Jack Henry & Associates CEO Discusses F3Q 2014 Results - Earnings Call Transcript

May. 2.14 | About: Jack Henry (JKHY)

Jack Henry & Associates, Inc. (NASDAQ:JKHY)

F3Q 2014 Results Earnings Conference Call

May 1, 2014; 08:45 a.m. ET

Executives

Tony Wormington - President

Jack Prim - Chief Executive Officer

Kevin Williams - Chief Financial Officer

Analysts

Kartik Mehta - Northcoast Research

Brett Huff - Stephens Inc.

Operator

Good day ladies and gentlemen and welcome to the Jack Henry & Associates, third quarter 2014 earnings conference call.

At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder this conference call is being recorded.

I would now like to turn the call over to your host, Chief Financial Officer, Kevin Williams. Mr. Williams you may begin.

Kevin Williams

Thank you Bridget. Good morning and thank you for joining us on the Jack Henry & Associates, third quarter fiscal 2014 conference call. I’m Kevin Williams, CFO and on the call with me today are Jack Prim, CEO; and Tony Wormington, President.

The agenda for the call this morning is as follows: Jack will start with an overview of the quarter. Tony will then provide some operational highlights in the quarter and then we’ll provide some additional comments regarding the press release we put out yesterday after market closed and then obviously we’ll open it up for some Q-&-A.

First of all, I need to remind you that remarks or responses to questions concerning future expectations, events, objectives, strategies, trends or results constitute forward-looking statements or deal with expectations about the future. Like any statement about the future, these are subject to a number of factors, which 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'll now turn it over to Jack.

Jack Prim

Thanks Kevin. Good morning and welcome to the call. We are pleased to again announce record revenue, net income and business backlogs for our third fiscal quarter.

Continued strong execution led to organic revenue growth of 7% in the quarter and solid gross and operating margins even as high margin license fees declined 8% from the year ago quarter. Although license fee is a little lower than the year ago quarter, it is worth noting that that quarter had the highest license fee revenue in the previous three fiscal years.

As we have previous indicated, with the strong preference for outsourced processing by new core customers and the continued movement of current in-house customers to outsourcing, the long term trend for license fees will be down. The trade-off here is that we will receive higher total revenue over the contract term and stable, predictable revenue streams.

We continue to see strong sales performances across three of our brands and continued market share gains in the credit unit segment, including our 5th billion dollar or larger credit union signed during the fiscal year.

We closed the acquisition of Banno in the quarter and the integration into Jack Henry is going well. We look forward to adding this innovative group to our team and integrating their mobile and web marketing capabilities into our Internet and mobile offerings.

Our biennial employee engagement survey again showed strong results as compared to external company measurements, outperforming these peer companies in ever measured category, and our customer satisfaction ratings remain at their industry leading levels. We believe these two measurements to be closely related.

Earlier we announced that Tony Wormington has announced his plan to retire at the end of our current fiscal year. I’d like to take this opportunity to thank Tony for his many contributions to the success of JHA during his 34 year career and wish him all the best in his upcoming retirement.

Dave Faust will assume the roll of President effective July 1 and continue this 15 year career with JHA.

We look forward to seeing many of you at our analyst conference next week, where Tony, Dave and several other key managers will be in attendance and several will go into more detail on various parts of the business.

With that, I’ll now turn it over to Tony for a closer look at the business.

Tony Wormington

Thanks Jack. We remain very pleased with the contributions from all components of support and services, which increased 8% in the quarter and 9% year-to-date compared to the prior year.

The largest contributor continues to be our electronic payments revenue, which grew 6% for the quarter and 11% year-to-date compared to the prior year period. Our outsourced data and item processing services increased 13% over the prior year quarter and year-to-date period. Our in house software and maintenance fees increased 5% for the quarter and 4% year-to-date over the prior period.

In addition, our one time implementation revenues were up 19% over the prior year quarter and 12% over the prior year-to-date period. Our electronic payments transaction volumes continued to experience solid growth in the quarter. The JHA payment processing solutions transaction volumes for ATMs, debt and credit processing were up 12% over the prior year quarter. Bill payment transaction volumes increased 9% over the prior year quarter.

Financial institution merchants installed and utilizing our enterprise payment solution increased to approximately 70,000 merchants, representing a 51% increase compared to the prior year quarter. Merchant related transaction volumes increased 29% over the prior year quarter.

In closing, as I reflect on my upcoming retirement, I would like to thank our customers, our associates and our shareholders for their continued loyalty to Jack Henry and Associates.

I’ll now turn it over to Kevin for a further look at the numbers.

Kevin Williams

Thanks Tony. Again our total organic revenue growth was 7% for the quarter with some difficult comps in there, in both payment and license fee as Jack mentioned and our license revenue was down 8% due to those sub-comps.

Our support and service revenue increased 8% this quarter over the same quarter a year ago and (inaudible) needs a little more detail. Our implementation revenue of $24.5 million was up 19%; our electronic payments of $109.3 million was up 6%; the total comps I mentioned are deconversion fees that we had in the same quarter a year ago. We are down about $3.5 million this year, which obviously will create some headwinds on that line.

Our outlink data processing was $59 million or it increased 13% and our in-house maintenance was $78.1 million, which increased 5% in the quarter. Hardware revenue increased 2% for the quarter’s third prior year and represents 5% of total revenue. Recurring revenue continued to experience nice growth at little over 7% for the quarter and 79% of total revenue for the quarter.

Gross margins were steady at 41% for the quarter. I mean last year’s quarter license margins were at a level of 92%. Support and service margins improved to 39% from 38% for the quarter, compared to the prior year quarter, driven a lot by the implementation services.

Our hardware margins decreased to 25% from 27% a year ago due to sales mix and our banking segment gross margin remains steady at 40%. Credit union segment margins improved to 44% this quarter compared to 42%, primarily driven by out length in some payments growth.

In the bank segment, license partners remain leveled at 90%. Support and service margins for the bank segment improved to 39% from 38% last year and our hardware margins decreased to 25% from 40% last year again due to sales mix.

In our credit union segment, license margins improved to 96% from 95% a year ago. Support and service margins improved to 40% from 38% and our hardware margins improved to 27% from 24% a year ago.

Our total operating expenses increased 9% for the quarter compared to the prior year on a GAAP basis. However in the prior year we had a net impact of about $1.3 million, due primarily to insurance settlements in that quarter related to the super-storm Sandy event.

Excluding these one-time events in previous years quarter, our operating expenses would have increased 7% in line with revenue growth for the quarter and the percentage of total revenue would remain leveled at 18% compared to the current year’s quarter. Our operating margins for the quarter increased slightly to 24% from 23% a year ago and our operating income increased nicely 9% for the quarter compared to last year.

The effective tax rate for the quarter was 34.3%, which is up significantly from last years effective tax rate of 29%. Last year we had the impact of the R&D credit, which was signed back into law in this quarter a year ago, which caused five quarters of the credit to be reported in that quarter, which is about a $0.05 EPS positive impact a year ago.

Our EBITDA increased to $98.9 million for the quarter compared to $92 million a year ago or an 8% increase. Depreciation and amortization expense was $27.4 million this quarter with $13.4 million depreciation and $14 million amortization, compared to $26.2 million in depreciation and amortization this quarter a year ago. Included in the total amortization is amortization of intangibles from acquisitions, which remains level of about $5.3 million for the quarter, compared to the same quarter last year.

Our operating cash flow increased to $161.4 million from $152.4 million a year ago. Free cash flow year-to-date calculated as operating cash flow less CapEx was $27.7 million, which was down slightly from $20.4 million a year ago.

Capitalized software of $44.6 million compared to $37.9 million last year, however this quarters cap software was essentially flat each quarter this year and dividends of $52.8 million this quarter compared to $31 million last year, due to the 54% special increase in dividends last spring combined with the more typical 10% increase in February this year caused our dividends to increase slightly.

Free cash flow decreased to $36.3 million compared to $65.3 million last year, which obviously the base contributors decreased and free cash flow was the large increase in dividends. This equates to free cash flow per share of $0.49 this year compared to $0.55 last year.

Just a reminder that our cash flows are significantly skewed to our first and fourth fiscal quarters, due to the annual billing and collection of our in-house maintenance contract revenues. Our cash balance is down significantly due to the purchase of 1.1 million shares during the quarter and the purchase of Banno.

In house backlog, which represents contracts of the in-house software and hardware and implementation services is $121.4 million, which was up 21% from last year. Outsourcing backlog, which is for the remaining life of the current data and item process contracts was at $389.3 million and up 8% compared to last year. Total backlog was up 11%.

For FY’14 guidance, there is no change in guidance that we’ve previously provided for the year. We expect our top line revenue to finish into the high end of the single digits. Our operating income is going to be somewhere in the mid to upper teens. We think we’re going to finish strong for the fiscal year.

Our effective tax rates should remain at about 35% for the full year since we can’t predict reinstatement of the R&D credit and also I just remind everyone that our fourth fiscal quarter revenue comps will be a little bit low as last year we had almost $9 million in one-time deconversion fees in the special credits. But we disclosed last year in the call that hopefully it will not be repeated in this year’s fourth year quarter, because that’s not how we like to make revenues and termination fees.

I would also like to wrap up by congratulating Tony on his future retirement and to thank him for all these years of service to our company.

This concludes our opening comments and we’re now ready to take questions. Bridget, will you please open the call lines up for questions.

Question-and-Answer Session

Operator

Sure, no problem. (Operator Instructions). Our first question is from Kartik Mehta with Northcoast Research. Your line is open.

Kartik Mehta - Northcoast Research

Good morning. Kevin, I know the backlog number is a difficult number for you, and it doesn’t really represent the business you have, but based on the backlog, that number that you look at or the numbers you look at and the installations that you know of, how long can you sustain this type of revenue growth, this high single digit or 6% to 8% revenue growth that you’ve been sustaining?

Kevin Williams

Well Kartik, I mean I don’t know there’s so much backlog. I mean obviously the backlog is the biggest drivers in there. It is in the in-house piece, there’s implementation services and software and both those are very good guidance. We look at other things. We look at our backlog of installs and what the timeline is of those, but also you know the biggest drivers in our business continues to be outsourcing, which is driven a lot by the in to out and all the new core customers are going to outsourcing and our famous business continues to be very strong.

We had very nice growth in that. If you kind of back out the one-time deconversion fees for last year and those continue to be our good drivers and the backlog is representative that kind of supports that. So I think for the foreseeable future, we’re going to see, we’ll be able to grow our top line revenue in mid to high single digits.

Kartik Mehta - Northcoast Research

And then have you seen any change in competition, at least from like Internet banking or bill payment? I think last time you talked about a little bit of competition in the bill payment. I’m wondering if that’s changed at all and if you are seeing anything on the Internet banking side?

Jack Prim

Yes Kartik, this is Jack. Well, I don’t know if we’ve seen anything change. Its pretty aggressive, particularly for any of the payments related business, not just bill pay, but ATM debit and credit card transaction, routing, etcetera. Our lenders are getting pretty aggressive with some of their bundling tactics and things of that nature, but that’s not a new phenomenon.

So related to Internet banking, I can’t say that we’ve really seen anything different there. For the most part you know the same products are still in the market. They would have been in the market for a lot of possibility with new ownership and a case or two here and there, but essentially the same products. I mean obviously that’s an area of both internet and mobile, where we’re continuing to invest heavily and to keep the products fresh and up to date, but I don’t know that we’ve seen anything particularly new in either of those areas.

Kartik Mehta - Northcoast Research

Well, thank you very much. I appreciate it.

Jack Prim

Thanks Kartik.

Operator

Thank you. (Operator Instructions) Mr. Williams, I’m not showing any further questions at this time. Please proceed with any further remarks. Oh, I apologize. It looks like we did have one more that’s just skewed up. I have Brett Huff on the line with Stephens. Your line is open.

Brett Huff - Stephens Inc.

Thank you. Good morning guys.

Jack Prim

Good morning Brett.

Brett Huff - Stephens Inc.

Can you guys talk a little bit about the sort of demand that you are seeing across your different product lines. We’ve heard from a couple of core providers in the last couple of weeks and it sounds like there’s more focus on revenue. There is the consistent focus on regulatory and compliance and fraud. Obviously still not an explosion in discretionary spending, but is revenue becoming more of a focus? Are you hearing that from your smaller and medium size banks as well?

Jack Prim

Hey Brett, I don’t know that its more of a focus. I mean I think other than in the depths of the financial crisis. I mean for the last year or two there certainly has been a focus on revenue. There’s been a number of studies here lately that indicate that the loan demand is growing particularly in some of the smaller banks and the indication that maybe some of the larger banks are pulling back a little bit in some of the lending areas with more of a focus on liquidity with some of the regulatory constraints that they are facing right now, but I don’t know that I’ve heard any of our banks saying, wow your loan demand is really great now, but I think there’s a number of indications that it is improving.

But again, I think that focus on revenue has been there. I think maybe the economy is just now, the economy and or the circumstances I just described are now maybe coming together to make that a little easier to realize, but there’s certainly been a strong focus on revenue and trying to figure out how to replace in some cases revenue that were impacted by the various aspects of the Durbin amendment. But I think that’s been the focus for a while.

Brett Huff - Stephens Inc.

Okay, and then my second question is, there is any new entrance into the core space? I mean, I think we’ve seen Zions make a pick outside sort of the big three folks. Are you seeing any changes or tone in conversation? Are the seats at the table with the final decisions on core changing a lot? Are we seeing changes in that as international folks and other not big three core providers try and enter the space?

Jack Prim

No, not really Brett. Not new news that some of the international players would like to be here. I think that it’s a lot easier to sell a system for the first time than it is to implement one. So before I attribute too much to that particular implementation that you mentioned, probably I’ll wait and see if it ever got implemented first, but international players have wanted to be here for quite a while. I don’t think there’s anything new in that, but with only these occasional very odd exception has there been any progress in that area and you know it will happen some day. I think its inevitable, some day it will, but not anything we’re seeing or terribly concerned about today.

Kevin Williams

And to your point Brett, I think where your going to see those is in the bigger banks, which is not really where we go access our core solutions anyway, before we see any of them on the low end of the market.

Brett Huff - Stephens Inc.

I figured that, just from a bank size point of view. And then I guess one more question is, is the spending on securing your systems continuing a pace? One of the things we’ve been looking at is a lot of the processors, be they are merchant acquirers or core processes, etcetera have been spending on making sure their systems are hardened. I know that you all have invested in some obviously infrastructure, some underground storage and things like that. Should we expect sort of a continuous increase in that kind of spending from you all and cores or has there already been a step function up? Kind of can you give us a sense of how to think about that?

Jack Prim

Yes Brett, I don’t know if I’d be necessarily looking for continued increases. It is at an increased level. I don’t think I’ll be looking for that level to drop off any. I think that yes, that’s going to be an area where we will all have to continue to remain vigilant. At the same time we’re also continuing to spend on our solutions in that regard in terms of security offerings that we can take to our customers.

So I mean I think its defiantly going to continue to be an area of emphasis. I think we certainly are investing more as our customers in the compliance area, audit area, to make sure that we are covering all the bases internally, looking at the systems, testing all the systems, looking for not only security related vulnerabilities, but you know for just risk management standpoint.

So I think there certainly is some elevated spending in those areas and I would expect it to remain roughly at similar levels for probably forever, if not at lease for the foreseeable future.

Kevin Williams

Yes, Brett, I would add that if you look at historically our total R&D spend, which is R&D expense plus that software has remained pretty steady at just over 10% of non-hardware revenues. So if our revenue has increased over the years, which we’ve had some really nice growth in revenue, our R&D expense is pacing right along with that and I don’t see that changing. So if the other question you are going to come up, is when you are going to deleverage our R&D, the answer is probably never expect it. That’s what continues to drive sales force.

Brett Huff - Stephens Inc.

Okay. That’s helpful. Looking forward to seeing you guys next week.

Jack Prim

Yes.

Operator

Thank you. I’m not showing any questions at this time.

Kevin Williams

All right. Thanks Bridget. We want to thank you all for joining us today to review our third quarter fiscal 2014 results. We are pleased with the results from our ongoing operations and the efforts of all our associates to take care of the customers. Our executives, managers and all of our associates continue to focus on what is best for our customers and shareholders.

We hope to see many of you next Monday afternoon at our Annual Analyst Day, which is once again being held at DFW Grand Hyatt. The even will begin at 1:00 p.m. with presentation from some of our executive team and all of our national sales managers and then we will wrap that even up with reception and many checks there and showoff a few of our hardware products on Monday evening.

With that, I would like to thank you again and Bridget, will you please provide the replay number.

Operator

I sure will. The number to call for the replay is going to be 1-800-291-4047.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a wonderful day.

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Jack Henry & Associates (JKHY): FQ3 EPS of $0.55 misses by $0.01. Revenue of $300.9M (+6.9% Y/Y) misses by $4.9M.