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Jack Henry & Associates (NASDAQ:JKHY)

F2Q08 (Qtr End 12/31/07) Earnings Call

February 7, 2008 8:45 am ET

Executives

Jack Prim - CEO

Kevin Williams - CFO

Tony Wormington - President

Analysts

Jon Maietta - Needham & Company

Tim Fox - Deutsche Bank

Dave Koning - Baird

Greg Wowkun - Banc of America

John Kraft - D.A Davison

Greg Smith - Merrill Lynch

Gil Luria - Wedbush Securities

Brett Huff - Stephens Inc.

Glenn Greene - Oppenheimer & Co.

Daniel Perlin - Wachovia Capital Markets

Tom Lamb - Weybosset Research

Operator

Please stand by, we’re about to begin. Good day and welcome to the Jack Henry & Associates second quarter fiscal year 2008 conference call. Today’s conference is being recorded. With us today is CEO Mr. Jack Prim, CFO Mr. Kevin Williams, and President, Mr. Tony Wormington. At this time I would like to turn the conference over to Kevin Williams. Please go ahead, sir.

Kevin Williams

Thank you, good morning and welcome to the Jack Henry & Associates second quarter FY 2008 earnings call. Statements or responses to questions may be made in this conversation which are forward looking or deal with expectations about the future. Like any statements about the future, these are subject to a number of factors which are subject to a number of factors which could cause actual results to differ materially from those which we anticipate. Such factors are disclosed in our recent SEC filings. There could also be other factors not included that could potentially cause results to differ materially. We are pleased to host the call this morning and to provide a company update and report our record financial results for our second fiscal quarter ended December 31, 2007. With that I will now turn the call over to Jack Prim, CEO.

Jack Prim

Thanks Kevin, good morning. We are pleased to announce another strong quarterly performance with new records for revenue, net income, and backlog.

Total revenue increased 15% with strong performance from both the bank and credit union segments, with bank revenue increasing 14% and credit union revenue increasing 18%. The organic component of total revenue was 12% in the quarter, and 13% on a year-to-date basis.

Revenue growth was fueled by EFT and maintenance growth and strong core sales, particularly in the credit union segment. We continue to show significantly greater core system market share gains in the credit union industry than any other vendor, as has been the case every year for the last eight years.

Licensing has increased 10% and set a new record for the second fiscal quarter, higher license fee revenues have only been attained in two prior periods, and both of those were fiscal fourth quarters. This occurred even as support and services continue to represent a larger percentage of our total revenue.

Support and service continued to show strong growth with an increase of 17%, to 76% of total revenue. This increase was driven by strong performance in the maintenance and EFT line items in particular.

We completed our transition to a new bill pay processor for our electronic transactions during the quarter, and it already began to see improvement in the percentage of payments that can be processed electronically.

The AudioTel integration, acquisition and integration is complete, and our efforts are now focused on leveraging their non-Jack Henry customer relationships, for other JHA products through our ProfitStars sales team.

A recently announced alliance with Shelby Systems, Inc. illustrates one of the reasons we were interested in acquiring AudioTel. Shelby is a leading provider of software solutions for faith-based and non-profit organizations. They will embed AudioTel;s Remit Plus solution into their software offering to electronically process and manage contributions.

Shelby joined over 20 other software provider serving a variety of industries, including other faith-based organizations, water and power utilities, and city county governments that have taken a similar approach to automating their customers' payment processing needs with one of our enterprise payment solutions.

Additionally, our check image system sales continue to be strong, and the AudioTel solution will now allow us to address the smaller bank market with a more affordable image solution.

Our operating income increased 16% in the quarter, and our backlog increased 7% from year ago levels to a new record, driven entirely by the outsourcing backlog, as the core system deliver package for banks continues to favor outsourced delivery.

We continue to believe that our stock represents a good investment, and repurchased approximately 700,000 shares in the quarter. We have not seen indications that the current economic environment has or will impact our sales in the near term, and we remain cautiously optimistic on the economic outlook in general.

We expect to continue to lead the industry in organic revenue growth, profitability, and customer satisfaction.

With that I will now turn it over to Tony Wormington for some additional comments on the business.

Tony Wormington

Thanks Jack, good morning. As Jack mentioned, our support and service revenue component continues to increase nicely. We are pleased with all the components of our recurring revenue, especially EFT services, which experienced the largest increase, along with in-house support and maintenance, outsourcing data and item processing and implementation services.

We are continued to see solid increases in all components of our electronic funds transfer transaction processing businesses. Our ATM/debit card processing volumes increased 26% compared to prior year, and bill payment volumes increased at nice pace of 38% in the same period.

The number of financial institutions installed with our enterprise payments, ASP solution for remote deposit processing increased 15% sequentially quarter over quarter, and compared to the prior year quarter, increased 127%.

The financial institutions merchants installed and utilizing this solution increased by 25% compared to the last quarter, and 280% compared to the same quarter a year ago. Along with finding new institutions and new merchants, we saw solid increases in the volume of transactions being processed by this solution. Transactions increased by 29% compared to the last sequential quarter, and 239% compared to the same quarter a year ago.

As indicated on a prior call, we continue to see strong demand for our many complimentary products and services in both the banking and credit union markets including our imaging solutions, CRM solutions, and risk management solutions, particularly our Yellow Hammer BSA solution.

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

Kevin Williams

Thanks Tony, again good morning. As Jack previously mentioned during the quarter just ended, we had revenue growth of 15% of 192.2 million in the quarter, of which 12% of this was organic.

This compared to the consensus estimate of 180.9 million in total revenue for the quarter. Year to date total revenue grew about 16% to 367.6 million.

License revenues increased by 10%, compared to the year-ago quarter, and is basically flat year-to-date, with a very strong core in license.Ee continue to believe that our sales teams have very good momentum going into the second half of fiscal 2008 under all three of our brands, and based on recent successes in our sales pipeline.

Support and services increased in every component within the line of revenue for the quarter, and year-to-date implementation revenues increased 13%, with a large portion of these not tied to specific license revenues, but rather to implementation of recurring revenue type items and convert mergers of bank of our customers, as our bank customers continue to acquire.

Our payments business was up 24% for the quarter, outlink data was up 9% for the quarter, and in-house support and services was up 19% for the quarter, as that piece of us continues to grow with a lot of work orders.

Our harbor revenue increased by 8% for the quarter, and 14% for the year compared to year-ago due to strong sales in iSeries upgrades, sorters for check imaging solutions, and our scanner sales for a remote (inaudible) casher.

We also had a strong quarter in year-to-date in our JHA direct forms and supplies business.

The products that are marketed under ProfitStars brand, as Tony mentioned, to both core and non-core customers continue to increase their contribution to revenue, gross profit, and net income.

We continue to maintain strong consolidated gross margins at 44% for the quarter and 42% for the year.

Our banking segment gross margins slipped a little, by 1% to 44% in the second quarter, primarily due to sales mix. However, our credit union segment margins increased to 45% from 39% due to the strong license revenue in the credit union segment in this year’s second quarter.

In the bank segment, for license margins, we saw a decrease from 95% to 91%, due to the higher amount of third party software sold during the quarter, driven by our BSA solution.

Support and service margins increased to 40% from 39% for the quarter, driven in part by the strong increase in [indentation] revenue, and EFT revenue, and harbor margins increased to 31% from 21% primarily due to sales mix and due to an increase, slight increase, in (inaudible) rebates from a year ago.

Our total operating expenses increased 17% for the quarter, and as percentage of total revenue remained level at 20% for the quarter compared to the prior year.

For the year, operating expenses have increased 14%, and remain level at 20% of total revenue.

Our selling and marketing increased 9%, R&D went up 27%, which the majority of this increase is in the acquired companies in the ProfitStars brand, to not only the three companies that we’ve acquired in the last 12 months, or 13 months, but also additional R&D spend for the existing product.

G&A went up 18% for the quarter, part of that is due to increased personnel costs compared to year-ago. Our user group fees were a half million dollars or more higher than they were last year, and also some additional accounting, auditing and tax-related type services were the majority of that increase, this year over last year. And just, fyi, in the quarter there was a little over $2 million in total cost related to the user group, which should not be there in the March quarter.

Our operating margin remained level at 24% for the quarter, compared to year-ago, and decreased slightly, by 1%, to 22% for the year compared to year-ago. The net result was increase in operating income of 16% in the quarter, and 13% year-to-date.

As we have discussed in prior earnings calls, the R&D credit, which was extended in December of 2006 for the period of January '06 through December of '07, had a significant impact on our approximately $3 million, or $0.03 per share during this quarter a year ago. Because of this and other offsetting factors, our effective tax rate for the quarter, this quarter, increased to 36.8%, from 30% last year. Year-date tax rate increased to 36.6%, from 33.5% last year. Without this one-time impact a year ago to our net income, or basically adjusting this to compare apples to apples, our net income this year would have been an increase of over 16%, with an 18% increase in EPS for the quarter compared to the prior year.

EBITDA increased this year to 113.5 million, from 98.4 million last year, or 15% increase. Depreciate and amortization of 30.1 million this year, compared to 23.9 million last year, or 20.6% increase, is due in large part to (inaudible) software in prior years, acquisitions, and additional upgrades to hardwares in all of our support structures. EBITDA margins remain low year-to-date, at 31%, compared to the prior year.

We continue to fee comfortable in providing guidance for the rest of FY '08, with top line revenue growth in the low double digits, with some slight margin improvement to expand operating income margins to somewhere in the low to mid teens. (Inaudible) cash. As Jack mentioned there were 700,000 shares of (inaudible) purchase this quarter, and 900,000 shares year-to-date. During January, we first noted 1.9 million shares, as we thought the drop in our stock price was a very good opportunity to utilize our capital. As you probably noticed also, the board recently increased the stock buy back by another five million shares, as the current number authorized of 10 million had gotten down below 100,000 shares left on the authorization. In the last three years since May of 2005, we have purchased roughly 9.9 million shares of our stock (inaudible.)

Also during the year-to-date, our cash use for acquisitions increased 13 million compared to last year, to 49 million. Our CapEx is up, compared to prior year, about 5.6 million, to 21.1 million, and which goes in line with the earlier guidance we gave of CapEx somewhere in the low- to mid- 40 million. Our backlog, as Jack mentioned, was up 240.2 million, with 61.6 million in-house and 178.6 million outsourcing, which those represent a 7% increase.

And again, I want to remind you that there are no transactional revenue represented in these backlogs that related EFT debit, bill pay or remote deposit capture, due to the large growth in those areas and we're trying to keep our backlogs as conservative as possible. With that, I will open the call up to your questions. Will you please open it up.

Question-and-Answer Session

Operator

(Operator’s Instructions.) Our first question comes from Jon Maietta from Needham & Company.

Jon Maietta - Needham & Company

Hey, thanks very much. Good morning guys.

The first question I had, Jack, on the previous quarter call you had mentioned that there were some license deals that had slipped, did any of those close in this current quarter?

Jack Prim

Yes, they did. The ones that we were tracking, mostly in the credit space, just took a little longer to get done but did get those done in the quarter.

Jon Maietta - Needham & Company

Okay, and then Kevin, were there any integration charges associated with acquisitions that fell into the December quarter that we may not see in the March quarter?

Kevin Williams

Very few, Jon.

We’ve got integration down pretty much to a science, so basically we just ask our people to do a little bit more rather than adding a whole bunch of additional costs but having said that we try to capitalize everything we can as part of the purchase pricing we do on acquisition, so there shouldn’t be much impact in the December quarter that would go away in future quarter.

The biggest thing that will go away in the March quarter will be the user group fees that we had before .

Jon Maietta - Needham & Company

Got you, okay. And then the last question I had, I know it’s early days, Jack, but if you could talk a little about maybe some of the early traction in regard to the mobile banking products.

Jack Prim

Yeah. John, that’s going very well, we have 49, at this point, financial institutions that have signed up for our mobile banking offering. Again our product is designed to work with any phone, any carrier. I think we have something like, 12 carriers represented among the 49 banks. It’s been very well accepted, it goes in very easily and again, is working well with pretty much any phone, any carrier out there so we are pleased with it at this point.

Jon Maietta - Needham & Company

Okay, thanks very much.

Operator

And our next question will come from Tim Fox of Deutsche Bank.

Tim Fox - Deutsche Bank

Thank you, good morning.

Since you ended your commentary on backlog maybe I can start there Kevin, just talking a little bit from a trend line perspective, up 7%, I think that's down a bit sequentially. Can you talk a little bit about the backlog, what we should expect from a trend line perspective, is that an indication in any way that things may be tightening or is this just more of a seasonal issue?

Kevin Williams

Well first of all, Jon, it’s actually up 1% sequentially, from the September quarter it did not go down. At September 30, our total backlog was 237.6 and at this point it is 240.2.

I think that one thing we always said about backlog is that in-house represents, contracts for software, hardware, installation services have yet to be delivered, so obviously when you have those type numbers, especially the hardware and software are going in and out there’s going to be some lumpiness in our in-house backlog is going to bounce around a little bit so I don’t know if I would take a whole lot away from it being down $2.3 million from last quarter. Then the outsource piece of the business, basically what that means is that we continue to sign up new customers and renew existing customers at a faster pace then we are actually rolling those amounts out on our quarterly basis.

Tim Fox - Deutsche Bank

Got it, okay, that’s helpful. And secondly, can you talk a little bit about the relative strength between the banking and credit union verticals?

What are you seeing in the credit union side of things? You mentioned strong licensing there, but is there anything in particular from a secular perspective going on there that is helping to drive that?

Jack Prim

Well, I would say Tim, that for whatever reason, and I am not sure I can give you a good reason why, but there appears to be a little more core system activity on the credit union side than there does on the banking side. Banking is strong and again, we had solid revenue growth there, a lot of de novo activity continues to be the case on the banking side but not as much replacement of the existing system on the banking side as we see on the credit union side. A fair amount of discussion around their internet banking systems and opportunities to make some improvements in a number of the capabilities there, but again just for whatever reason the credit union side seems to be a little more likely to change core systems than what we see form established banks in the banking segment.

Tim Fox - Deutsche Bank

Okay, great and lastly, big picture, you mentioned cautiously optimistic on both the banking and credit union front.

You know, we have seen a lot of the same headlines, I am sure, of the credit tightening trickling down to regional banks and maybe even at some point credit unions, but are you suggesting that at this point that it doesn’t seem to be trickling down to IT budgets as it relates to the systems you are selling?

Jack Prim

You know Tim, in terms of what we had seen and heard to date and the first half of my statement where I said that we haven’t seen anything that looks like it is going to impact our sales in the near term that would be sort of how we see things at this point.

The qualifier of being cautiously optimistic about the economic outlook in general, I think that’s as much as anything else a reflection of the fact that we keep hearing stories in the press about the larger banks and in some cases the regional banks and news media, are we in a recession or are we not?

So you know, if enough of that kind of discussion continues, it’s probably not going to be a good thing, so it’s basically our way of saying right now our business hasn’t been impacted, we have not immediately heard anything that leads us to believe that it’s going to be impacted but there seem to be an awful lot of people out there ringing their hands over the economic situation so we don’t want to appear to be unaware of that discussion going on.

Tim Fox - Deutsche Bank

Understood, that’s helpful. Congratulations.

Operator

Thank you, and our next question comes from Dave Koning, with Baird.

Dave Koning - Baird

Hi guys and welcome back Kevin after about six months of you not being on the calls with the last quarter you being gone.

Kevin Williams

Thank you, it’s good to be back. I wanted to be here.

Dave Koning - Baird

Exactly, that’s great. On the organic growth side, when we think about support and services, I think AudioTel there did contribute to Q2.

I saw a little bit of deceleration in support and services, even though it looked like AudioTel was in the numbers this quarter for that. And just maybe you could talk a little bit about that and the deceleration and maybe what contributed to that?

Kevin Williams

I don’t know that I would really classify that as a deceleration, David. We still report services at 17% for the quarter. Our guidance going into this year was somewhere in the upper teens and I think we are still there.

Even if you back out AudioTel and Gladiators, which both of those contribute important services, our organic growth in the support service line is still above 15% for the quarter compared to last year, and if you look at the sequential quarters, there are some things in the first quarter, like we got a significant one-time rebate in the EFT world that basically went in there and pumped up revenue a bit which also helped the margins a little bit.

There is always some one-time things that happen in the quarterly that’s going to cause all of our lines to move around a little bit. But for us continued growth for services is 15%, I am pretty proud of that.

Dave Koning - Baird

I definitely agree, that’s a very good growth.

Kevin Williams

Especially when you consider with that, David, that even throw in acquisitions in there, we were able to actually expand the support and services margins.

Dave Koning - Baird

Yeah, that’s great. And I guess the one other question on the license side, what should we expect looking forward, I know there’s always a lot of volatility there but given you got some of the revenue from Q1 into Q2 getting those deals closed, will Q3 kind of fall off a little bit and then we’ll get the normal seasonal ramps in Q4?

Kevin Williams

I don’t know that it will fall off much in Q3 David, I mean one thing about sales people is that once they get going and get some momentum it seems like they can maintain that momentum (inaudible) in that quarter but we have some deals slip in every quarter. In the first quarter there was two or three pretty significant ones that we thought we were going to find, in fact one of those we thought we were going to find in the first quarter, did find, then they decide to outlink instead of in-house. There is always going to be some slippage and there is always going to be some of those banks and credit unions that at the twelfth hour, when it comes time to contract, for whatever reason, they decide to go outsource instead of in-house. So there's going to be, probably some (inaudible) in the license revenue line.

Jack Prim

One thing I would add to that is that the pipelines on both the banking and credit union sides look pretty strong, which again on the credit union side, the per dominant delivery preference is for in-house delivery while the preference on the banking side is for outsource delivery; again, that’s what we saw in the current quarter and based on sales forecast that we are looking at we expect to see something pretty similar in the upcoming quarter.

Dave Koning - Baird

Great, thank you.

Operator

Thank you, and our next question comes from Greg Wowkun from Banc of America.

Greg Wowkun - Banc of America

Good morning, gentleman, you highlighted that R&D spiked in the quarter a bit, how should we think about R&D trends going forward?

Kevin Williams

Well R&D should level out a little bit. One of the things you have in the quarter, there is a couple of things that impacted it, AudiotTel in there, throwing in their R&D costs, we've obviously added some head count, and then also one of the

things that’s out of our control is, this time last year we had some major projects, we still have some major projects going on, but in any given quarter there can be some salaries and personnel costs that now become expense instead of being capitalized as those products get rolled out into G&A.

Greg Wowkun - Banc of America

Thank you.

Kevin Williams

I don’t look for R&D to go down any, I will put it that way, I think it should roll a little less in the next quarter than it did in the quarter we just ended.

And it will maintain the same percentage of total revenue.

Operator

Thank you. (Operator Instructions.) And we'll now go to John Kraft from D.A. Davidson.

John Kraft - D.A Davison

Good morning.

Kevin Williams

Hi, John.

John Kraft - D.A Davison

Most of the questions have been answered but just a couple follow-ups here.

The remote deposit, obviously were very strong, what percent of that business is actually done at the branch versus at the merchant?

Kevin Williams

John, in our case when we talk about those numbers, the numbers we are talking about are entirely at the merchant location. We really don’t quote; frankly, don’t know if we even track what has actually taken place in the branch.

We are certainly seeing an increase in interest in branch capture, Tony, if you know off the top of your head what kind of installation we got or percentages. We're seeing strong growth in branch capture but those transactions typically don’t pass thorough our system.

In other words, the financial institution captures the transition at there branch and sends those transactions directly to their core systems for processing so they don’t pass through counting mechanisms, if you will, so it really isn’t something we track, there’s the license fee and related scanner sales to the banks. For implementing branch capture, we certainly see those but any of the numbers you hear us talking about that are in the EFT section are all merchant related capture.

John Kraft - D.A Davison

Okay, are you seeing license scanner sales, license sales, implementation fees, that sort of thing, in the branch growing at similar rates?

Tony Wormington

This is Tony, the branch sales, we still continue to see strong purchasing for our branch capture solutions but certainly not at the pace that were seeing the ramp-up of the merchant capture or remote deposit captures.

I would say that our branch purchases by our institutions are in line with what they have been for the last several quarters.

Jack Prim

One things I would add John, just for future reference, the actual scanner sales, as far as merchant capture in the quarter were down compared to the previous quarter, down over 20%, that is not a reflection of waning demand at the merchant site for the offering. It's more of a reflection of the fact that these scanner have become pretty much a commodity item. You can pick one up at Office Depot and install it, unlike some of the core systems that we sell, where we do extensive testing of the operating systems provided by IBM and everything before we release and support those for our customers. Frankly, there's not a lot of value add that we can do to a $300 scanner, so I think we have seen a fair amount of folks buying their scanners directly and locally. So I would mention that simply to say that scanner sales in previous quarters have driven a fair amount of the growth in our hardware, but as we annualize on some of those quarters, I don't know that we're going to see quite the same kind of percentage growth in hardware that we have seen in recent quarters based on at least the component related to scanner sales.

John Kraft - D.A Davison

Okay, interesting, that's helpful. And then, moving on to another fast-growing area of bill pay. This switch you made, this processor switch, you mentioned Kevin, that it improved your electronic rate, but ultimately, what was going on here was you trying to lower your overall costs, right? I guess my question is, has that happened and by what percent roughly were you able to do that?

Jack Prim

Well, there's a couple things there. As I think we indicated on the last call, there's some modest reduction in pricing, but we didn't make this move so much for the near-term cost savings as much as we did for the ability to position ourselves to be able to least-cost routing a couple of years down the road. I don't have much explanation that I want to go into about that, but basically there were some things that we needed to be able to do in terms of database management, to be able to take advantage of a variety of providers of payments that we weren't in a position to do with our database at the time.

So the biggest reason for the change was to position ourselves for the least-cost routing, two to three years down the road. We have seen some cost reduction that is pretty modest cost reduction in the transaction pricing; the benefit that we're more likely to see out of that is the increase in the electronic transactions because of the lower cost associated with the electronic transactions, as compared to the printing of checks. And we have, as indicated, begun already to see, even in the middle of that transition, improvements in our electronic penetration percentage.

John Kraft - D.A Davison

Okay, thanks Jack, that's all I got guys.

Operator

Thank you and your next question will come from Greg Smith, with Merrill Lynch.

Greg Smith - Merrill Lynch

Hi guys. You mentioned that third-party software sales were incrementally higher. What are some examples of those third-party software sales?

Kevin Williams

Probably the biggest, Greg, would be our BSA product that we actually had built for us outside, and we split the license revenue with them, as we saw it. That would be the biggest one, and then, on the credit union side, obviously we sold some upgrades to the OTG product, which is a [inaudible] that we use to market before we acquired Synergy. We no longer market that to new customers, but there's still some upgrades there. Just like with Intervoice and the credit union space, we sold some upgrades there, which is a third-party, and we actually split the revenue with them, with all those people as we saw the license.

Greg Smith - Merrill Lynch

Okay, and then, just remind me, what causes hardware margins to jump around, quarter to quarter? Is that just mix? Maybe more scanners lowers it a little bit.

Kevin Williams

It's a couple things, Greg. It's primarily mix. We had a strong quarter this year, or this quarter, with iSeries upgrades, because IBM came out with a new upgrade last summer, and the more iSeries we sell, the higher [inaudible] rebates we get from them, and they put us in different programs, which help improve the margins on that side; but also it depends on how our JHA directives have done, because we get pretty healthy margins off our forms and supply business. So a lot of it's just sales mix, and then depending on what we're selling within that mix.

Greg Smith - Merrill Lynch

Okay. And then, you guys really don't play in the mortgage market. Are there any opportunities for you? I mean, is this the time to be looking at that space from a processing standpoint?

Jack Prim

Greg, I don't think we would particularly look at mortgage from a processing standpoint. We continue to think about whether we need a mortgage loan origination product. A number of our banks and credit unions both are into conventional mortgages and have a solution for mortgage loan origination. I think our challenge is to figure out if we can add to that part of the transaction, in all likelihood by partnering with a vendor and doing some tight integration of a strong mortgage loan origination system with our core solution. But that's about the only thing we're discussing related to the mortgage market at this point in time; it's not an area that we have been in, in the past, and don't know it's one we're real anxious to jump into right now.

Greg Smith - Merrill Lynch

Okay, and then just one last question. You talked about the economic environment, Jack, your comments were helpful. Just wondering, is there something we can watch for that would be a big warning sign or is it more just "hey, this is recurring revenue, mission critical stuff for banks, and we're going to keep ticking along?"

Jack Prim

Greg, I don't know of any red flags I could tell you to watch for. One of the things we've said all along is that, in a recession, one of the negative impacts to the business would be a slowdown in formation of the de novo banks. We do a good bit of business every year with new startup banks, to the extent that if capital became constrained, or for whatever reason there was a reduction in the formation of the de novo banks, that could impact our business, but even in that case, it would be unlikely to affect our business in the near term. De novo bank doesn't spend a whole lot of money with you right after they open the doors. You're 12 months into that relationship before there's much material revenue being generated out of that. So even if de novo sells stock completely tomorrow, it would potentially be nine months to a year before we would see that reflected in the business.

Similarly on the credit union side, if all of a sudden credit unions shut down and stopped spending, that would be something that would be more noticeable in the near term, but again, if anything, credit unions appear to be, in terms of percentage of financial institutions that will make a change in any given year, actually appear to be changing at a faster rate than the banks so. Part of that, I think, is the fact that they are not as concerned about having to report to stockholders; as not-for-profit organization, they don't have to report to stockholders, and if average return on assets for credit unions, as I believe the industry, is about 0.75, and if that number drops to 0.5 or 0.25, it's not ideal, but it's not overly concerning to them as it would be to somebody that has to report to stockholder and that kind of thing. So they will spend money, they will continue typically to spend money on technology, if they believe it will improve member service. So I don't know of anything I can highlight for you that would say, hey, if this happens, be cautious. But again, we continue to watch it.

Kevin Williams

Greg, the other thing I'd throw in there, is now that almost 70% of our revenue is recurring in nature, and that recurring revenue piece is growing in high teens, roughly 18 or 19%, this quarter and last quarter, that's something that they can't spending. Because those are long-term contracts, we're going to keep getting the per-click charges, so that (inaudible) is going to grow. So even if there was some sort of red flag we watched for out there, what it's going to really impact is that 30% of our business in license and hardware. But I agree with Jack, I don't know what that red flag would be, but we feel a whole lot better with 70% of our business now being recurring, than five years ago when it was 35 or 40%.

Greg Smith - Merrill Lynch

That was very helpful, thank you.

Operator

Thank you and our next question will come from Gil Luria, from Wedbush Securities.

Gil Luria - Wedbush Securities

Thank you. A follow-up on the de novo question. There's a stream of de novos that's coming in, and when you talk to them, are you hearing more about the fact that they're starting up in spite of the current environment? Are you hearing that they see this as an opportunity, because other banks are saddled with the bad decisions they've made, and therefor this may not be the same as previous recessions, where de novo activity was reduced?

Jack Prim

Gil, I think that what we're hearing is pretty much, the lease, there's an opportunity because of acquisitions that have taken place in local markets, or for whatever reason that they feel like they can better serve the market, and certainly a factor is the ability to come in unhindered by previous decisions and processes and methods, which again, is kind of the thing you hear whether the economy is good or bad, from de novos for starting a bank. I don't know that I've heard anybody say that the economic environment is actually better for them, but at the same time, we're really not hearing from the de novos that it's any more difficult for them either. So I think that the reasons that they are forming banks are the same as the reasons why they have traditionally formed banks over the years.

Kevin William

The other thing I'd throw in there Gil, I think we've got about as many de novos in our sales forecast and pipeline, recurrently as we ever have.

Gil Luria - Wedbush Securities

And can you share with us about what percentage of de novos you've won, let's say over the last 12 months?

Jack Prim

Out of the percentage of all de novos that have been formed? I don't know that I could give you that percentage. I think in the last 12 months we're somewhere north of 40 de novos that we've signed. I'm not sure if everybody counts de novos exactly the same way, for example, we've got one customer that their business is forming de novo banks. They go into various states and areas where they think there's a good economic opportunity and form a de novo bank. We're really not counting those into the number of new footprints that we're adding, because they're kind of a captive customer, they just choose to open it and run it as a de novo separately when they do that. So I don't know exactly what percentage that is of the total number of de novos that were formed in the last year.

Gil Luria - Wedbush Securities

And the last question, I think you mentioned, you talked about slight margin improvement. Does this mean that, because I think you started, I think in May, by saying that you expect to see 100%, 100 basis point EBITDA margin expansion. Should we now expect that to be on the low end of that?

Kevin Williams

Yeah.

Gil Luria - Wedbush Securities

Thank you.

Operator

Thank you, and our next question comes from Brett Huff with Stephens Incorporated.

Brett Huff - Stephens Inc.

Good morning, everybody, nice quarter. I wanted to follow-up on the EFT discussion in more of a long-term question. Obviously the percentage growth in that line of business has been great. Can you give us a sense of, from your view, will that continue on, and will it take more investment, new products, etc. Will we start lapping some really nice comps? How do we think about that, sort of the next two years or so?

Jack Prim

Brett, I think that the business continues to strong, in that it's driven by a couple of things. The largest piece of that EFT business is ATM/debit card processing, and really it's debit card processing. ATM is flat, wouldn't be surprised if it goes down slightly, but I think for the most part that the ATM transaction aspect is pretty flat. The debit card component is driven by a couple of things. More people using debit cards and using them in more places, and you're seeing more and more financial institutions that are coming out with reward programs designed to incent customers to use their debit cards. So you've got some tailwinds there that help that situation.

It's also driven by us continuing to sign new bank and credit union customers to use our debit card processing, compared to whatever processor they were using before. And we've continued to see some solid growth in new customer signings to move to our debit card switching. So, frankly, at some point I expect to see that level out, but I am not sure that I could tell you where that point is.

The bill payment component, to be honest with you, I expected to see that level out by now. Again, our bill payment product today, we sell only to people who use our Internet banking system, and we only sell our Internet banking system to people that use our core system. And we've got excellent penetration, particularly on the banking side, of the bank customers who use our Internet banking system who also use our bill payment product. So there's a fairly limited runway there. That's somewhat offset by the fact that more people are adopting electronic bill payment, and the people who have previously adopted it tend to write more checks the more comfortable that they get with it. I think that you'll also see, probably two or three quarters out, more emphasis in the credit union space, on our bill payment product, as we begin to do some system changes there, and also the AudioTel customers, there's an opportunity for us to take the bill payment product to some non Jack Henry core customers that are using internet banking systems. So, again, some things in our favor on the bill payment side, but again expect to see that business potentially level out in the not too distant future. It will level out from 38% growth, down to who knows what, 25% maybe.

And then on the merchant capture solution, obviously there's been a significant ramp-up. I can't remember a product that has ever ramped-up as fast as this one has in the banking industry, outpacing ATM adoption or anything else. Again, the expected runway on that is probably 12-18 months where we see the financial institution adoption of the product will likely start to level out.

But, as I mentioned in the start of the call, we are pursuing other initiatives simultaneously like the partnership with Shelby Systems and over 20 other software providers to a variety of industries that have seen our Enterprise Payments product, realized that we've got a more comprehensive offering than most of the people out in the market and have chosen to imbed our Enterprise Payments solution or some piece of our Enterprise Payments solution into their software offering that they sell to a variety of non-financial customers, but customers who still need to process payments.

So, we hope that there is some opportunity for additional traction there even as the financial institutions themselves may hit a point where their adoption begins to slow somewhat. So, a lot of components there, a lot of different factors that are affecting the business, makes it a little hard to pinpoint exactly what it will do on a quarter-by quarter basis.

Brett Huff - Stephens Inc.

Thanks, that helps. And another product question, Kevin, I think you had mentioned that the Yellow Hammer solution continues to sell well. If you look at trends and wave of note deposit and all these things, what is the hottest product right now and what do you see in the next 12 months?

Kevin Williams

Remote Deposit Capture continues to be the hottest product. I mean, that is just a huge land-grab out there because typically, and historically, anything we tried to sell through our banks was very unsuccessful because our customers aren’t real good at pushing our products out to the end users. But this is a product that the merchants are demanding and they're either going to get it from their bank or they are going to go somewhere else to get it. So, the banks know they have to have this offering. So that’s by far the hottest product.

I think (NYSE:CSA) is probably close on its heels, which is the (AML) with BSA or Bank Secrecy Act products which we've had very good success with that since we rolled it out last June 1st. So, that continues. Anything related to check imaging continues to be a hot topic, either at the branch or at one of our IT centers we continue to see significant growth in all the check image products.

Jack Prim

I would just add to that, in the security area it’s a little early, but as we've mentioned before with the acquisition of the Gladiator technology one of the initiatives there is working on an Enterprise Security Solution that will, we believe, enable us to deliver a much broader set of security related solutions and reporting solutions than is available in the marketplace.

Again, that one is not finished it is not rolled out for general availability yet, and it will take some ramp-up time, based on the fact that it’s a completely return revenue type of an item but that is one that we expect in fiscal year '09 will get a lot of attention.

We also think that there's a fair amount of interest in internet banking on the credit union side with some of our other products that we are in the process of adapting for that marketplace as well. That again is not a near-term impact, it is more of a fiscal year '09 solution but one, based on the feedback we're getting, we think will present some opportunities for us.

Brett Huff - Stephens Inc.

That's great. Just two more quick questions. On the G&A side, were there any year-end pay related stuff, bonuses or anything like that that were in there Kevin? I know you mentioned there's a $2 million user group, but was there anything pay related that was bonus?

Kevin Williams

Not in G&A. Well, there was the holiday bonus that happened in November, which obviously part of that would be in G&A. But that gets spread out to - there would be a little of that in G&A. And that would have a slight impact with pretty small… Other than there was no other year-end bonuses that were paid or accrued.

Brett Huff - Stephens Inc.

Okay, and then the last question is, you obviously have been aggressive so far in January in buying back stock. Can you just give us your thoughts on capital deployment? It sounds like you still think your stocks are a good deal, especially at the prices it was earlier. But, anything on, thinking about M&A and multiples coming down or just give us a sense of capital deployment.

Kevin Williams

Well, I would tell you that we constantly get books and teasers on companies and there's very few that we even have spent much time reading the book. And that was one of the reasons why we stepped up and accelerated our stock buy back this quarter. But as we continue to evaluate other potential acquisitions or different markets or whatever we may choose to go in that direction, if those seize economically, we would much rather use our cash to do acquisitions. But, onto the second best use of that cash, continue buying back stock at some price level and now when our stock gets down to $22, $23, we'll probably very aggressively grab this. When it gets up to $25 and higher, we'll probably get a little less aggressive based on the commentary we got from the board last week.

Brett Huff - Stephens Inc.

Okay, that's helpful, thank you.

Operator

(Operator Instructions) And our next question comes from Glenn Greene with Oppenheimer.

Glenn Greene - Oppenheimer & Co.

Good morning guys. I want to go back to the macro picture in question two and I actually want to go back to last time you got an earnings growth slowdown, and let's say earnings went the other in was 2002, 2003, and it correlated to the fact that the Fed cut rates pretty dramatically form 6% to 1% directionally. We're not quite in that environment now, but clearly the Fed's pretty aggressive. I'm just trying to understand what happened five years ago and why that did slow down IT spending and why this environment right now is different.

Kevin Williams

Well, one thing Glenn is back then when they started cutting the rates, they cut them, I believe, seven times in eight months. And at that point the banks were still getting pretty good interest spread. What we've been, for the last two years, our FI's have been fighting the inverse yield curve and skinny interest margin. So they have all been focused on other ways to get fee income which the good thing is we've got a lot of this product that will help them better additional fee income and expand their margins.

So, the big thing back then was it was just a big unknown and when you drop interest rates that fast in seven months, the banks are now paying higher interest rates on their CDs and their volume of money outpour which is not a good thing for an FI. Compare that to today, I think the banks are a little more ready for what they're facing because as I've said they've been fighting the inverse yield curve, but also they've been focused on getting their institutions more on non-interest fee income related typed products.

Jack Prim

I would just add to that, the percentage of our revenue is now recurring in nature compared to what it was in 2002 and is substantially higher as well. So, I think there's some buffer there that we probably didn’t have in 2002. The other thing that I think was a factor in that timeframe was I think we have been doing a better job of managing headcount growth in the last couple of years than what we probably were doing in 2002. At that timeframe, particularly with the ramp-up for Y2K and even before that, one of the biggest challenges we had was how are we going to find enough people to deliver all the systems that we're selling? While, certainly after Y2K that slowed down some, I think we expected a turnaround in the economy sooner than it came. And it probably didn’t restrain hiring to the extent that we should have at that time. And I think that our managers have done an outstanding job of managing the headcount to the business environment that we're dealing with today. So, I think those two factors in addition to the points Kevin made make this a - again, recession is not going to be good, there's nothing good I can say about what happens if we go into recession, but what I would say is that I think we're in better shape to come out of it strong than we were in 2002.

Kevin Williams

One more comment, Glenn. If you think about 2002, 2003 - 2002 was actually a record year for us in revenue and EPS. The first half of F1 '03 was a horrible six months of margins drop-down because we didn’t do a (risk) because we don’t, as Jack mentioned, we were trying to get buy, we didn’t want to lose the good ones. So, our margins were falling first half, but then from June, of course, that year we went right back to having record quarters. So it actually was just six months in the last 18 years that was really a huge shortfall.

Glenn Greene - Oppenheimer & Co.

That's very helpful. Different direction. Kevin, could you just help me - what was the growth for the Profit Stars brand portfolio and also for your aggregate payments business? If you said it I missed it. And also what percentage of revenue did those two represent?

Kevin Williams

Profit Stars currently represents about 13% of our total revenue.

Glenn Greene - Oppenheimer & Co.

What was the growth on the quarter roughly?

Kevin Williams

In revenues, 30% for a year ago quarter.

Glenn Greene - Oppenheimer & Co.

And the payments, various payments businesses?

Kevin Williams

Payments business, was up 24% for the quarter.

Glenn Greene - Oppenheimer & Co.

And percentage of revenue roughly?

Kevin Williams

Hold on.

Glenn Greene - Oppenheimer & Co.

I can get it offline if you don’t have it.

Kevin Williams

I'm going to have to ask you to do that for that one.

Glenn Greene - Oppenheimer & Co.

Okay, and just clarify your '08 outlook, you're comfortable with low double-digit revenue. And you say mid-teens EPS or mid-teens net income?

Kevin Williams

Operating income.

Glenn Greene - Oppenheimer & Co.

Operating income.

Kevin Williams

I'm trying to avoid the taxes and go to the bottom line, because I still don’t know what's going to happen with the R&D credit in some of those things. With this being an election year, its hard telling what some of them may do to try and gain some votes or whatever. So, it's very possible the R&D credit could be put back in place before the end of the year which obviously has a significant impact. If they don’t leave it there our tax rates (work into that).

Glenn Greene - Oppenheimer & Co.

Okay, I think I'm good. Thanks guys.

Operator

Thank you and our next question comes from Dan Perlin with Wachovia Capital Markets

Daniel Perlin - Wachovia Capital Markets

Thanks, good morning guys. My question, I need to go back for a second to clarify a statement you made earlier Kevin about the license in the second half. One of the earlier callers had asked that should you typically see this fall-off in the third quarter and then bounce back, which I would have expected, but then you made a comment that it might not actually fall off that much, and I was wondering are you referring to the percent change or are you talking about the absolute dollar of license going into that third quarter not falling off as much?

Kevin Williams

Absolute dollar in license revenue should be fairly level in the third quarter. I would think it’s the same as the second quarter.

Daniel Perlin - Wachovia Capital Markets

Okay, and so that should continue roughly into June quarter as well? That was your pipeline?

Kevin Williams

Typically June quarter is our strongest quarter. So you would think that license revenues for the fourth quarter would go up somewhat.

Daniel Perlin - Wachovia Capital Markets

And then on the margin side of that equation, are you seeing the third party products actually growing faster than the other areas?

Kevin Williams

Well BSA is growing faster, and obviously depending on what percentage that is of total license fees it can have a significant impact on margins. On the crediting side, the two major products over there is third party products or Intervoice and OTG. Those are basically in upgrade modes. We're not actually marketing OTG. We will sell Intervoice to a new customer but those don’t happen very often.

Daniel Perlin - Wachovia Capital Markets

So we should expect similar margin profile for license in the back half as what we've seen out of this quarter?

Kevin Williams

Yes.

Daniel Perlin - Wachovia Capital Markets

Okay. And then can you just clarify specifically the reason for staying at the low end of your margin guidance now as opposed to maybe previously thought. Just what the key driver to that is?

Kevin Williams

Well, I think the key driver to that is the shortfall that we have seen in license revenues, especially in the first fiscal quarter.

Because obviously if license revenue would have been what we had anticipated in the first quarter, we'd be extremely strong in license fees here today which would make me feel a whole lot better EBITDA margin expansion going forward. But when our EBITDA margin is permanently at 31% year-to-date, which is where we were last year, you have half a year to gain that additional spread.

Daniel Perlin - Wachovia Capital Markets

And then lastly, I think at one point in the past you talked about payments, gross margins being 50% plus. Is that still a true statement? Do I have that right?

Kevin Williams

Yeah, they're in the 50%, gross margins.

Daniel Perlin - Wachovia Capital Markets

And they are pretty much all capture in support and services.

Kevin Williams

Yes, those are all in support and services.

Daniel Perlin - Wachovia Capital Markets

Great, thank you very much.

Kevin Williams

And one follow up on the question that Glenn asked, our EFT as a percentage of total revenue. It's about 15%

Operator

Thank you. And our last question comes from Tom Lamb from Weybosset Research.

Tom Lamb - Weybosset Research

Good morning, gentlemen. A couple of questions, one is regarding the de novos again. Are you seeing them flat or up year-on-year, or year-to-date?

Jack Prim

Tom, the number of de novo formations appears to be down a little bit but I don’t think substantially from a year ago. I think its down slightly to flat.

Tom Lamb - Weybosset Research

Okay, thanks. And then, when you think about your recurring revenues, is there tendency in the contracts or the product flow to make the recurring revenues rise or stay flat or decline? In a scenario where you are not delivering more product, would your recurring revenues be declining or staying flat or in terms of the volumes being processed are they going up? If you could give me a sense of where you see recurring revenues going in a couple of different scenarios.

Kevin Williams

First of all, you need to remember that our recurring revenues have three primary components. There's our outsourcing for (inaudible) for redoing the back office processing. There's our in-house maintenance which that's pretty level throughout the year because we charge the majority of those in June for the following year which that goes then for revenue, which basically just gets spread over 12 months. The (onus) for that increase is for us to add additional product or additional customers with core solutions which would drive the maintenance up a little bit, but you'd hardly even notice it. And then the third part of the recurring revenue is our payment business, EFT business which that is almost exclusively transaction based.

Tom Lamb - Weybosset Research

All right, great, that's very helpful. Thanks a lot.

Operator

It appears there are no further questions at this time. I'll turn the conference back over to you for any additional comments or closing remarks.

Jack Prim

Thank you. We want to thank you for joining us today to review our second fiscal '08 quarterly results. We are very pleased with our overall financial performance during the quarter and year-to-date. We remain confident that we are very well positioned and we have the right products and services to approach the markets that we are going after. We also believe we have proper resources and the proper technology to take advantage of these opportunities in front of us, continue to expand our margin improvement and our products and services are committed to all of our competitive streams.

Our executives, managers and all of our employees are focused on doing the right thing for shareholders. With that I would appreciate your Marybelle, giving them the callback number.

Operator

Thank you (Operator Instructions) And that concludes today's conference. We appreciate your attendance and have a wonderful day.

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Source: Jack Henry & Associates F2Q08 (Qtr End 12/31/07) Earnings Call Transcript
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