Kevin D. Williams - Chief Financial Officer, Principal Accounting Officer and Treasurer John F. Prim - Chairman, Chief Executive Officer and Member of Risk & Compliance Committee Tony L. Wormington - President.

Brendan Hardin Peter J. Heckmann - Avondale Partners, LLC, Research Division Michael Landau - Evercore Partners Inc., Research Division Brett Huff - Stephens Inc., Research Division.

Good day, and welcome to today's Jack Henry Second Quarter 2014 Earnings Call. This call is being recorded. For opening remarks and introductions, I would like to introduce Kevin Williams, Chief Financial Officer. Please go ahead..

Thanks, Tyrone. Good morning. Thank you for joining us today for the Jack Henry & Associates Second Quarter Fiscal 2014 Conference Call. My name is 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 will be as follows. I'm kicking off.

Jack will start with an overview of the quarter from his perspective, and then Tony will provide some operational highlights, and then I'll add some additional color around the press release that was put out after market close yesterday.

First, 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'm now going to turn the call over to Jack..

Thanks, Kevin. Good morning. We're pleased to announce a record quarter for revenue, operating income and net income. As you recall, a year ago, we incurred significant charges due to Hurricane Sandy-related events and the subsequent recovery that significantly impacted our New Jersey item processing facility.

The receipt of funds in the most recent quarter for our related insurance claims clutter the year-to-year comparisons more than they would already have been, but I'm sure Kevin will be able to clear that out. My comments related to the financials will exclude Sandy-related impacts, although we have provided both in our press release.

We saw solid organic growth of 9% and maintained strong gross margins even though the high-margin license fees declined in the quarter. The credit union segment in particular had a solid margin performance, as license fees declined 14% from the year-ago quarter, a quarter which had been up 42% compared to its prior year.

Solid expense control, with operating expenses increasing 6%, allowed operating margins to increase to 27% from 26% in spite of an increased disaster recovery infrastructure-related spending.

Solid sales performances across all 3 brands, with strong core and complementary sales in the banking and credit union segments, and a strong outside-the-core base performance by the ProfitStars team led to an 11% increase in the backlog.

Related to the Hurricane Sandy event, as promised a year ago, we have undertaken significant reviews of all company disaster recovery plans and operations and, where appropriate, implemented changes to ensure that this would be a onetime event.

We have maintained ongoing communications with our customers and the regulatory agencies to make sure they are fully informed of our progress. I'd like to thank our over 5,000 employees for their continued efforts, on behalf of our customers, that allowed us to deliver these solid financial results.

With that, I'll turn it over to Tony for some additional business updates..

Thank you, Jack. Good morning. We remain pleased with the contributions from all components of support and services, which increased 10% in the quarter and year-to-date compared to the prior year.

The largest contributor continues to be our electronic payments revenue, which grew 12% for the quarter and 13% year-to-date compared to the prior year periods. Our outsourced data and item processing services increased 11% over the prior year quarter and 12% over the prior year-to-date period.

Our in-house annual maintenance fees increased 6% for the quarter and 4% year-to-date over the prior periods. In addition, our onetime implementation revenues were up 8% over the prior year quarter and 9% over the prior year-to-date period. Our electronic payments transaction volumes continued to experience nice growth in the quarter.

JHA Payment Processing Solutions transaction volumes for ATM debit and credit processing were up 16% over the prior year quarter. Bill payment transaction volumes increased 7% over the prior year quarter.

Financial institution merchants installed and utilizing our Enterprise Payment Solutions increased to approximately 65,000 merchants, representing a 45% increase compared to the prior year quarter. Merchant-related transaction volumes increased 20% over the prior year quarter.

In closing, I'd like to thank our customers, our associates and our shareholders for their continued loyalty to JHA. I'll now turn it over to Kevin for a further look at the numbers..

Our implementation services, or those onetime implementation revenue was $22.6 million for the quarter, which was an increase of 8%. Our electronic payments, which we've talked about a lot and continues to grow very nicely, was $110.6 million, it was a 12% increase. OutLink data, item processing was $58.1 million or an 11% increase.

And our in-house maintenance of $82.9 million, which is a 6% increase for the quarter compared to the same quarter last year. Our hardware revenue increased 1% for the quarter, or relatively flat, and it still represents 5% of our total revenue.

Recurring revenue for the quarter, which is our electronic payments, OutLink data process and in-house maintenance, experienced a growth of 8% for the quarter compared to last year and represented 78% of our total revenue for the quarter. Consolidated gross margins were steady at 44% for the quarter and last year's quarter.

License margins increased to 93% this quarter from 91% a year ago, obviously due to less sale of third-party software during the quarter. Our support and services margins were also steady at 42% for both this and last year's quarters. However, margins decreased slightly to 29% from 31% a year ago due to sales mix.

In our banking segment, our gross margins remained steady at 44%. And our credit union segment margins were also steady at 45% for the quarter. In our bank segment, license margins increased to 91% from 86% a year ago. Support and service margins for the bank segment were steady at 43%.

And hardware margins decreased slightly in the bank segment to 31% from 33%. In our credit union segment, our license margins were steady at 96%. Support and service margins improved slightly to 42% from 41%. And our hardware margins remained level at 25% in the quarter compared to last year.

Total operating business decreased 21% for the quarter compared to prior year on a GAAP basis, as Jack highlighted. However, this was impacted a little bit by Superstorm Sandy that occurred in this quarter a year ago. In the prior year, we had a $13.7 million charge in operating income.

In this quarter, we had a $2.9 million recovery of interest settlements, which is the last of the insurance claims and settlements. Excluding these onetime events, our operating expenses would have actually increased 6% for the quarter.

And as a percentage of total revenue, operating expenses would have been 17% of total revenue, down from 18% a year ago, if you consider these onetime impacts. Our operating margin for the quarter increased to 28% from 21% a year ago, as reported.

However, without the onetime impacts created by Superstorm Sandy, it improved 27% from 26% a year ago, which is relatively in line. Our operating income increased 40% for the quarter compared to last year's reported and 10% without the impacts of Sandy.

Our effective tax rate for the quarter was at 35.2%, which is up significantly from last year's effective rate of 30.6% this quarter.

If you remember, last year, we had the relief of about $2.8 million or a $0.03 EPS impact of previously unrecognized tax benefits from closed IRS audits that occurred in the December quarter of last fiscal year, which obviously we didn't have those same impacts this year.

EBITDA increased to $109.9 million for the quarter compared to $83.9 million a year ago, or a 31% increase or actually a 10% increase without the impact of the onetime charges and impacts of Sandy.

Depreciation and amortization expense was $26.2 million this quarter, with $13.2 million depreciation and $13.1 million amortization, compared to $24.2 million in depreciation and amortization this quarter last year.

Included in the total amortization is amortization of intangibles from acquisitions, which was $5.2 million for the quarter, down from $5.3 million in the same quarter last year. Operating cash flow year-to-date increased to $131.3 million from $119.2 million a year ago.

Free cash flow year-to-date, calculated as operating cash flows less CapEx of $21.9 million, which is up a little bit from $19 million a year ago; cap software of $29.1 million compared to $23.8 million year-to-date last year, which the quarter was essentially flat sequentially; and dividends of 31 -- or $34.1 million, up from $19.8 million last year, which obviously this is due to the 74% increase in dividends that we did in 2 increases last spring, free cash flow decreased to $49.0 million compared to $56.6 million last year.

And obviously, the base contributors to the decrease in free cash flow is a large increase in dividends that we did last fiscal year. This equates to free cash flow per share $0.57 this quarter compared to $0.66 last year. As Jack mentioned, we continue to have record backlog. Backlog was $122.3 million, which is up 36% from last year.

Outsourcing backlog, which is the remaining live current data and item process contracts, was $381.5 million, which is up 5% compared to last year. Total backlog was up 11%. For guidance, we continue to release [ph] the guidance we've previously provided for this year.

The second quarter and the first half were pretty much in line with the guidance we provided. Top line revenue should continue in the upper mid to high single-digit revenue growth, with some ongoing leverage to our margins.

The results of this continued revenue growth and slight margin leverage should provide operating income growth in the low double digits for the year, which we have seen in the first half of the year. Our effective tax rate should remain at about 35.5% since we cannot predict the reinstatement of the R&E credit.

Therefore, EPS should grow pretty much in line with operating income growth in the low double digits for the entire fiscal year. Also, just to remind everyone, in our third fiscal quarter, comps will be as difficult as our second quarter fiscal comps were easy.

Last year in our third fiscal quarter, we had 5 quarters of the R&E credit catch-up which was reenacted in that quarter, which we will not have this year. As well, last year, we had insurance reimbursements from lenders in that quarter that we will not have this year as all instructions have now been settled.

With these combined was an approximately $0.06 EPS positive impact last year, which means that on an adjusted basis or on an apples-to-apples comparison, the consensus estimate of $0.55 that's currently out there would represent a 17% increase in EPS. So just FYI. That's pretty solid increase on an apples-to-apples comparison.

Not saying we should change that outlook but just wanting to highlight that you -- or make sure that you all have that in your models as we look at the third and fourth quarters. With that, that concludes our opening comments. We're now ready to take questions.

Tyrone, will you please open the call up for questions?.

[Operator Instructions] First question is from Brendan Hardin of Northcoast Research..

I guess I have a question regarding the electronic payments. You provided another strong quarter with that.

I guess, based on our backlog and pipeline, I guess, do you see this growth sustainable?.

Well, first of all, we don't disclose any of our electronic payments in our backlog. That's one thing that's not in backlog, but I will tell you that our electronics payments backlog is very strong. We continue to have a very strong backlog of implementations out in the future.

So I think that we will continue to see very strong growth in electronic payments. I think this quarter is down slightly, which I think that's probably more reflected with the long-term growth, but I think that, that growth is very sustainable for the foreseeable future..

And just a quick follow-up.

I guess, do you see any acquisition opportunities? Or would you say prices are still a little too high for your preference?.

Brendan, it's Jack. We continue to look at the opportunities out there, but I will just tell you that a lot of the recent deals have gone for prices that, while they may have worked in somebody else's model depending on what problem they were solving for them, they didn't come close to working in any of our models. So we'll continue to look at those.

And there could be some things we would look at and, in some cases, pay up for if it met a sufficiently strategic need. But some of the more -- some of the larger acquisitions that have taken place out there didn't fit into any of those categories.

So certainly have the cash, certainly have the free cash flow to look at something substantial, but there's got to be a reasonable return in our estimation..

The next question is from Peter Heckmann of Avondale Partners..

Can you just give us an update? We're seeing clearly a flurry of press releases here. It appears that the tenor of the competitive environment in the credit union side has upticked a little bit with some of the consolidation in the space.

How do you the feel the credit union landscape looks for you in terms of growth? Where do you think Jack Henry is going to continue to grow? You've had some real significant successes over the last decade in gaining share in the mid- to large-size credit unions.

Do you think any of the changes competitively are going to slow that ability to continue to gain share? And if you could comment if pricing is a component of some of the competitions you're seeing in the market today..

Yes, Pete, the -- you're right. I mean the credit union segment has just been very strong for us, and we believe that, that will continue to be the case. We think it'll likely, at some point, get a little bit more competitive with some of the acquisitions that have been done over there. But frankly, we closed 16 new core sales in the quarter.

Every 1 of those was a competitive takeaway. We continue to be, with our Episys platform, the platform of choice for the larger credit unions. We have considerably more billion-dollar-plus credit unions installed on that platform than any other platform.

In fact, if you combined other vendors' billion-dollar-plus credit unions across their multiple platforms, it would barely be in that same range. So we feel like we've got the right product for that marketplace and that it will continue be strong.

We do expect that environment probably will get a little more competitive, but we like our -- like the opportunities that we see out there right now. Pricing has not been, for the most part in the credit union segment, a major issue. I would say, not anymore major than it has been.

It's -- there's not a significant change in what we're seeing in the area of pricing competition, but it's been pretty aggressive for quite a period of time on both the banking and the credit union segments of the market.

So the core business, of course, a continued strength, as just talked about in the credit union space, we think there are some good opportunities on the banking side as well with increased activity in and among some of the mid-tier banks, the $1 billion to $20 billion kind of the evaluations taking place.

And you won't close 16 of those in a quarter, but 1 or 2 here and there can make a nice impact..

Definitely. Definitely, okay. And then there's been maybe a modest uptick in M&A amongst the bank industry.

Do you see -- I guess, in your internal models, do you see bank M&A starting to pick up here over the next year? And if so, how do you anticipate that might affect your business?.

I think it's certainly possible that we could see some uptick. We've benefited from a couple of those here recently that -- we think there will likely be some continued activity. Certainly, have been predictions for quite a long time, some of them ridiculous in terms of the level of consolidation that some people expect to see in the marketplace.

I think, at the end of the year, you can compare this year to every year for the last 10 or 15 and you'll probably see a net reduction in the number of financial institutions of 3% to 3.5%, and again which is a very consistent number you could see year in, year out for the last decade, if not the last 2 decades. That's where we think it'll be.

Now will the size of the banks that are showing an interest in consolidation change? I mean, there -- looked like it was maybe going to be the small banks because compliance costs and other things were going to make it difficult for them to compete.

Now there's been a little more activity in the last quarter or 2 from banks in the mid-tier-size range. I think that's going to shift around a -- some. But again, at the end of the year, you can add it all up and I think you're going to see a 3% to 3.5% net reduction, which we've managed to cope with quite nicely for several decades..

Can you just give us an update on the landscape in bill payments, talk a little bit about your current installed base of core institutions? How many of those are now using Bill Pay from you? And what will be the further opportunity to gain wallet share there?.

Yes, I don't know if I have the numbers, or Tony may have them, related to the number of installations at my fingertips. But we continue to see strong growth.

We certainly see heightened competition, particularly for -- if you'll remember, when iPay was an independent provider, their core agnostics still are, and had a lot of customers that were using competitive core systems.

We've seen kind of some stepped-up aggressiveness from one or more core providers who kind of want to bring that business back into the fold, along with their core, but we continue to win some of their customers on a go-forward basis as well.

So I would say the competition has probably picked up a little bit for -- primarily for that reason, but we've got a new refreshed version, refreshed user interface version, of our product that we're rolling out to our customers now and we think will continue to help us compete very effectively for new bill payment and competitive replacement bill payment opportunities..

The next question is from Michael Landau of Evercore..

Sitting in for David Togut. Just a little bit of a follow-up.

Would you guys be able to quantify the impact on 2Q Symitar bookings from Fiserv's recent acquisition of Open Solution?.

Well, I would tell you that it has -- I don't know that I could quantify it. I would tell you that we have not seen any slowdown. If anything, we've seen activity pick up since that acquisition. Now again, I think that will change.

I think that the initial efforts there had been to go back and resecure the business that they had signed to the discontinued platform that they had. So I think that's where their initial efforts have been and focused along with normal integration activities that take place with a significant acquisition.

So I think, once they've kind of gotten their arms around that, that they could very well be, that there'll be more competitive attention focused on the marketplace, but I think our perspective is it's pretty clear that there's really only one viable go-forward solution at this point, and that would be the D&A product.

There's a lot of credit unions out there on legacy products that are not in that spot.

And we think that -- even if they do have some success in some of the new opportunities with the D&A product, that there will be potentially enough other credit unions looking on some of those legacy platforms that aren't getting the level of R&D and enhancements that they like to see.

The -- we believe the credit union segment could have a pretty good level of core replacement activity for the foreseeable future..

That's great color.

Would you be able to quantify the expected growth in your customers' IT budgets for 2014?.

Michael, I really couldn't. I mean there's a number of surveys that have been out there by various folks that depending on sample size and validity of the survey, you could be looking at 3% to 5% probably. But I'm just -- that's not my estimates, that's my best recollection of things I've seen..

Okay, that's fair.

And I -- and just lastly, would you be able to quantify your software capitalization expectations for the second half of '14 or into '15?.

Well, I don't know if Kevin can. I don't....

Yes, Michael, we're probably on about the run rate now that we're going to be for the next 1.5 years or so, and maybe beyond that because of the different projects that are ongoing. So it kind of ramped up about this time last year, and it's been pretty much on a level pace now for the last 3 or 4 quarters.

I mean I don't see that changing significantly in the foreseeable future..

The next question is from Adam Downes [ph] of Baird..

You guys turned in, it looks like, some record operating margins this quarter.

I was just kind of curious, is that a sustainable level? And how should we look at that going forward?.

Well, I would tell you, I mean our -- all of our margins remained fairly level this quarter. I mean our gross margins were about the same at 44%, as they were this time last year. Our support services margins were pretty level, which obviously are going to bounce around a little bit.

We were able to squeeze a little bit more to the operating margin line. But if you also remember, there was some insurance reimbursements in the quarter in there that impact that slightly. So yes, our operating margins were up slightly.

It was kind of right in line with the guidance we gave at the end of the year that we thought there were some margin improvements that could be had during the year. So it is going to bounce around a little bit, obviously, from quarter to quarter.

So it is sustainable, I think, for the year there, but obviously, it could bounce around a little bit next quarter because of all the impacts that I mentioned..

And then one quick follow-up.

Any termination fees to call out this quarter?.

There were some termination fees, and I think they were up -- hold on a little, I have it right at my fingertips. They were up slightly. I think they were up about $1 million this quarter over what they were a year ago but not a significant amount..

[Operator Instructions] Next question is from Brett Huff of Stephens..

A couple of quick questions. One -- and I hopped on late. I'm not sure if you've talked about this, but I know you're still in the process of a fairly big user interface refresh across a number of your products.

And just wanted to see -- hear how that was going, how the client reception was or if we're rolling it out yet and kind of where we are in the inning rollout there..

Yes. It's going well, Brett. We -- that -- this is an ongoing project. We've -- there's been a significant amount of work. I think our third release related to the -- that user interface refresh is pending here shortly.

But again, the -- we are working on user interface and sort of migrating those to a more common look and feel across a large variety of platforms.

So 3 to 5 years from now, we'll probably still be talking about this to some extent, although the -- I'd say most of the heaviest lifting is probably, for the most part, done at this point, but there are just a lot of systems and a lot of things going forward. So it's going well, it's been well received.

I would say it's primarily available today for the SilverLake core system. And then a number of other complementary modules are in-line as well at this point. And we probably have roughly 25% of the SilverLake base that's actively using it, and more adopting it on a daily basis..

Okay, that's helpful. And then bigger picture. You guys' organic growth has been great, outpacing your peers in the market by a factor of 2 or 3. I know some of that's just taking shares. Some of it is cross-sales of some of the products you've acquired in the last couple of years.

What is the -- as you guys think beyond the next year or 2, is there another product or group of products that you need to get or would like to get in order to help continue that cross-sell opportunity? And I guess it's -- a larger question is, how long can we sustain this very good high single-digit organic growth?.

Well, Brett, I don't know that there's a lot that we need in the way of products. I think, certainly, we're looking at some additional opportunities in the mobile area. We've had good success with our mobile offering. I think we could -- we can grab a larger share of that market. And we're focused on some activities there.

But there's not a lot of products that we currently lack in. And some of these products, the credit union core system sales environment, as we talked about, has been very strong and we think can remain very solid. The banking space, with some of the increased mid-tier activity that we're seeing out there, we think has the opportunity to contribute.

And then of course, when you win those core deals, there's -- particularly if you're able to also win the payments-related businesses, that adds very significantly.

Our payments growth, while, as we mentioned earlier, it was probably at a little less intensive pace this last quarter than it had been previously, but still very solid and well above industry averages that we're seeing out there, and we believe that will continue to be the case.

So we think we've got a product set that still has a lot of runway to continue that growth. And could it slow up at some point? I -- possibly, but I still feel like that we'll be able to put up faster organic growth rates than other players in our space for the foreseeable future..

Okay, that's helpful. And then one last one. And again, you may have addressed this already, but you guys are going to be building cash here pretty quickly.

I know that buybacks or M&A are always on the docket, but can you give us thoughts beyond that, if there are any, or sort of give us -- just go through the use of cash in your view given the build of cash that's coming?.

Well, Brett, I mean, obviously, we increased the dividend significantly last year. We typically increase the dividend in our February board meeting, which is coming up later this week. So there -- I'm assuming that it'll probably be a normal small increase like we have in years past, not to the magnitude we did last year.

We have not bought any stock back this year because of the regulatory agreement that was filed just before Christmas. Because of that, we had our board and executive blacked out, and when our board and executive are blacked out, I -- do not let the company participate in stock buybacks.

So now that, that is filed and behind us, we'll probably back in the market buying back stock, especially with the 11% pullback that we've seen in the last couple of weeks. I would think we will probably be back in the market. We will be taking a look at M&A, but we -- as Jack pointed out, Brett, we're in a really good position. We're growing nicely.

We don't have the pressure to have to do something. So if we build up a little cash, we build up a little cash. But we'll continue to be optimistic buying back our stock. We'll continue to look at dividends and potential M&A..

With no further questions in the queue, I'd like to turn the call over to Kevin Williams for any closing remarks..

Thanks, Tyrone. Again, we want to thank you for joining us today to review our second quarter fiscal 2014 results. We are very pleased with the results from our ongoing operations and efforts of all of our associates, and we want to thank all of our associates and managers for helping take care of our customers.

Our executive managers and all of our associates will continue to focus on what is best for you, our shareholders, and especially all of our customers. With that, I want to thank you again.

And Tyrone, will you please provide the replay number?.

Ladies and gentlemen, this conference will be available for replay today after 11:45 a.m. Eastern Time through February 12, 2014, 11:59 Eastern Time. You may access the replay system at any time by dialing 1 (855) 859-2056 or 1 (800) 585-8367 and entering the access code 34846116. International participants may dial (404) 537-3406.

That does conclude our conference for today. Thank you for your participation. You may now disconnect..