Jack Henry & Associates Inc (JKHY) 2019 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Jack Henry & Associates Second Quarter FY 2019 Earnings Conference Call. (Operator Instructions). As a reminder, this call will be recorded.

I would now like to introduce your host for today's conference, Kevin Williams. Please go ahead.

Thanks, Chris. Good morning. Thank you for joining us today for the Jack Henry & Associates Second Quarter Fiscal 2019 Earnings Call. I'm Kevin Williams, CFO and Treasurer, and on the call with me today is David Foss, our President and CEO.

The agenda for this morning will be opening comments from me, and then I will turn the call over to Dave to provide some of his thoughts about the state of the business and our performance for the quarter. Then I will provide some additional thoughts and comments regarding the press release that was put out yesterday after market close, and then we'll open the lines up for Q&A.

I need to remind you that remarks or responses to questions concerning future expectations, events, objectives, strategies, trends or results constitute forward-looking statements or deal with expectation 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.

With that, I am going to turn the call over to Dave.

Thank you, Kevin. Good morning, everyone. We're pleased to report another quarter with record revenue and earnings. As always, I'd like to begin today by thanking our associates for all the hard work that went into producing those results for our second fiscal quarter.

Total revenue increased 8% for the quarter and increased 9% excluding the impact of deconversion fees from both quarters. Year-to-date, revenue is also up 8% and is up 9% year-to-date if you exclude the impact of deconversion fees. We had a very solid quarter in the core segment of our business. Revenue increased by 5% for the quarter and increased by 6% if you exclude the impact of deconversion fees from both quarters. Our payments segment performed extremely well, posting a 14% increase in revenue this quarter and a 13% increase excluding the impact of deconversion fees.

We also had a strong quarter in our complementary solutions businesses, posting a 7% increase in revenue this quarter and a 9% increase excluding the impact of deconversion fees. On the topic of deconversion revenue, I'm sure you've noticed that in both Q1 and Q2, this line of revenue was down meaningfully year-over-year. We expect that trend to continue as we look forward to the second half of the year with Q3 significantly lower year-over-year and Q4 slightly lower. In many respects, this is a good problem to have because, although we experienced a short-term revenue impact, it indicates that far fewer customers are deconverting and their long-term revenue contribution stays in place. As we've discussed many times in the past, deconversion revenue is largely outside our control and very difficult to forecast. But Kevin will provide more detail regarding what we see on the horizon in his remarks.

Our sales teams, again, had a very solid quarter in Q2. We booked 13 competitive core takeaways and signed 19 customers to our new debit processing solution. None of those 19 customers had used Jack Henry for debit processing in the past. We also saw very strong bookings in our payments and complementary solutions segments. Several of our newer solutions, including our Banno Digital Suite, our commercial lending automation solution and treasury management saw strong demand.

We also booked 17 in-to-out deals between Banking and Symitar. The sales organization ended the first half of the fiscal year at 109% of quota and they've built a solid pipeline for the remainder of the year. The pipeline is up 26% over where we ended June 30 of 2018.

Regarding our new debit and credit processing solution, we now have 214 customers live on the debit platform, including 21 customers installed as new rather than as a migration. We also have 3 new credit customers live on the platform.

So far, all of these migrations and new installations have been successful and our program continues to progress well. As we discussed on the last call, we suspended our migrations during the holidays, but we have already completed a group migration in January and remain on track to complete the migration process sometime in the first half of calendar 2020.

As most of you are aware, we've branded our industry-leading digital suite as Banno. The second quarter was significant for our Banno team because we brought 45 new clients live on 1 or more of the Banno modules, including a $35 billion bank that went live with the complete Banno solution. Today, we have 27 banks and credit unions running on the complete suite, which includes Banno Online, Banno Mobile and Banno Conversations. We have an additional 155 financial institutions live on Banno Mobile only. We're seeing a 95% month-over-month return rate with the Banno applications, which indicates that once a consumer downloads the app, they're extremely likely to keep using it each month. This is a very high percentage for a consumer-facing application. Our Banno Conversations module is receiving particularly high marks. So we're excited about the Banno Suite as a true differentiator for our banks and credit unions as they serve their customers in the highly competitive digital world.

As we begin the second half of our fiscal year, we continue to be optimistic about the strength of our technology solutions, our ability to deliver outstanding service to our customers, our ability to expand our customer relationships, the spending environment and our long-term prospects for success.

With that, I'll turn it over to Kevin for some detail on the numbers.

Thanks, Dave. The services and support line of revenue increased 6% compared to the prior year restated quarter. Again all previous numbers have been restated for the new revenue recognition rules under ASC 606. We had a very strong quarter for license, in-house maintenance, software usage, software subscription, data processing, hosting, revenue, all in this line of revenue. We do continue to have some headwinds from decreased implementation revenue due to the vast majority of our core installs are electing our outsourcing model, which the implementation revenue must be spread over a period of time according to the contract unlike under 605.

As Dave mentioned, our deconversion fees were down $3.1 million compared to year ago quarter. And as we've discussed previously, we have no control over these, and all of our deconversion fees were in this line of revenue. The process line of revenue grew 11% compared to the prior year quarter and had no impact from deconversion fees. Total revenue was up 8% reported and a little higher than 9% adjusting for the deconversion fees.

Our reported consolidated operating margins were down from 24% last year to 23% this quarter. As we discussed previously, there are 2 headwind impacts on operating margins this year. First, the additional cost of processing our debit card customers as we transition them over to the new payments platform. And then the second is the additional cost for the employee pay-for-performance plans that are being funded with a portion of the savings from the Tax Cuts and Jobs Act that we discussed on previous calls. Remember that we have the benefit of the reduced federal income tax this year compared to last year, and our operating margins for the year remain flat at 25%. But as previously guided, there will be additional pressure on our margins because of these items as we continue to increase cost related to the migration of the payments platform in the second half of this year.

Our segments' operating margins continue to be very solid with small fluctuations. But payments segment will see some increased margin headwind going forward, again, as we increase these double costs as we migrate these customers over to the new platform.

Our effective tax rate was obviously impacted significantly by the TCJA for the quarter. The effective tax rate this year was 23% compared to a negative 90% last year. For the balance of the year, our effective tax rate will increase slightly each quarter and our projected total year effective tax rate is expected to be approximately 23% by the time we wrap up this fiscal year.

For cash flow included in the total amortization, which was disclosed in the press release, is cash flow -- is the amortization intangibles from acquisitions, which increased to $10.3 million year-to-date this fiscal year compared to $7.4 million last year. Depreciation is down slightly for the quarter but amortization up primarily due to more of our internally developed products being put into production plus the acquisitions that we did in October that we announced previously. And remember, when a product gets to our beta, we stop capitalizing according to the FASB rules, and we begin amortizing at that time.

Our operating cash flow was $192 million for the first 6 months, which represents an 8% increase over last year. The significant increase in capital expenditures year-to-date was primarily due to the cash paid out in Q1 that we discussed on the last call. Our cash flows will have the same seasonality as historical with significantly higher cash flows in Q1 and Q4 due to the collection of annual in-house maintenance billings. We did invest $89.7 million back in our company through CapEx and development products, which is up from $65.2 million a year ago with -- again with the vast majority of the increase due to the data center upgrades that we talked about in Q1. We did buy 150,000 shares of our stock from Treasury during the quarter.

For guidance for the balance of the year, as Dave and I already mentioned, our deconversion fees were down compared to last year in both the first and second quarters, which is a good thing as that means we are not losing as many customers through M&A. But it does create some challenges in year-over-year comparisons, which is why we back them out to show non-GAAP true operations in the press release. It appears now that our deconversion fees in Q3 are going to be down significantly compared to last year. And in fact at this time, it appears that they could be down by as much as $13 million in Q3 compared to last year. Therefore, since each million dollars of deconversion fees essentially equates to approximately $0.01 of EPS, we need to bring the consensus EPS estimate down by approximately $0.13 for Q3 and the year due to the significant decrease in these fees. For the year, we are projecting deconversion fees to be down roughly $20 million compared to last year at this time, which were down almost $6 million in the first half, which means we're going to be down about $14 million in the second half.

However, with these headwinds, our GAAP revenue growth for the fiscal year should still wind up to be in the 5.5% to 6% range with operating income essentially flat due to both the decrease in deconversion fees and the additional cost headwinds for our payments platform migration and the new pay-for-performance plan that we previously talked about.

On a non-GAAP basis, our revenue growth should still be in line with the original guidance of approximately 7% for the year with some leverage to our operating income line. Then obviously, with the reduction of our effective tax rate this year to the full year projected 22% to 23% from the adjusted 28% last year, our EPS will still be up nicely for the year compared to last year after adjusting out the TCJA impact on our deferred taxes last year.

With that, we'll now open this call up for comments. Chris, will you please open the lines up?

(Operator Instructions) And our first question comes from David Togut with Evercore ISI.

What's your assessment of the competitive impact on your business from Fiserv's announced acquisition of First Data? And then just as a related question, any impact expected on your joint venture with First Data and PSCU as a result?

Okay, Dave. This will probably be a little bit of a long answer, but I'll take a shot at both of those questions. So first off, as far as the overall competitive impact, we've talked many times in the past about the fact that our 2 major competitors are larger than we are. They've been larger than us for a long time. We have a very long track record of winning against them, even though they both have been very significantly involved in the payments side of the business, and they are core competitors, of course, Fiserv on both the banking and the credit union side of our business. So the competitive landscape, they're much larger than they were before, assuming this deal closes. But as far as we're concerned, it's business as usual competing with them. And again, we have been winning significant market share, and I expect us to continue to do that. As far as the existing partnerships, so a few things that you need to keep in mind with regard to the First Data partnership that we have. First off, the role of First Data in the partnership was simply to process transactions, right? They're not reselling, we're not -- they're not active in the sale process with us. They don't install anything, they don't support anything. They never talk to a Jack Henry customer. The model was that Jack Henry sells, installs and supports the solution. The front-end tools that the Jack Henry customer uses come from PSCU. The First Data role was to process transactions. So our expectation is that when we -- assuming this deal is completed, that the processing engine will still be in place and that they will continue to process transactions for us. So we sell, we install, we support as a Jack Henry solution, they just happen to be the processing engine underneath with the PSCU tools laying over the top. So that's the model, just to make sure we're clear on what it is that we're doing with First Data. The other thing I would point out is, so now First Data becomes a part of Fiserv. We have -- we don't talk about it a lot, but we work in a coopetition environment every day. So people we cooperate with one day, we're competing with the next. And that's been our role with Fiserv for many years. So I don't think we've ever mentioned it on one of these calls, but we were partnering with them for years on their CashEdge solution. We just recently got out of that partnership because we inherited a better answer through another solution but we had a very successful partnership for years, and so my anticipation is that we can do the same thing here. We have a long-term agreement in place today with First Data that includes pricing and service level agreements and so on. I've talked to the executive leadership team in First Data several times since this deal was announced, just to ensure that everything stays in place going forward, and I'm confident that the processing requirements continue as we go forward. We would become a significant customer for Fiserv. So it's not a smart thing for you to make trouble for a significant customer. Obviously, we'll have to work through all that as time goes by. But it's in their best interest to make sure that we are happy and successful working with them. So I think if you put all those things together, the future is still bright for Jack Henry. We have -- we're totally committed to this platform. We're having great success already, and I don't see that changing as a result of this acquisition.

Understood. If I could just dig into the gross margins a bit? Kevin, I appreciate all the helpful callouts on operating margin impacts, but was there anything specific behind the 100 basis-point decline in gross margin year-over-year? Was that the new pay-for-performance program?

Well, that was part of -- there's also the increased cost in our move to the new payments platform, Dave. I mean, we were continuing to add resources in the first half of the year. In fact, we're still adding some. And then remember, we are unable to take any cost out at this point because we still have to keep the 2 platforms in place. We have to keep all of those offers in pace. We have to continue to keep those compliant with the cards payments requirements. And as we -- as Dave mentioned, we've now moved 207 of our existing customers over to the new platform. We're now having to pay a per-click fee on every transaction that those 207 customers are processing. So the costs are going to continue to increase and continue to put headwind on our margins until we are able to get all of our customers opt one of those platforms so we can shut one of them down and start to take some costs out. So that was in my opening comments is we're going to continue to see increased margin pressures especially in the payments segment for the next year plus until we can get through this migration process.

Got it. And then just walking through some of the revenue growth trends in the 3 reporting segments, very nice acceleration in payments, revenue growth to 13% from 10%, but we saw some deceleration both in the core and the complementary revenue. Any callouts, a, behind the acceleration in payments and sustainability, and then some of the decel in the other 2 segments?

Well, so on the core side, Dave, and I mentioned that in my opening comments that the headwinds are primarily from our implementation revenue because you might as well say 100% of our new banking core customers are going outsourcing and probably -- and close to 80% of our new credit union customers are going outsourcing, and that implementation revenue has to be spread over the life of the contract, where an in-house customer, you actually recognize that implementation revenue upfront when you actually deliver the software. So that's the biggest headwind we're seeing on the core side. Complementary is somewhat the same. There's also some implementation challenges there because again, as we're installing these complementary products in an outsourcing solution, we have to spread that revenue. So that's really the only headwinds we're seeing. I mean, we -- as Dave mentioned, we continue to see very strong sales and very strong deliveries and products across both bankings and credit unions in core and complementary. Obviously, payments had some increase from some of the acquisitions. So I don't know that, that growth is totally sustainable, but I think we'll continue to see very nice growth as we continue to add new customers in just about every bucket of our payments, which is obviously, as we talked about before, there's 3 different buckets in our payments offerings and all 3 of those are showing nice growth.

Understood. Then just a quick final question for me. Dave, you called out a $35 billion asset bank that you signed on for the new Banno Digital Suite. Can you talk about the drivers of that win? That's certainly a very large win in terms of asset size. And then do you expect that to lay the groundwork, if you will, for more banks in that size range?

So first off, we won that contract many months ago, right? My point was that they went live in this quarter. So we signed that deal many months ago. And are we targeting $35 billion banks with the Banno solution? We are not. We're targeting banks and credit unions running the spectrum. My key point there is that it is a solution that is working very well. I mean, they are very happy. I've just recently talked to their CEO about the rollout and they're very happy with the rollout, very happy with the solution. And I think the significant thing about that solution is, regardless of the size of the institution, it positions our customer to compete heads up against primarily the 2 that a lot of people call out every day, BofA and J.P. Morgan Chase, they're investing billions in their technology to serve their consumers through the digital channel. And this solution, our Banno solution, positions our customers very well to compete in that environment. The key thing and I stressed it in my opening comments and I'll just say it here too, 3 different modules in Banno. So Banno Online is what we used to think of as online banking. Banno Mobile, of course, mobile banking. And then there's Banno Conversations, and that's been the real differentiator for this large institution and several of our other customers in that they can communicate with their consumer in the channel -- in the banking channel. They can do chat essentially with their consumer through their help desk. And that's a differentiator for our solution and it's definitely a differentiator for these customers, and it's one of the things that really attracted this particular customer to that solution. So we expect certainly large banks and credit unions to adopt this but we also expect a lot of institutions that are smaller than that because it takes strategic solution for them to compete with the Tier 1 banks in the United States.

Dave, one more comment too. I highlighted implementation revenue being down, but that also goes hand-in-hand with our license revenue because as more and more of our new core customers go outsource, obviously, we're not selling license revenue, and in this quarter a year ago, we had a very large win and merger that drove quite a bit of license and implementation revenue in the quarter, which made sort of a tough comp for both core and complementary compared to a year ago.

And our next question comes from Kartik Mehta with Northcoast Research.

Dave, just your perspective on how your customers are feeling, and if you look at kind of spending as we look at 2019 kind of compared to 2018, how you think that will trend for the banks and credit unions.

Sure. So I mentioned earlier that the sales pipeline is up 26% over where we ended in June. The reason I mentioned that was because in June I talked about -- at the end of the June quarter, I talked about how significant the pipeline was going into the new fiscal year. Frankly, I'm shocked that the pipeline is up so significantly over where we were last June. So the interest in Jack Henry solutions, the spending environment today is definitely very strong. I did yesterday, for the first time, see a survey that some bankers were starting to get a little bit concerned about -- as they look into calendar 2020, starting to get concerned about the -- where the economy is going and that kind of thing. But the good news for us is that they are focusing a lot of their attention now on preparing for a potential downturn in the economy. So the digital suite, for example, that I just mentioned when I was talking to Dave, very important to them to position themselves to compete going forward with the digital solution. Lending is still strong, and so I highlighted that in my comments, our Commercial Lending Solution is getting great interest. That is helping them position for the future. Then the other topic that's high on their list is efficiency. Their efficiency ratio is a key metric for our customers and that too helps them as they kind of position themselves to make sure that they can weather any economic downturn that might come. So right, now spending environment is very strong. I don't see any slowdown as far as what our sales reps are seeing. I am, of course, monitoring things like the report that I just referenced that would indicate that in 2020 maybe there's a little bit of a concern about the economy, but we are not seeing any impacts right now as far as sales are concerned.

Yes. And I'd also add to that, Kartik. I mean, right now, we continue to see a lot of activity in core valuation. There is just an enormous amount of core valuation going on out there. I have a weekly call with our sales teams to review some of the activity that's going on out there, and it's just amazing how strong that continues to be.

And then, Dave, just maybe a backdrop on your comments about 2020. One of the thoughts was, as you move to this new credit and debit card portfolio, maybe some of your banks would be interested in issuing their own credit cards as a way to generate more fee income. Have you seen a change in that trend at all? Do you still see interest? Or was maybe the economy -- their concern about the economy, is that waning a little bit?

No. I think it's the opposite. I think that this -- the opportunity to issue on the credit card side helps them potentially if there were to be some kind of downturn in the economy. So no, absolutely no slowdown as far as interest is concerned. It's -- things are good right now as far as sales are concerned.

And Kevin, just one last question. You talked about the deconversion fees, obviously, have an impact for you this year. What is the long-term -- I imagine the long-term is a little bit more positive impact because you're not seeing these customers migrate away or merge away. And is there a way to look at maybe the revenue impact from this as you move to the next year -- next fiscal year?

Well, like we said before, Kartik, I mean, that's why we break out, said in the press release, because we have no control over it, we have no visibility. And I understand that, I mean, 90 -- I mean close to 100% of deconversion revenue comes from M&A activity. So it's just when our banks and credit unions get acquired and they have to pay out these long-term contracts, so we have no control over that. We have no visibility for that. So there's really no way I can even predict what's going into next year. I mean, the only way I know for this quarter and then basically the second half is typically we get notified 3 to 6 months before they actually deconvert when they project they're going to deconvert. But again, under the old revenue recognition rules, we couldn't recognize $0.01 of revenue until they actually deconvert and wrote the check. Under the new revenue recognition rules, when they give us notice and sign the paperworks, we have to start spreading that estimated deconversion fee revenue from that point to the projected deconversion date. If the date shifts, then we have to readjust how that gets spread. So I don't have any more visibility into deconversion fees for 2020 than I did for this year going into 2019.

Yes, maybe -- again, my question was more about the fact that you're not going to have these deconversion fees. I guess the revenue is going to -- you're going to keep your revenue.

It's good news. We're going to get revenue from these customers. And so obviously, the headwinds will be less going into next year than they were going into this year, absolutely.

I don't know that's -- I mean, I've mentioned that in my comments. But the good news in all of this is that fewer customers are deconverting. So on the core side, we don't typically lose a customer because they choose to go with one of our competitors. But M&A certainly has an impact. But then we've been pretty open on these calls about the fact that on the payments business, we were losing customers. They were leaving Jack Henry, and they were paying a deconversion fee sometimes to leave us because they weren't happy with the platform. And of course, that has virtually come to a stop now. So the good news is that revenue stays in-house for Jack Henry, continues to build both because we're not losing customers through M&A and we're not losing customers on the payments side that are flat leaving us. Quantifying what the impact of that is as a reduced headwind, I don't know that, that's -- there's any way to accurately do that, but you can just logically see where that's a positive for us going forward. If you look at -- if you take the long-term view of Jack Henry, that's a really good signal for us. The other thing is, to Kevin's comment earlier, that almost every core customer we're signing these days on the banking side are going outsourced and much more, many more of the credit union customers that we sign today are choosing outsourced model, and we're continuing to do these in-to-out migrations. I mentioned in my comments the number of in-to-outs that we did, 17 in-house to outsourcing. All of those set us up with recurring revenue. So if you take the long-term view, those are all good signs for Jack Henry.

And Kartik, one more comment. I mean, you're not talking about the score. There's no way to project what future revenue there is tied to a deconversion fee because it could be a bank or credit union that has 6 months left on their contract that has a plethora of our products, they're going to pay us a huge deconversion fee. Or it could be a small bank that has 4 years left that only has a couple of our products, they're going to pay us a much smaller fee. So you really can't tie the deconversion fees to forward-going revenue.

And our next question comes from Peter Heckmann with Davidson.

Just wanted to follow up, make sure we're following the number. Can you, Kevin, just for reference purposes, give us that guidance again in terms of looking at adjusted -- I think you said adjusted revenue, which would exclude term fees should still for the year be up about 7%?

Yes.

Okay, you gave your commentary as regard the impact or the big drop in high margin deconversion fees in the third quarter. But for the year, it still sounded as if we're looking at that kind of high single digits to maybe potentially 10% EPS growth for the year. Is that the right way to interpret it?

On a GAAP -- well, on a non-GAAP basis, yes, Pete. I mean, once you back deconversion fees out, I mean, revenue growth should still be roughly 7% for the year, operating margins will get some leverage from that, and then obviously a little more leverage to EPS from that from the lower tax rate. So obviously, EPS on an adjusted basis, if you back out the TCJA, again, we've got some crazy numbers compared to last year because of the impact of TCJA on our deferred taxes last year, which was well over $1 of EPS. So you have to back that out to really get an apples-to-apples comparison. But yes, so we'll still have a nice EPS growth if you adjust all that out.

Okay, okay. And kind of a good -- just again for reference purposes, a good fully adjusted fiscal 2018 EPS for the year, is that around $3.30?

I'm sorry, say again, Pete.

Just so if we're looking at a kind of a non-GAAP EPS figure for fiscal year '18, would you put that figure around $3.30?

I think it's around $3.29, Pete.

$3.29, great, great. Okay. And then just fundamentally, I did want to follow-up on Zelle. You had talked about some of the pilots that were occurring late last summer and through the fall. I wanted to see what type of uptick you're seeing there, if any, in volumes and banks' relative appetite to adopt or incorporate that service.

Well. So what we've talked about with Zelle is the fact that they've had so much trouble bringing the processors live. So they -- today, Zelle has 60 institutions live on their platform, 15 of those are 1 holding company, 8 or whatever it is were the original founding banks and then the other 12 that were part of the original clear exchange program. So 35, 40, whatever that adds up to, of them were part of the original plan, and then there's another 20-or-so that they brought live. All of them have been point-to-point connections, where they've developed their own interface from the bank into the Zelle platform. None of the processors are live as processors. So -- but we have sold 15 so far. We have customers that are in testing, and so there's a lot of interest. But as far as live volume going through us as a processor, meaning we're aggregating transactions for a bunch of banks and processing them live, we don't have any of those live today, nor do any of the other processors have them live today.

And our next question comes from Glenn Greene with Oppenheimer.

David, thanks for the clarification on the First Data situation, we've been getting a lot of questions on that. I guess the first question is, could you guys sort of talk a little bit about the drivers of the payments strength, the 13% in the quarter? And maybe if you can parse it across the key product areas that drove that?

Sure. So the 3 primary product areas. So first off, we have what we call EPS, Enterprise Payment Solutions. EPS is our traditional Remote Deposit Capture and ACH processing platform. So EPS was up approximately 6%, I guess, as far as revenue is concerned for the quarter. But that's a business that -- it's an ACH-based business but continues to grow nicely, not only through our banking customers but through partnerships that we do through EPS, and we've talked about some of those in the past. The second is our bill pay business, iPay, which traditional aggregator business. Transaction counts there were up almost 4% for the quarter. So that business continues to grow nicely. And then the third is the card processing business. So it's the transactions that we're processing through the First Data platform but also the legacy platforms that we're hosting today. Transaction counts are up nicely there. They were up 8%, almost 9% for the quarter. So it's kind of across the board. The thing to kind of zero in on is the point that I made earlier about the number of customers that we now have live on the new platform. I mentioned that 19 customers signed with us today that were never on the old platform. So it's not that we'll be migrating them, it's that we'll -- it's that they're brand new customers to Jack Henry. I also mentioned that out of the customers we do have live processing today, 21 of them were never on the old platform. So there is new revenue that's coming in, in addition to migrating customers over and seeing growth out of those customers because they have more functionality on the new platform. We're adding new customers through the -- through signing customers because they like the functionality that we have particularly with the PSCU technology laying over the top. So it's kind of all 3 areas are growing well. But certainly, we're seeing nice growth in CPS because of all those customers that we're adding net new to Jack Henry.

And one other thing, Glenn, so probably what you're going to ask next is margins. So as we add these new customers, obviously, that helps to offset some of the headwinds on margins of the customers we're migrating over, which makes it even more of a challenge and difficult to quantify what the true margin impact is going to be in 2020 when we take all these costs out. Because the more new customers we're adding, they help to offset those margin headwinds. So just food for thought.

Yes, I'll follow-up on payments, frankly, I'm still struggling on to see how you get to 13%, but I'll take that off-line. I wanted to follow-up on Pete Heckmann's question because I heard a couple of things on the margin expectations. Kevin, you had said in your prepared comments, it's somewhat flattish, and then to Pete's question, you suggested some margin leverage. And I thought I also heard you say flattish EBIT overall, implying sort of a 23% tax rate. My back of the envelop math got me $3.55, $3.60-ish EPS. I just wanted to know if that's sort of sanity checks with how you're thinking about it? It's a little bit different than your answer to what -- to Pete.

So Glenn, the operating income for Q3 is going to be basically flat on a GAAP basis. On a non-GAAP basis, when you back out the deconversion fees and other non-GAAP adjustments, you're going to have some decent leverage to the operating margin line. So your EPS for the adjustment is pretty much in line in that $3.55 to $3.60, somewhere in there for the year after we adjust out. So I hope that answers your question. But in my opening comments, revenue growth even is going to be in the 5.5% to 6% on a GAAP basis. On a non-GAAP basis, it should still be basically roughly 7% based on what we're looking at now by backing out the deconversion fees with very little leverage to the operating income line on a GAAP basis but some decent leverage on a non-GAAP basis. Obviously, when you have a $20 million headwind from deconversion fees through the year, that's going to have some impact on your margin from a GAAP-reported basis.

Understood. And one more question. Any more current thinking on where your margins trend once you get past the debit conversion?

Well, again, like I just said, Glenn, the challenge there is as we add new customers, which we've already added several, that's new revenue and new margins, which is actually at a higher margin than our old customers are that we're deconverting off. So we continue to increase costs but we also have that offset of new revenue and new margins, which is kind of reducing that headwind. So at this time, it's still kind of a challenge and I think I've been pretty consistent that by the end of this fiscal year, I hopefully will be able to give you much clearer guidance on what that impact is going to be in the second half of 2020.

And our next question comes from Tim Willi with Wells Fargo.

A couple of questions. One, I was curious if you could just talk about the pricing environment. I'm curious about some of the faster-growing areas like mobile. If there's just any sort of callouts around some of your, I guess, major revenue drivers, where you feel like the pricing environment is maybe favorable versus under any kind of traditional or extraordinary pressure. Sort of trying to get a gauge on that. And then I had a couple of follow-ups.

Sure. So in the mobile area, definitely a differentiated solution with our Banno solution. Because we have a single platform that's doing what we traditionally call as online banking, what we traditionally called mobile banking, we have an advertising platform through it, we have the conversations component that I just talked about earlier and we can host the financial institution website all on the same digital channel. It is definitely a differentiated solution. So when you think about price, it's not like we're trying to line up our pricing in a per widget with somebody else because it's a totally differentiated solution. Now we're in a competitive environment, and we have to be able to follow the standard competition stuff, but it's a good place for us to be as far as having a differentiated solution and being able to sell value as opposed to just trying to compete per widget with somebody who's out there with exactly the same thing. If you look across the broader product suite, as I said earlier, the spending environment is strong today, and we're not seeing the intense pressure as far as price compression. There are certain pockets here and there, but it's not like it was, say, 3, 4 years ago, where there was real intense price compression going on in several areas of the business. Today, that's just not the case. I think part of it is because several of our technology solutions really are differentiated. We've talked about treasury management, for example. It is a unique new solution. We've brought mobile -- the mobile component live this past quarter, I didn't even highlight that earlier, but to have a treasury management solution with a complete set of mobile functionality is a real differentiator. So it's -- there's pressure. We're in a competitive environment. We always deal with that. But I think several of our technology solutions now are highly differentiated from our competition, and so that always helps when you're talking price.

Great. And then just the 2 follow-ups and I guess they're somewhat related. But just curious about anything on the M&A environment that's changed since the last couple of calls, where I think the answer has been things are really expensive and there is no shortage of stuff being presented to you. Maybe if you could address that directly. And I just had a follow-up that sort of ties into that as well.

Things are really expensive and there's no shortage of stuff being presented to us. I mean, it really is. It's the same environment that we've been in for quite some time. I got an updated number just the other day. There is still $1.5 trillion of PE money sitting on the sidelines, waiting to be invested. We certainly see that when we're in competitive deals. That private equity, they're looking for places to put their money, and so they're pretty ready to outbid on deals. So it's definitely very competitive. But you saw us do the 2 little deals in October, the Agiletics deal and the BOLTS deal. And then Ensenta a year ago now, all of those deals were competitive but Jack Henry oftentimes has an edge because of reputation and culture. And you oftentimes don't think of culture as winning the day when it comes to a competitive-bid acquisition, but it really does help in those situations. And so we continue to ensure that, that message is out there, and that when we do an acquisition, we'll take care of the employees and the customers and certainly the seller. But we're very focused on making sure that the employees and the customers land in an environment that's going to help them be successful long term.

Great. And so my follow-up on that was, this has come up periodically, obviously Jack Henry is hyper-focused on customer experience, retention, culture or in a very dynamic tech environment, open banking to open computing-type environment. Do you have any different stance around internal development versus partnerships in lieu of finding attractive M&A opportunities? Is there anything at all where there's a tilt one way versus the other about maybe looking at partnerships and building that ecosystem out more so than you would've thought a year ago or 18 months ago? Or do you feel like anything your customers are looking for, if you can't find a way to acquire it, you've got the bandwidth and the resources to develop it internally?

It's a good question. We've talked quite a bit in the past couple of years about the whole build-by-partner methodology that we go through. Whenever we have a need for a solution that our customers are looking for, we go through this build-by-partner analysis trying to find what is the best approach for us. So you've seen us build some solutions like treasury management, you've seen us partner like First Data deal and then the acquires -- acquisitions that we just talked about. So we've done a lot of that -- all 3 of those in the last year or 2. And certainly Jack Henry has a history in all those areas. So with the points that you mentioned, I don't know that there's any need for us to change the way we do that, and you kind of have to define the word partner in the question that you asked. So partner usually implies that we're -- there's a revenue share and all that kind of stuff. Keep in mind, Jack Henry forever has been -- had a very open approach to working with third-party vendors, and we don't require a rev share. We've opened up our full systems for years to make it easy for third-parties to integrate into our core to enable our customer to get whatever it is that they're looking for. And that philosophy and strategy hasn't changed. And frankly, it feeds perfectly into the open-banking concept that you're talking about. However, our competitors have not had that approach. We've been open for years and have provided the tools for years to help enable third-party products with Jack Henry cores. Now we need to expand on that, and we're close to rolling out the complete set of Open APIs that kind of extends that functionality, but we're well positioned to address the open-banking concept as it's being defined today.

And Tim, it really depends on the situation because obviously back to your -- I think your second question, we're obviously always getting hit with opportunities to buy companies and if they fit and it makes sense then, yes, we'll try to buy them. But on the other hand, when a customer has come to us, why -- today as an example with treasury management, you look out there, did we have the cash to build it? No. But we found the right manager to hire and build a team and build a solution because it made more sense because there's really nothing out there to buy. But when you look at like Ensenta, we didn't have -- we couldn't have built or replicated that, so it made more sense to just buy it and the same way with FTC, it made more sense to partner because there was -- we couldn't build it and there was nothing out there for us to buy. So it really depends on the situation, which direction we're going to ultimately end up going.

And our next question comes from Joseph Foresi with Cantor Fitzgerald.

My first question, I want to go back to the FIS -- Fiserv FTC deal. I guess 2 questions there. One, do you believe that by making that acquisition, it strengthened Fiserv's position in the market particularly around core processing? In other words, do they now become a little bit more attractive because they have sort of the front-end and the back-end? And then my second question is, does it really make sense to continue with the FTC processing aspect of your partnership? Or would it make more sense to be with a different merchant? Because couldn't Fiserv go to clients and theoretically say, well, we've got the processing, we've got the back-end. Wouldn't that put them in a better competitive position?

I don't believe, first off, that it strengthens them at all on the core side because this acquisition has nothing to do with their core. As far as the payments equation, we believe that the platform that we have with First Data is a terrific solution for Jack Henry, and what Fiserv does as far as a sales strategy, as I mentioned earlier, we will be a very large customer for them. And so you have to keep that in mind as they go forward and develop their sales strategy. So I don't think that would be a prudent move for them to try to do something like what you're suggesting. But you'll have to ask Fiserv what their strategy is, I'm not sure.

And the other thing, Joe, remember our agreement is really with PSCU, and PSCU has the agreement with FTC, which they've had a working relationship with First Data for 30 years. So that relationship has been in place forever, and our agreement was with PSCU to process our transactions through PSCU to FTC, and FTC is just basically processing the transactions.

Got it, okay. And then just on the competitive environment. We've seen some press releases around Infosys helping some banks maybe move some of the work to the cloud. And then of course I think we've heard some rumblings about Temenos in the Midwest and a bank there. I was just wondering what your thoughts were about the move to the cloud and Temenos and sort of the structure of the industry at this point, and if you're seeing any changes on the competitive landscape?

No major changes on the competitive landscape. Temenos and Infosys for that matter have been working to establish a foothold in the U.S. for many years. So there's nothing particularly new there. They're working on implementing deposits for a single bank in the Midwest. But getting deposits, loans, general ledger, everything rolled out is a tall order. So -- but again, they -- both of them have been working in the U.S., trying to establish a foothold in the U.S. for a long time. So I don't see any significant change there. As far as moving to the cloud, we have the same type of projects going on at Jack Henry. Some products are already public cloud residents and others we're in the process of moving things there as they make sense. So I think we're positioned well to be competitive with either of those players if they get a stronger presence in the U.S.

Got it. And then the last question for me. Our channel checks have seemed to imply that bank spending, at least on IT, continues to be good heading into next year or this year at this point. Can you just give us your thoughts on spending patterns this year versus last year? And maybe call out where you see some of the major areas and how you're positioned in them?

Yes, so I mentioned earlier that our pipeline is up 26% over where it was at the end of June, and you may or may not recall but I highlighted it at the end of June last year because it was up so significantly and I was frankly kind of shocked with how large the pipeline was getting. And so here the sales team now, after receiving a quota increase, there's already at 109% year-to-date and the pipeline is up 26%. So the interest in Jack Henry solutions, the overall spending environment very strong right now. Keep in mind almost everything that we're selling today, and I won't say everything, I'll say almost everything that we sell today, is the recurring-revenue type of agreement. So you don't see a revenue pop in the quarter. You see that come over time, and that's -- the good news is customers are signing long-term contracts for almost anything that they're buying from Jack Henry today. So spending environment is strong. Where we see particular interest, I have added a couple of these already. The digital channel, a lot of activity there. Kevin mentioned, there is so much activity going on in the core space right now, which normally you don't see big blips when it comes to the core business. It's usually pretty steady both on the banking and the credit union side. We tend to win a very large portion of those deals that go up for decision. But right now, there are just a lot of deals in play and so that's interesting, it's good. De novo activity is up. So there have been 24 new banks chartered in the past 12 months. We've won 13 of those, so more than half. The other less than half have gone to a variety of other different vendors, but Jack Henry has won more than half. That's good for Jack Henry because they tend to grow quickly and that produces revenue. So spending environment is strong, the overall environment is good and again, I think the technology solutions that we're offering today have really positioned our company well to be competitive.

And Joe, I would tell you that Dave and I both challenge our sales organization to make sure and scrub those -- the sales pipeline. And I can assure you that the numbers that Dave is quoting are all very much sales opportunities.

Yes, they're legitimate.

And our next question comes from Dave Koning with Baird.

So just a couple of quick ones on guidance. I think you said Q3, we should take -- I think consensus was $0.90, we should take that down by $0.13 to $0.77. Is it roughly what you're saying on that, right?

Yes.

And did you say EBIT, oh, go ahead, sorry.

Yes. But I mean -- so Dave, obviously, deconversion fees were down $6 million roughly in the first half of the year. We were able to basically overrule that with some of the pull forward of the software subscriptions and some different things. So it didn't have much of an impact.

Because of 606.

Because of 606, yes. And -- but when you have a $13 million headwind in this quarter and probably another $1 million decrease in deconversion fees in Q4, I don't see any alternative other than to take guidance down.

Yes. That makes sense. And did you say EBIT for the year -- I think the base of last year is $3.57-ish. Did you say that would be about flat in '19, so it would be another -- something right around that same number?

For GAAP, yes.

Yes. Okay. And then one thing that was really encouraging. So margins in the first half, if you'd strip out term fees, so I guess your non-GAAP margins, were actually up year-over-year despite all the implementation fees, despite the severance payments and all that stuff. So have some of those investments just been a little slower to start? Or is it just the core margins are -- have been just so good?

Well, I mean we actually had a decent first half in some areas like license fees and software subscriptions were up nicely, which obviously that's very nice margins. Payments business was up nicely in the first half. But again, we continue to add additional costs. We continue to add -- double the fees for the payments platform migration. So we're going to see increased margin headwinds in the second half above what we saw in the first half. But yes, I mean, our associates and our managers have done an extremely good job in the first half to overcome and offset some of the increased costs we had in this half, including depreciation and amortization from some of the new products and facilities upgrades that we did in the first half of the year.

Okay, good. Yes. And then I guess, lastly and then maybe a little corollary to this. Your revenue growth organic, ex term fees and everything was about 8% in the first half. It was one of the strongest periods in the last 5 years or so. Is that -- I mean, you mentioned some of the drivers. But I mean, is a lot of this just the pipeline and work is good, the new products are good? And I mean, do you think we're just in a period that might be a little better than normal over the next couple of years?

Well, it's a combination of all that, Dave, and then also remember 606 pulled some revenue forward in the first half, which again is causing some headwinds in the second half. So revenue growth is not going to be 8% in the second half of the year. I mean, obviously, revenue growth is going to be down especially on a GAAP basis in the next 2 quarters to get us down to where I've said that 5.5% to 6% growth. So obviously you can tell that the Q3 and Q4 is going to be down slightly because we've pulled that back. But again, as I said on last quarter, it's going to take us a year to get through all the bumps and hurdles of 606 and kind of get into a normalized pattern. So I think what you're seeing, Dave, is we're probably getting more into a normalized pattern, where we're going to have a little more revenue growth in the first half. It's going to be a little more headwinds in the second half. I think we're going to see that again next year and then the following year, it's kind of unknown because that's when we finish the migration of the payments platform. So we're going to be taking a lot of costs out. We'll have anniversaried the new pay-for-performance bonus. So yes, there's going to be a lot of changes even in FY '20 but even more than that in FY '21.

And our last question comes from Brett Huff with Stevens Inc.

One specific question and then a couple of other product updates. When we did the math on incremental margins for the payments segment this quarter -- this past quarter, it was above 60%. I think it was maybe 30% or 35% in 1Q. And Kevin, I think you called out there's some M&A that helped but, Dave, then you said -- mentioned that the transaction counts are pretty good. Is there something about the new M&A that made that margin go up? Or is it maybe some 606 stuff? Or -- is that anomalous or something we should think about?

There was nothing really M&A related that would cause the margins to go up. And really not 606, Brett, because actually 606 goes the other way. 606 actually takes revenue out and carves it back into license implementation. So it's -- it was just a really good quarter. It was a nice mix of the 3 buckets of revenue, as Dave pointed out. So I mean, I don't know that it's actually sustainable but it was just a really good quarter within the base and the mix of payment sales that we had in the quarter.

Okay, that's helpful. And then 2 product questions. We've talked a little bit about treasury management and commercial cash management. I know you guys have been selling those for a while. It sounds like they're selling well and that it's helping retain some of those larger customers that were looking around. Can you tell us about the competitive environment there? I know it's a very fragmented market. There's some legacy players and there's a couple of new players that I think are taking share. Are you at all focused on your base first? Or is this something that ProfitStars can go out and sell? Or -- give us an update on the competitive environment there.

It's a good question. So we are -- and you're reading that environment very well. We've booked 10 new treasury management deals in the quarter. And you're absolutely right, it's larger customers who are looking for a solution to serve their commercial customers better. There's a lot of interest in that area. I highlighted commercial -- the interest of our clients to serve their commercial base earlier when I was talking about lending, but it's certainly true on the treasury side as well. The environment out there, as far as companies offering a full treasury solution, is fragmented. As far as I know, and I'm not an absolute expert in treasury, but I'm pretty involved. As far as I know, nobody has the breadth of functionality that we have with this new solution, including the fully enabled mobile platform that we have with the mobile functionality that we have with the treasury solution. And that's getting a lot of attention because it's a very robust platform to begin with, but then it has all the functionality on the mobile side. So there are players out there. I don't know that I could highlight anybody that has a solution that's as modern as the platform that we have and that has the breadth of functionality when you add in the mobile piece. So I think that's helping us win new customers. To your question about the strategy as far as the base that we're approaching, that's exactly the way we defined it originally. We wanted to go after the Jack Henry base first, make sure that we had some success within our core base. But eventually this will be a ProfitStars solution that will sell outside the Jack Henry core base just like many of the other solutions that we offer.

And then of those 10, are those competitive takeaways? Or are those banks that are looking to grow and want to establish a commercial banking practice? And then the last question, I just wanted an update on the fraud system. It seems like that's kind of a sleeper and an important one, but I'll stop there.

Yes, that's -- I can't quote for you accurately how many of those were competitive takeaways and how many had never had a treasury solution. I would hazard to guess that most of them had something. They probably had a cash management solution, which is a more rudimentary version of full treasury management. But there were probably a few that didn't have anything significant before, but most of them are either converting off of somebody else's treasury solution or they're probably upgrading from a cash management solution to full-on treasury management. And as far as the product solution, the partnership with SaaS, yes, that has been a sleeper as you said. We have a lot of interest from our customers. But as we disclosed last year when we first started talking about it, there were several modules for us to roll out. There was kind of 9-phase rollout of that product. That continues on. We don't have a whole lot of customers live with that yet because there's still a lot of development work going on in the partnership. But a year from now my expectation is, we'll have a lot more to talk about with that solution.

And that does conclude today's question-and-answer session. I would now like to turn the call back to Kevin Williams for any further remarks.

Thank you. Again, I'd like to repeat we are pleased with the results from our ongoing operations and efforts of all of our associates to take care of our customers. Our executives, managers and all of our associates continue to focus on what is best for our customers and our shareholders.

With that, I want to thank everyone for joining us. And Chris, would you please now provide the replay number for the listeners?

Ladies and gentlemen, this conference will be available for replay after 1:45 p.m. Eastern Standard Time today through February 13, 11:59 p.m. Eastern Standard Time. You may access the remote replay system at any time by dialing (800) 585-8367 and entering the access code 2945179. International participants dial (404) 537-3406. That does conclude our conference for today. Thank you for participating in today's conference. You may all disconnect. Everyone, have a great day.