated gross margins decreased slightly. They rounded down to 43% for the quarter, compared to 44% in last year's quarter.

License margins decreased -- or remained level at 92%, I'm sorry. And for both this quarter and last year, support and service margins were level at 42%, and hardware margins increased to 31% from 29% a year ago due to sales mix. I do have to apologize. As Jack mentioned, we kind of got hit with some things at 11 PM Monday night, so I do not have any breakdown of margins for these segments. We will have to get you to those later with, so again I apologize. But overall the segments are going to be pretty much in line with where they have been, and our total gross margins continue to be strong.

Our total operating expenses increased 5% for the quarter, compared to the prior year. Our operating margin for the quarter remained fairly flat at 27%. It was down less than 1% from last year. Our operating income increased 4% for the quarter. Organic operating income increased a little over 5% compared to last year, as the acquisition of Banno that we did last March continues to be slightly dilutive to our operations.

The effective tax rate for the quarter was 32.8% compared to 35.2% last year, which is primarily due to the reinstatement of the R&E credit. Our net income increased 7% for the quarter compared to last year. So EPS of [72%] was up 13% over last year, which is impacted obviously positively by our stock buybacks.

To break down the noise in the quarter, you start out with the $0.72 that we reported. There was about a $0.04 impact from the TeleWeb product sales. There was about a $0.03 impact from the R&E credit, and then there was $0.02 of one-time expenses in the quarter that went the other way. And then the revenue recognition impact was a little less than a $0.01 in the quarter, which is about a $0.04 net takeout, which gets you down to -- right at about a [68%] EPS from operations, compared to the $0.67 consensus estimate out there.

Our EBITDA increased to $118.3 million for the quarter, compared to $110.8 million a year ago, or an approximate 7% increase. Depreciation and amortization expense of $59.4 million year-to-date, with $27.4 million depreciation and $31.9 million in amortization. Amortization for intangibles from acquisitions was relatively flat at about $10.5 million compared to last year. Free cash flow was down slightly this year, primarily due to the timing of the annual maintenance billings collections in June of last year. Compared to last year, we collected a lot more before this year started, which is the primary impact for our cash flow.

As far as guidance going forward, there is no change in our guidance. We continue to expect our top line revenues in the same growth range that we've seen. We expect margins to be relatively flat as they have been year-to-date. They are basically almost exactly flat with last year, which is the guidance we gave going into this year.

So that concludes our opening comments. We are now ready to take questions. Andrew, will you please open the call lines up for questions?

(Operator Instructions)

Kartik Mehta, Northcoast Research.

Hey, good morning, Jack and Kevin. Kevin, just a couple questions on your revenue recognition issue. What was the catalyst that forced this change or made the auditors look at it?

Well, I would say, Kartik, we were notified, I believe in October, by our audit firm that they were being reviewed by the PCOB, and that we had been fortunate enough to be selected for that review. And that's pretty much when it started. And it's really kind of kicked off about Thanksgiving but I will tell you it really didn't heat up until last week.

And then, how many of the products are included? Is it just one product or is it several?

Well, it's really a couple of different things, Kartik, and obviously I don't want to get too deep in the weeds here. The first phase was the recognition revenue on multi-product contracts. So the way we have always recognized revenue, and the way us and our legal department have always viewed our contracts, that we had multiple contracts with our customers under one kind of a general addendum.

And what we would do is we would ship software and we would recognize revenue and bill that as we implemented the software. So if a piece of software, a part of that multi-product contract was not delivered for two years, we didn't ship the software. We didn't recognize it, and obviously the customer didn't pay for it.

Under the new interpretation, we are required to -- once the contract is signed we are required to ship 100% percent of the software or we can't recognize any revenue from the software implementation, maintenance or anything until that last piece of software ships. So even if we have a customer that has, let's say, our Synapses solution, that they know they're not going to install for two years, under the old methodology we wouldn't have shipped it. Because it wouldn't make any sense because what we would have shipped them on the day of the signed contract, is not the same piece of software that would have been sold two years later anyway.

But under today's guidelines, we couldn't have recognized any revenue for the SilverLake software implementation or anything else until we shipped that last piece of software. So that's what it's come down to. They said we had to go back and defer all those revenues and push those forward, so those went into deferred revenue. They will be recognized in the future. And that's pretty much in a nutshell what it is.

And Kartik, just to clarify a little bit there, that relates to software and related implementation fees, and that has washed through at this point. Those adjustments are reflected in the earnings release that we put out. The open item is the software maintenance, which, again, we've had less than 48 hours to work on. And so, similar kind of concept, but, again, everything Kevin just described has already been adjusted and accounted for in the financials.

And, Jack, just your thoughts on the competition, the credit union market. Have you seen any change at all or how you view your position?

We have not, Kartik. We have in the credit union space 14 new core sales this year, which is tracking reasonably in line with last year. And so, the answer to your question is no, the competitive dynamic really is exactly the same, essentially the same in both banking and credit union segments at this point.

Yes, in fact, Kartik, the press release should have just hit your inbox that we posted this morning of the Symitar wins in the first half. We signed 14 new takeaways, and actually had 14 in the first half signed contracts to move from in-house to outsourcing.

Hey, Kevin, what's going to be the tax rate now going forward? I am assuming that changes a little bit?

Yes, it is going to be about 35% for the year, Kartik. I mean, obviously, it went way down this quarter because we had to take four quarters for the impact of the R&E credit. But for the year and going forward for the next two quarters, you could probably use about 35% and be in the ballpark.

All right. Well, thank you. Appreciate it.

Thanks, Kartik.

Dave Koning, Robert W. Baird.

Yes, hey, guys, nice job on the core business. I'm just wondering, the electronic, like the payments business grew 10%. I think that's the strongest in the last four quarters, and maybe you can just talk about what's happening there with the acceleration?

Yes, Dave, I don't know if there is any one thing I would call out. We had good growth in our bill payments businesses. Debit card growth rate is a little slower, but in our ATM transaction, processing grew nicely. Certainly, the remote deposit capture continues to grow quite nicely. Don't know that there's any particular items that stand out. It's just continued, customers being added with various payment processing services.

Yes, good. And then, how big was TeleWeb about, just so we can take those out of some of the year-ago periods, just to get an apples-to-apples comparison?

Yes, Dave, and don't hold me to this, but the operating income from those products was right at $1 million. The revenue from that, if I remember correctly, was about $5 million.

Okay. And those are both the annual?

Yes, annual revenue was $5 million or $6 million, and operating income was $1 million. Those came through the AudioTel acquisition back in 2007. Those were not strategic products going forward. That's not why we did the acquisition, and those were kind of just dwindling down because they were not really marketed products. So we made the decision that it was best to go ahead and sell them, get some cash out of them, before we watched them just go to nothing.

Yes, okay. And I think that -- you talked a little bit about the gain. I think in the last 10-Q, you said it was a $3 million gain, and then the one-time expenses are about half as big, the way you described it. So those one-time expenses must have been like $1.5 million or something like that?

Yes, just right at $2 million, which includes some one-time bonuses, and just some other costs we had in the quarter which were all one-time costs, Dave.

Okay. All right. Good job. Thank you.

Thanks, Dave.

Glenn Greene, Oppenheimer.

Thanks, good morning. Not to belabor the whole accounting issue, but I guess one question. First, the order of magnitude of the issue on the software maintenance side, I mean, it sounded like the changes in the restatement you've made were very immaterial which is one question really, why they even made you do this. But just trying to understand the order of magnitude of the software maintenance revenue, and related to this, is this like a new GAAP accounting regulation, or just like an interpretation that your auditors have?

Well, you asked a whole series of questions there, Glenn. So first, though, let me just say that the adjustment that we already made is clearly just a different interpretation of existing GAAP rules. This is all under SOP 97-2 that's been in place for a long time. We have complied with that for years. We have not changed anything we did.

But apparently, our audit firm decided to look differently at it. They brought in different partners, and my understanding is the big four audit firms kind of have their own set of interpretations. And that's the direction that they're going. So we're kind of required to comply with it. And so, we will make the changes, and I will tell you that going forward, it will have little to no impact on our revenue recognition.

We will just adhere our policies to those, so we can kind of continue to recognize revenue the way we have been. So it's not a big deal. But it's just kind of a restatement, and getting everything adjusted going forward for the prior year for comparison purposes. So again, there is going to be a little noise for the next three or four quarters, as we restate historicals on a year-over-year comparison.

As far as the maintenance piece, I honestly believe it's going to be immaterial, Glenn. Because really all it's doing is looking at the [VSOE] of maintenance, which we are very, very confident that we have VSOE, which is kind of a term that is thrown out there. But it really comes down to the timing of when maintenance is recognized. So it really relates primarily to the maintenance associated with new license sales in any given year, and when that maintenance should be recognized. So in my opinion, it's going to be clearly immaterial. But it's just one of those things that we have got to go through, and get documented, and prove to the audit firm where we are and what it is.

And, Glenn, I think it's probably obvious that for clarity, whatever happens with maintenance, the revenue doesn't go away. It either gets pushed forward or gets pulled back. So there is potentially some movement between quarters or possibly overlapping fiscal years. But it's just where it ends up being allocated to, rather than not being allocated anywhere.

Got it. Different question. So on the competitor side, you talked about this a little bit on the Symitar, and I did see the press release. So just to put it in context, the 14 competitive takeaways, is that a similar number to what you had in the first half of 2014? And is it roughly distributed across sort of market shares as we would think it would be? And also, the conversions from in-house to outsource, that 14, which I think that's a different independent number, is that comparable to what you saw in the first half of 2014 also?

Yes, the new core wins is almost exactly in line, Glenn. I think last year, we might have had 15 in the first half, but it's pretty much right in line. And just like last year, we haven't lost any. The conversions from in-house to outsource, that's actually accelerated a little bit from what we saw in the first half of last year.

Glenn, you asked about the distribution. I would just say, that nine of the 14 came from one vendor, and the rest were scattered out among other vendors.

That's helpful. And then just finally, to clarify the margin guidance of flattish for the year, does that include all these one-time items in the quarter? Or how should we think about the impact of these one-time -- the net effect of these one-items for that margin commentary?

Immaterial.

Okay, great. Thanks, guys.

David Togut, Evercore ISI

Good morning, this is Rayna Kumar for David Togut. The TeleWeb gain, was that all included in your G&A line?

Yes.

And cost of support and services, I see that grew 10% above revenue growth. Were there any one-time items there? And I guess if not, what were the drivers of that increase?

There was a few one-time things. The biggest driver within that increase was personnel costs, which there was some one-time special bonus-type things in there. But also depreciation and amortization in the quarter, which we have talked about for the last three or four earnings calls, from the investments that we have made in our infrastructure, so depreciation amortization went up.

The other thing I would point in G&A, is, yes, the one-time gain from Tele is in there, but also if you remember last year, there was about a $3 million insurance proceeds from settlement from the Lyndhurst debacle from the year before that. So just to compare apples and apples, you have kind of got to back both of those out.

That's helpful. Are you seeing increased competition from Fiserv's G&A product?

No.

Can you provide us an update on your estimate for FY15 capitalized software and internal use software? I think you were saying it was flattish for the year, but you were up 26% in the quarter.

For what?

Capitalized software.

For capitalized software?

Yes.

I said we're going to be up for capitalized software compared to last year. But it has leveled off, and the 2Q was pretty much in line and level with Q1. So, I mean, we have said all along that it's going to go up. I mean, that has kind of been the trend because of all the major projects we have going on.

Do you expect a 20%-plus increase over the next two quarters, in line with the first two quarters?

Yes.

And just one final question. Could you just call out the term fees in the quarter?

They were up about $2 million over the same quarter last year.

Thank you.

Yes.

Peter Heckmann, Avondale.

Good morning, gentlemen. I wanted to follow up on the CapEx side. Looked like CapEx was a little bit lower than I expected in the quarter, after ramping up a little bit ahead of some of the things you are doing with infrastructure as a service, given three, four, five months since the formal introduction of that service. Can you give us an update?

Yes. I mean, I will take you -- there was a significant amount of CapEx in Q1 for a couple of things. One, obviously we took possession of the third plane. But also we accelerated in the first quarter quite a bit of the new storage capacity that we were putting in place. Because it is one of those things, that you can't be half pregnant, so we went ahead and put a lot of boxes in, and so we should be good for storage now for some time. So CapEx will level off a little bit. But CapEx is still probably going to be in the $55 million-ish so for the year.

And any initial commentary on the infrastructure operations for the effort?

Just that it is going quite well, and, Pete, we have greatly expanded the scope of our testing environments. Feel very comfortable that we've accomplished what we set out to do by significantly improving our disaster avoidance and recovery capabilities.

Great, great. And then as regards, we have seen a little bit in an uptick in M&A in the banking space. Anything worth calling out there, or is it too soon to tell in terms of potential opportunities or losses from bank consolidation?

Well, obviously, one of our larger customers, Susquehanna Bancshares in Lititz, Pennsylvania was one of the acquirees announced last half of 2014. That was not the way we would like to have seen that transaction gone down. But again, we do not have any single customer that represents more than 0.5% of our total revenue. So as much as we hate to see those folks go away, the financial impact will not be there.

But to the general environment, there clearly is merger activity going on. I don't know from what we've seen that it's significantly different than what we've seen for the last couple of years. Our implementation teams, particularly on the banking side, they have been full to capacity for probably the last two years. I don't know that their backlog is any bigger right now than it has been.

And just as a quick follow-up, or as a reminder, Susquehanna was an in-house installation, correct?

Yes.

Okay. All right. I will get back in the queue. I appreciate it.

Thanks.

Brett Huff, Stephens Inc.

Good morning, guys. On the license, Kevin, I don't know -- or Jack, I don't know if you talked about this. But the license was down, but there was some caveat you put on that decline, Kevin. Can you just go over that for me again?

I don't know if Kevin put a caveat on it or I did, Brett. My point was that -- so obviously there was, well, $1.2 million adjustment, and I think most of that landed in the license. So my comments were, taking that out, we would have been down about 14% on license fees, as compared to whatever that may have been, I don't have it in front of me at the moment, but 26%, maybe.

And that's treating license the same in both, that's apples to apples now?

Yes.

Okay. And then, in terms of buyback and things like that, with all the accounting, with the accounting open item on the software maintenance, what can you guys do in terms of buyback and stuff? Is any change to what you can do there?

No. There is no change, because -- I mean, once it's public knowledge, Brett. I mean, as long as anybody else can buy, the Company can buy back stock. I mean, obviously, we were blacked out until we announced earnings anyway. But if we [hadn't] been blacked out for that reason, then obviously we would not have been able to be in the market until that became public knowledge.

Okay, and then last question. On the infrastructure question follow-up that was asked before, I think you -- this has been generally available for four or six months, is that right?

Yes, and actually, Brett, I may have misunderstood Pete's question earlier. I thought he was referring to the capital investments that Kevin had just finished talking about, related to some of the infrastructure for our own systems, our outsourcing processing systems, et cetera. But related to what I think you are referring to, which is our hosted network solutions that we mentioned a while back, we officially put that in the hands of our sales team in July at the start of the fiscal year.

It has received a significant amount of interest. We've had a number of sales closed. I look at a report every month, from the forecast of the number of deals that are in the evaluation stage, and it's a steep and steady upward to the right climb, if you charted it out of banks that have shown interest in that.

It is a complex sale. It's, A, it's networks, that adds a pretty significant level of complexity, and other factors make it a fairly complex sales cycle. But we are very pleased with the response that we are seeing relatively two quarters into having the service generally available.

I don't know if it was last quarter or the quarter before, but you guys seemed to say that [be this] fiscal year, you didn't think there would be a whole lot of revenue from this, just given that you had just started this year. Do you still feel that way? And/or can you give us a sense of how quickly, given the complexity of the sale, is it late this year where it's the kind of things you put numbers around from a revenue point of view? Or is that more of a next-fiscal-year discussion?

Well, Brett, we talked about this last year. I think we even talked about it at the Analyst Day, but I know we talked about it at the earnings call last year. It's one of those things that it's going to slowly ramp up, because it's all similar to outsource servicing. So it's one bank at a time. There is no license fee or anything, so it's just layering on and obviously we've got some nice momentum there. We've got some nice contracts in place.

But it's also one of those things where a bank will listen to the spiel, because of the complexity and say, hat sounds pretty good, but you know what, out of my 60 servers here, take three. Let's see how it works, and then we'll talk a year from now. So we've got some of that going on. So it's going to be a slow- building thing. So it's kind of like we said last summer is, going into next fiscal year and probably at the Analyst Day, we will be able to give you a whole lot better idea of what type of revenue we can expect for FY16, than we even can now.

Okay. That's what we needed. Thanks for your help.

Thanks, Brett.

(Operator Instructions)

Glenn Greene, Oppenheimer.

Hey, Kevin, I know you don't have the margins for the segments because of the accounting issues, but your best guess as what the margins might look like if you didn't have those accounting issues? Just wanted to get directional trends there.

Yes, I will tell you, Glenn, and I hate to tell you this, because there is some impact from those, but it's not going to be significant. But banking was about 42% or 43% for the quarter, so just down slightly from a year ago, because of the decrease in license revenue. Credit unions margins were probably about flat, at about 45%.

Okay, great. Thank you.

Thanks, Glenn.

(Operator Instructions)

And it looks like we have no questions in the queue. I would like to turn the call back over to the speakers.

Thanks, Andrew. Again, we want to thank you for joining us today to review our second-quarter FY15 results. We are pleased with the overall results from our ongoing operations, and very pleased with the efforts of all of our associates that take care of all of our customers. Our executive managers and all of our associates continue to focus on what is best for our customers and our shareholders.

With that, I want to thank you again. And, Andrew, would you please provide the replay number?

Ladies and gentlemen, thank you again for your participation in today's conference. The replay number is going to be 800-585-8367. That's 800-585-8367. Thank you very much for your participation again, and have a great day.