filings.toolsItem 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following section provides management's view of the financial condition and results of operations and should be read in conjunction with the Selected Financial Data, the audited Consolidated Financial Statements, and related notes included elsewhere in this report.
OVERVIEW
Jack Henry & Associates, Inc. (JHA) is headquartered in Monett, Missouri, employs nearly 6,100 associates nationwide, and is a leading provider of technology solutions and payment processing services primarily for financial services organizations. Its solutions serve over 9,000 customers and are marketed and supported through three primary brands. Jack Henry Banking® supports banks ranging from community banks to multi-billion dollar institutions with assets up to $50 billion, with information and transaction processing solutions. Symitar® is a leading provider of information and transaction processing solutions for credit unions of all sizes. ProfitStars® provides highly specialized products and services that enable financial institutions of every asset size and charter, and diverse corporate entities outside the financial services industry, to mitigate and control risks, optimize revenue and growth opportunities, and contain costs. JHA's integrated solutions are available for in-house, outsourced, or hosted delivery.
Each of our brands share the fundamental commitment to provide high-quality business solutions, service levels that consistently exceed customer expectations, integration of solutions and practical new technologies. The quality of our solutions, our high service standards, and the fundamental way we do business typically foster long-term customer relationships, attract prospective customers, and have enabled us to capture substantial market share.
Through internal product development, disciplined acquisitions, and alliances with companies offering niche solutions that complement our proprietary solutions, we regularly introduce new products and services and generate new cross-sales opportunities across our three business brands. We provide compatible computer hardware for our in-house installations and secure processing environments for our outsourced and hosted solutions. We perform data conversions, software implementations, initial and ongoing customer training, and ongoing customer support services.
We believe our primary competitive advantage is customer service. Our support infrastructure and strict standards provide service levels we believe to be the highest in the markets we serve and generate high levels of customer satisfaction and retention. We consistently measure customer satisfaction using comprehensive annual surveys and randomly generated daily surveys we receive in our everyday business. Dedicated surveys are also used to grade specific aspects of our customer experience, including product implementation, education, and consulting services.
A significant proportion of our revenue is derived from recurring outsourcing fees and electronic payment transaction processing fees that predominantly have contract terms of five years or greater at inception. Support and service fees also include in-house maintenance fees which primarily contain annual contract terms, implementation services revenue, and bundled services revenue, which is a combination of license, implementation, and maintenance revenue
from our revenue arrangements. Less predictable software license fees and hardware sales complement our primary revenue sources. We continually seek opportunities to increase revenue while at the same time containing costs to expand margins.
During the last five fiscal years, our revenues have grown from $1,107,524 in fiscal 2013 to $1,431,117 in fiscal 2017. Net income has grown from $167,610 in fiscal 2013 to $245,793 in fiscal 2017. This growth has resulted primarily from internal expansion.
We have two reportable segments: bank systems and services and credit union systems and services. The respective segments include all related license, support and service, and hardware sales along with the related cost of sales.
We continue to focus on our objective of providing the best integrated solutions, products and customer service to our clients. We are cautiously optimistic regarding ongoing economic improvement and expect our clients to continue investing in our products and services to improve their operating efficiencies and performance. We anticipate that consolidation within the financial services industry will continue. Regulatory conditions and legislation will continue to impact financial institutions' discretionary spending.
A detailed discussion of the major components of the results of operations follows. All dollar and share amounts are in thousands and discussions compare fiscal 2017 to fiscal 2016 and compare fiscal 2016 to fiscal 2015.
RESULTS OF OPERATIONS
FISCAL 2017 COMPARED TO FISCAL 2016
In fiscal 2017, revenues increased 6% or $76,471 compared to fiscal 2016, with strong growth continuing in our support and service revenues, particularly our outsourcing services, electronic payment services, and bundled services. Cost of sales increased 6%, in line with revenue, and gross profit increased 5%. The company continues to focus on cost management.
Net operating expenses increased 11% year over year, due mainly to the gain on the sale of our Alogent business ("Alogent") to Antelope Acquisition Co., an affiliate of Battery Ventures, in the prior year, which is discussed below in the operating expenses section. Provision for income taxes increased 9% compared to the prior year, due a lower prior year effective tax rate, which is described in the following discussion. The above changes resulted in a 1% decrease in net income for fiscal 2017.
We move into fiscal 2018 following a strong performance in fiscal 2017. Significant portions of our business continue to provide recurring revenue and our healthy sales pipeline is also encouraging. Our customers continue to face regulatory and operational challenges which our products and services address, and in these times they have an even greater need for our solutions that directly address institutional profitability, efficiency, and security. Our strong balance sheet, access to extensive lines of credit, the strength of our existing product line and an unwavering commitment to superior customer service position us well to address current and future opportunities.
A detailed discussion of the major components of the results of operations for the fiscal year ended June 30, 2017 follows. All dollar amounts are in thousands and discussions compare the current fiscal year ended June 30, 2017 to the prior fiscal year ended June 30, 2016.
REVENUE
| License Revenue | Year Ended June 30, | % Change | ||||||||
| 2017 | 2016 | |||||||||
| License | $ | 2,385 | $ | 3,041 | (22 | )% | ||||
| Percentage of total revenue | <1% | <1% |
License revenue represents the sale and delivery of application software systems contracted with us by the customer, which are not part of a bundled arrangement. We license our proprietary software products under standard license agreements that typically provide the customer with a non-exclusive, non-transferable right to use the software on a single computer and for a single financial institution.
Non-bundled license revenue decreased due mainly to a reduction in standalone license sales in our Bank segment, with Alogent headwinds accounting for $570 of that decrease. Excluding the Alogent headwind, license revenue decreased 3%. Such license fees will fluctuate as non-bundled license sales are sporadic in nature.
| Support and Service Revenue | Year Ended June 30, | % Change | ||||||||
| 2017 | 2016 | |||||||||
| Support and service | $ | 1,384,338 | $ | 1,300,978 | 6 | % | ||||
| Percentage of total revenue | 97 | % | 96 | % | ||||||
| Year over Year | ||||||||||
| $ Change | % Change | |||||||||
| In-House Support & Other Services | $ | 2,790 | 1 | % | ||||||
| Electronic Payment Services | 26,930 | 5 | % | |||||||
| Outsourcing Services | 39,822 | 13 | % | |||||||
| Implementation Services | (8,837 | ) | (14 | )% | ||||||
| Bundled Products & Services | 22,655 | 24 | % | |||||||
| Total Increase | $ | 83,360 |
Support and service revenues are generated from supporting our in-house customers in operating their systems and to enhance and update the software, electronic payment services, outsourced data processing services, implementation services (including conversion, installation, configuration and training) and revenue from our bundled software multi-element agreements. There was growth in most support and service revenue components in fiscal 2017, despite Alogent revenue of $27,673 included in the prior year. Excluding that headwind, support and services grew 9%.
In-house support and other services revenue increased despite headwinds of $13,062 created from the Alogent sale. Excluding the Alogent headwind, in-house support and other services revenue increased 5%. The increase was due mainly to increased revenue from work orders and from customers consulting with our Client Services Consulting group. The group's operational assessments help banks and credit unions maximize their operating efficiency and productivity, identify new revenue and market opportunities, and reduce costs.
Electronic payment services continued to show growth over the prior year. The revenue increases are mainly attributable to strong performance across debit/credit card risk management and transaction processing services, remote capture and ACH processing, and online bill payment services. Deconversion fees (fees charged when customer agreements are terminated prior to the end of their contracted term) for electronic payment services decreased $2,901 compared to the prior year. Excluding these fees from both years, electronic payment services revenue increased 6%.
Outsourcing services for banks and credit unions continue to drive revenue growth as customers continue to show a preference for outsourced delivery of our solutions. Revenues from outsourcing services are typically earned under multi-year service contracts and therefore provide a long-term stream of recurring revenues. We expect the trend towards outsourced product delivery to benefit outsourcing services revenue for the foreseeable future. The increase in outsourcing revenue was mainly due to data processing. Deconversion fees within outsourcing services increased $4,736. Excluding these fees from both years, outsourcing services revenue increased 12%.
Implementation services include implementation services for our electronic payment services customers as well as standalone customization services, merger conversion services, image conversion services and network monitoring services. Implementation services revenue decreased due partly to Alogent headwinds of $4,465, with the remainder of the decrease due mainly to a decline in stand-alone implementations in the Bank segment. Revenue from these standalone services has decreased as implementation services related to our bundled arrangements have increased.
Bundled products and services revenue is combined revenue from the multiple elements in our bundled arrangements, including license, implementation services and maintenance, which cannot be recognized separately due to a lack of vendor-specific objective evidence of fair value. Bundled products and services revenue increased, despite $10,145 of Alogent headwinds, mostly due to terminations of pending products and services on certain contracts that have allowed for the release of revenue that was being deferred until contract completion in both our Bank and Credit Union core and complementary arrangements, as well as increased revenue being released due to completion of final installations and services on our Bank multiple element arrangements.
| Hardware Revenue | Year Ended June 30, | % Change | ||||||||
| 2017 | 2016 | |||||||||
| Hardware | $ | 44,394 | $ | 50,627 | (12 | )% | ||||
| Percentage of total revenue | 3 | % | 4 | % |
The Company has entered into re-marketing agreements with several hardware manufacturers and suppliers under which we sell computer hardware, hardware maintenance and related services to our customers. Revenue related to hardware sales is recognized when the hardware is shipped to our customers.
Hardware revenue decreased due to decreases in revenue from power systems, servers, and other complementary hardware products delivered. Although there will be quarterly fluctuations, we expect an overall decreasing trend in hardware sales to continue due to the change in sales mix towards outsourcing contracts, which typically do not include hardware, and the general deflationary trend of computer prices.
COST OF SALES AND GROSS PROFIT
Cost of license represented the cost of software from third-party vendors associated with non-bundled application software licenses. These costs were recognized when license revenue was recognized.
Cost of support and service represented costs associated with conversion and implementation efforts, ongoing support for our customers, operation of our data and item centers providing services for our outsourced customers, electronic payment services and direct operating costs. These costs were recognized as they were incurred or, for direct costs associated with obtaining and implementing our bundled arrangements, they were deferred and recognized ratably as the related revenues for these arrangements are recognized, typically beginning when Post Contract Support ("PCS") is the only remaining undelivered element, and ending at the end of the initial bundled PCS term.
Cost of hardware consisted of the direct and indirect costs of purchasing the equipment from the manufacturers and delivery to our customers. These costs were recognized at the same time as the related hardware revenue was recognized. Ongoing operating costs to provide support to our customers were recognized as they were incurred.
| Year Ended June 30, | % Change | |||||||||
| 2017 | 2016 | |||||||||
| Cost of License | $ | 730 | $ | 1,197 | (39 | )% | ||||
| Percentage of total revenue | <1% | <1% | ||||||||
| License Gross Profit | $ | 1,655 | $ | 1,844 | (10 | )% | ||||
| Gross Profit Margin | 69 | % | 61 | % | ||||||
| Cost of support and service | $ | 786,143 | $ | 737,108 | 7 | % | ||||
| Percentage of total revenue | 55 | % | 54 | % | ||||||
| Support and Service Gross Profit | $ | 598,195 | $ | 563,870 | 6 | % | ||||
| Gross Profit Margin | 43 | % | 43 | % | ||||||
| Cost of hardware | $ | 32,161 | $ | 35,346 | (9 | )% | ||||
| Percentage of total revenue | 2 | % | 3 | % | ||||||
| Hardware Gross Profit | $ | 12,233 | $ | 15,281 | (20 | )% | ||||
| Gross Profit Margin | 28 | % | 30 | % | ||||||
| TOTAL COST OF SALES | $ | 819,034 | $ | 773,651 | 6 | % | ||||
| Percentage of total revenue | 57 | % | 57 | % | ||||||
| TOTAL GROSS PROFIT | $ | 612,083 | $ | 580,995 | 5 | % | ||||
| Gross Profit Margin | 43 | % | 43 | % |
Cost of license consists of the direct costs of third-party software that are a part of a non-bundled arrangement. Sales of these third-party software products decreased compared to the last year. Shifts in sales mix between the products that make up these costs cause fluctuations in the margins from period to period.
Cost of support and service for fiscal 2016 includes $12,332 related to Alogent sales. Excluding those costs, our cost of support and service increased 8%. Gross profit margins in support and service remained consistent with the prior year.
In general, changes in cost of hardware trend consistently with hardware revenue. For the current period, margins were lower due to decreased sales of higher margin hardware upgrade products compared to the prior year.
OPERATING EXPENSES
| Selling and Marketing | Year Ended June 30, | % Change | ||||||||
| 2017 | 2016 | |||||||||
| Selling and marketing | $ | 93,297 | $ | 90,079 | 4 | % | ||||
| Percentage of total revenue | 7 | % | 7 | % |
Dedicated sales forces, inside sales teams, technical sales support teams and channel partners conduct our sales efforts for our two reportable segments, and are overseen by regional and national sales managers. Our sales executives are responsible for pursuing lead generation activities for new core customers. Our account executives nurture long-term relationships with our client base and cross sell our many complementary products and services.
Selling and marketing expenses increased compared to fiscal 2016 due mainly to increased commission expense, but remained a consistent percentage of total revenue in both periods.
| Research and Development | Year Ended June 30, | % Change | ||||||||
| 2017 | 2016 | |||||||||
| Research and development | $ | 84,753 | $ | 81,234 | 4 | % | ||||
| Percentage of total revenue | 6 | % | 6 | % |
We devote significant effort and expense to develop new software, service products and continually upgrade and enhance our existing offerings. We believe our research and development efforts are highly efficient because of the extensive experience of our research and development staff and because our product development is highly customer-driven.
Research and development expenses increased primarily due to a 4% increase in headcount, but were consistent with the prior year as a percentage of total revenue.
| General and Administrative | Year Ended June 30, | % Change | ||||||||
| 2017 | 2016 | |||||||||
| General and administrative | $ | 69,601 | $ | 67,514 | 3 | % | ||||
| Percentage of total revenue | 5 | % | 5 | % |
General and administrative costs included all expenses related to finance, legal, and human resources, plus all administrative costs. These expenses increased primarily due to a 4% increase in headcount, but were a consistent percentage of revenue in each year.
Gains on Disposal of Businesses
In fiscal 2017, we recognized gains on the disposals of businesses totaling $3,270. $2,136 was related to last year's sale of Alogent, and $1,134 related to the sale of our Regulatory Filing products to Fed Reporter on May 1, 2017. In fiscal 2016, we had a gain totaling $19,491, due to the sale of Alogent.
| INTEREST INCOME AND EXPENSE | Year Ended June 30, | % Change | ||||||||
| 2017 | 2016 | |||||||||
| Interest Income | $ | 248 | $ | 307 | (19 | )% | ||||
| Interest Expense | $ | (996 | ) | $ | (1,430 | ) | (30 | )% |
Interest income fluctuated due to changes in invested balances and yields on invested balances. Interest expense remained low for both the current and prior years, in line with our average debt balances in both years.
| PROVISION FOR INCOME TAXES | Year Ended June 30, | % Change | ||||||||
| 2017 | 2016 | |||||||||
| Provision For Income Taxes | $ | 121,161 | $ | 111,669 | 9 | % | ||||
| Effective Rate | 33.0 | % | 31.0 | % |
The increase in the effective tax rate was primarily due the prior year's rate being reduced by the tax basis in excess of book basis in Alogent stock at disposal.
NET INCOME
Net income decreased 1% to $245,793, or $3.14 per diluted share, in fiscal 2017 from $248,867, or $3.12 per diluted share, in fiscal 2016. This decrease was due to factors discussed above, including the prior year Alogent gain and lower effective tax rate in fiscal 2016.
FISCAL 2016 COMPARED TO FISCAL 2015
In fiscal 2016, revenues increased 8% or $98,456 compared to fiscal 2015 due primarily to strong growth in our support and service revenues, particularly outsourcing services, bundled services, and electronic payment services. Cost of sales increased just 7%, contributing to an 8% increase in gross profit.
Net operating expenses increased 1% and the provision for income taxes increased 6% compared to fiscal 2015. The increased revenue and above changes resulted in a combined 18% increase in net income for fiscal 2016 compared to the prior fiscal year.
REVENUE
| License Revenue | Year Ended June 30, | % Change | ||||||||
| 2016 | 2015 | |||||||||
| License | $ | 3,041 | $ | 2,635 | 15 | % | ||||
| Percentage of total revenue | <1% | <1% |
License revenue represents the sale and delivery of application software systems contracted with us by the customer, which are not part of a bundled arrangement. We license our proprietary software products under standard license agreements that typically provide the customer with a non-exclusive, non-transferable right to use the software on a single computer and for a single financial institution.
Non-bundled license revenue increased due mainly to an increase in standalone license sales in our Bank segment. Such license fees will fluctuate as non-bundled license sales are sporadic in nature.
| Support and Service Revenue | Year Ended June 30, | % Change | ||||||||
| 2016 | 2015 | |||||||||
| Support and service | $ | 1,300,978 | $ | 1,200,652 | 8 | % | ||||
| Percentage of total revenue | 96 | % | 96 | % |
| Year over Year Change | ||||||||
| $ Change | % Change | |||||||
| In-House Support & Other Services | $ | 17,846 | 6 | % | ||||
| Electronic Payment Services | 28,325 | 6 | % | |||||
| Outsourcing Services | 33,941 | 13 | % | |||||
| Implementation Services | (11,289 | ) | (15 | )% | ||||
| Bundled Products & Services | 31,503 | 50 | % | |||||
| Total Increase | $ | 100,326 |
Support and service revenues are generated from supporting our customers in operating their systems and to enhance and update the software, electronic payment services, outsourced data processing services, implementation service (including conversion, installation, configuration and training) and revenue from our bundled software multi-element agreements. There was growth in most support and service revenue components in fiscal 2016.
In-house support and other services revenue increased due to annual maintenance renewal fee increases for both core and complementary products as our customers’ assets grow and new customers began renewing their annual maintenance. Increased software usage revenue from Alogent mobile remote deposits also contributed to the increase.
Electronic payment services continued to show growth over the prior year, although that growth slowed due to some of our large customers being acquired and price compression on contract renewals in our card services offerings. The
revenue increases are mainly attributable to strong performance across debit/credit card transaction processing services, online bill payment services and ACH processing. Deconversion revenue for electronic payment services increased $9,616 over the prior year. Excluding these fees, we had a 4% increase in electronic payment services revenue.
Outsourcing services for banks and credit unions continue to drive revenue growth as customers continue to show a preference for outsourced delivery of our solutions. Revenues from outsourcing services are typically earned under multi-year service contracts and therefore provide a long-term stream of recurring revenues. We expect the trend towards outsourced product delivery to benefit outsourcing services revenue for the foreseeable future.
Implementation services include implementation services for our electronic payment services customers as well as standalone customization services, merger conversion services, image conversion services and network monitoring services. Implementation services revenue decreased due to a decrease in stand-alone implementations in the Bank segment. Revenue from these standalone services has decreased as implementation services related to our bundled arrangements have increased.
Bundled products and services revenue is combined revenue from the multiple elements in our bundled arrangements, including license, implementation services and maintenance, which cannot be recognized separately due to a lack of vendor-specific objective evidence of fair value. Bundled products and services revenue increased over last year mainly due to increased revenues from our core and complementary credit union arrangements. $26,567 of the increase was due to terminations of minor pending products and services on certain contracts that have allowed for the release of revenue that was being deferred until contract completion in both our Credit Union and Bank core and complementary arrangements.
| Hardware Revenue | Year Ended June 30, | % Change | ||||||||
| 2016 | 2015 | |||||||||
| Hardware | $ | 50,627 | $ | 52,903 | (4 | )% | ||||
| Percentage of total revenue | 4 | % | 4 | % |
The Company has entered into remarketing agreements with several hardware manufacturers under which we sell computer hardware, hardware maintenance and related services to our customers. Revenue related to hardware sales is recognized when the hardware is shipped to our customers.
Hardware revenue decreased due to a decrease in complementary hardware products delivered. Although there will be quarterly fluctuations, we expect an overall decreasing trend in hardware sales to continue due to the change in sales mix towards outsourcing contracts, which typically do not include hardware, and the general deflationary trend of computer prices.
COST OF SALES AND GROSS PROFIT
Cost of license represented the cost of software from third-party vendors through remarketing agreements associated with non-bundled application software licenses. These costs were recognized when license revenue was recognized.
Cost of support and service represented costs associated with conversion and implementation efforts, ongoing support for our customers, operation of our data and item centers providing services for our outsourced customers, electronic payment services and direct operating costs. These costs were recognized as they were incurred or, for direct costs associated with obtaining and implementing our bundled arrangements, they are deferred and recognized ratably as the related revenues for these arrangements are recognized, typically beginning when PCS is the only remaining undelivered element, and ending at the end of the initial bundled PCS term.
Cost of hardware consisted of the direct and indirect costs of purchasing the equipment from the manufacturers and delivery to our customers. These costs were recognized at the same time as the related hardware revenue was recognized. Ongoing operating costs to provide support to our customers were recognized as they were incurred.
| Year Ended June 30, | % Change | |||||||||
| 2016 | 2015 | |||||||||
| Cost of License | $ | 1,197 | $ | 1,187 | 1 | % | ||||
| Percentage of total revenue | <1% | <1% | ||||||||
| License Gross Profit | $ | 1,844 | $ | 1,448 | 27 | % | ||||
| Gross Profit Margin | 61 | % | 55 | % | ||||||
| Cost of support and service | $ | 737,108 | $ | 680,750 | 8 | % | ||||
| Percentage of total revenue | 54 | % | 54 | % | ||||||
| Support and Service Gross Profit | $ | 563,870 | $ | 519,902 | 8 | % | ||||
| Gross Profit Margin | 43 | % | 43 | % | ||||||
| Cost of hardware | $ | 35,346 | $ | 38,399 | (8 | )% | ||||
| Percentage of total revenue | 3 | % | 3 | % | ||||||
| Hardware Gross Profit | $ | 15,281 | $ | 14,504 | 5 | % | ||||
| Gross Profit Margin | 30 | % | 27 | % | ||||||
| TOTAL COST OF SALES | $ | 773,651 | $ | 720,336 | 7 | % | ||||
| Percentage of total revenue | 57 | % | 57 | % | ||||||
| TOTAL GROSS PROFIT | $ | 580,995 | $ | 535,854 | 8 | % | ||||
| Gross Profit Margin | 43 | % | 43 | % |
Cost of license consisted of the direct costs of third-party software that was part of a non-bundled arrangement. Sales of these third-party software products increased slightly in fiscal 2016 compared to fiscal 2015. Shifts in sales mix between the products that make up these costs cause fluctuations in the margins from period to period.
Gross profit margins in support and service remained consistent with the prior year.
In general, changes in cost of hardware trended consistently with hardware revenue. For fiscal year 2016, margins were slightly higher due to increased sales of higher margin hardware upgrade products than in the prior year.
OPERATING EXPENSES
| Selling and Marketing | Year Ended June 30, | % Change | ||||||||
| 2016 | 2015 | |||||||||
| Selling and marketing | $ | 90,079 | $ | 89,004 | 1 | % | ||||
| Percentage of total revenue | 7 | % | 7 | % |
Dedicated sales forces, inside sales teams, technical sales support teams and channel partners conducted our sales efforts for our two reportable segments, and were overseen by regional and national sales managers. Our sales executives were responsible for pursuing lead generation activities for new core customers. Our account executives nurtured long-term relationships with our client base and cross sold our many complementary products and services.
Selling and marketing expenses for fiscal 2016 increased slightly compared to fiscal 2015 due to increased salary expense, but remained a consistent percentage of total revenue in both periods.
| Research and Development | Year Ended June 30, | % Change | ||||||||
| 2016 | 2015 | |||||||||
| Research and development | $ | 81,234 | $ | 71,495 | 14 | % | ||||
| Percentage of total revenue | 6 | % | 6 | % |
We devote significant effort and expense to develop new software, service products and continually upgrade and enhance our existing offerings.
Research and development expenses increased in fiscal 2016 over the prior fiscal year, primarily due to increased headcount and related personnel costs, but were consistent with the prior year as a percentage of total revenue.
| General and Administrative | Year Ended June 30, | % Change | ||||||||
| 2016 | 2015 | |||||||||
| General and administrative | $ | 67,514 | $ | 64,364 | 5 | % | ||||
| Percentage of total revenue | 5 | % | 5 | % |
General and administrative costs included all expenses related to finance, legal, human resources, plus all administrative costs. These costs increased in fiscal 2016 primarily due to increased headcount and related salaries, but were consistent with the prior year as a percentage of total revenue.
Gain on Disposal of Businesses
In fiscal 2016, we had a gain totaling $19,491 due to the sale of our Alogent business to Antelope Acquisition Co., an affiliate of Battery Ventures. In fiscal 2015, we sold the TeleWeb™ suite of Internet and mobile banking software products to Data Center Inc. (DCI), resulting in a gain of $6,874.
| INTEREST INCOME AND EXPENSE | Year Ended June 30, | % Change | ||||||||
| 2016 | 2015 | |||||||||
| Interest Income | $ | 307 | $ | 169 | 82 | % | ||||
| Interest Expense | $ | (1,430 | ) | $ | (1,594 | ) | (10 | )% |
Interest income fluctuated due to changes in invested balances and yields on invested balances. Interest expense remained low for both years.
| PROVISION FOR INCOME TAXES | Year Ended June 30, | % Change | ||||||||
| 2016 | 2015 | |||||||||
| Provision For Income Taxes | $ | 111,669 | $ | 105,219 | 6 | % | ||||
| Effective Rate | 31.0 | % | 33.3 | % |
The decrease in the effective tax rate was primarily due a significant difference in the book versus tax basis in Alogent stock, as well as the retroactive permanent extension of the Research and Experimentation Credit ("R&E Credit") to January 1, 2015 during fiscal 2016.
NET INCOME
Net income increased from $211,221, or $2.59 per diluted share, in fiscal 2015 to $248,867, or $3.12 per diluted share, in fiscal 2016. This translates to an increase of 18% in net income.
REPORTABLE SEGMENT DISCUSSION
The Company is a leading provider of technology solutions and payment processing services primarily for financial services organizations. The Company’s operations are classified into two reportable segments: bank systems and services (“Bank”) and credit union systems and services (“Credit Union”). The Company evaluates the performance of its segments and allocates resources to them based on various factors, including prospects for growth, return on investment, and return on revenue.
| Bank Systems and Services | |||||||||||||||||
| 2017 | % Change | 2016 | % Change | 2015 | |||||||||||||
| Revenue | $ | 1,055,763 | 6 | % | $ | 996,668 | 4 | % | $ | 962,729 | |||||||
| Gross profit | $ | 429,441 | 5 | % | $ | 407,600 | 2 | % | $ | 400,659 | |||||||
| Gross profit margin | 41 | % | 41 | % | 42 | % |
In fiscal 2017, revenue in the Bank segment increased 6% compared to the prior fiscal year, despite revenue headwinds of $28,422 due to the sale of Alogent. The increase was due to a 7% increase in support and service revenue, partially offset by decreased hardware and stand-alone license sales. The increase in support and service revenue was driven by increases in the outsourcing services, electronic payment services, and bundled products and services revenue streams. Those increases were partly offset by decreased revenue from in-house support and other services and
implementation services, due mainly to the Alogent headwinds. Gross profit margin remained consistent with fiscal 2016.
In fiscal 2016, revenue in the Bank segment increased 4% compared to the prior year. The increase was due mainly to a 12% increase in outsourcing services. Gross profit margins decreased only slightly compared to fiscal 2015.
| Credit Union Systems and Services | |||||||||||||||||
| 2017 | % Change | 2016 | % Change | 2015 | |||||||||||||
| Revenue | $ | 375,354 | 5 | % | $ | 357,978 | 22 | % | $ | 293,461 | |||||||
| Gross profit | $ | 182,642 | 5 | % | $ | 173,395 | 28 | % | $ | 135,195 | |||||||
| Gross profit margin | 49 | % | 48 | % | 46 | % |
In fiscal 2017, revenue in the Credit Union segment increased 5% due to increases in support & service revenue totaling 6%, partially offset by decreased hardware and stand-alone license revenue. Support & service revenues grew through increases in bundled services, in-house maintenance renewals and outsourcing services, partly offset by decreased electronic payment services and implementation services revenue. The increase in bundled services was due to an increase in terminations of pending products and service obligations on certain contracts allowing for earlier recognition of revenue on our bundled arrangements. The decrease in electronic payment services revenue was mainly due to decreased deconversion fees and decreased revenue from card manufacturing. Gross profit margin for the Credit Union segment increased 1%.
In fiscal 2016, revenue in the Credit Union segment increased 22% due to increases in support & service revenue. Support & service revenues grew 22% through increases in electronic payment services, in-house maintenance renewals, and bundled services. Gross profit margins for the Credit Union segment increased 2% mainly due to economies of scale realized from growing transaction volume in our payment processing services.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents increased to $114,765 at June 30, 2017 from $70,310 at June 30, 2016. The increase from June 30, 2016 is primarily due to cash generated from operations.
The following table summarizes net cash from operating activities in the statement of cash flows:
| Year Ended | |||||||
| June 30, | |||||||
| 2017 | 2016 | ||||||
| Net income | $ | 245,793 | $ | 248,867 | |||
| Non-cash expenses | 186,626 | 161,004 | |||||
| Change in receivables | (22,499 | ) | (13,735 | ) | |||
| Change in deferred revenue | (8,800 | ) | 4,364 | ||||
| Change in other assets and liabilities | (43,798 | ) | (34,078 | ) | |||
| Net cash provided by operating activities | $ | 357,322 | $ | 366,422 |
Cash provided by operating activities decreased 2% compared to fiscal 2016. Cash from operations is primarily used to repay debt, pay dividends, repurchase stock, and for capital expenditures.
Cash used in investing activities for fiscal 2017 totaled $141,586 and included: capital expenditures on facilities and equipment of $41,947, which was mainly for the purchase of computer equipment; $89,631 for the ongoing enhancements and development of existing and new product offerings; and $16,608 for the purchase and development of internal use software. This was partially offset by $5,632 of proceeds from the sale of businesses and $968 of proceeds from the sale of assets. Cash used in investing activities for fiscal 2016 totaled $135,963 and included: capital expenditures on facilities and equipment of $56,325, which mainly included the purchase of computer equipment and aircraft, $96,411 for the development of software, $11,826 for the purchase and development of internal use software, and $8,275, net of cash acquired, for the acquisition of Bayside Business Solutions. These expenditures were partially offset by $34,030 of proceeds from the sale of our Alogent division and $2,844 of proceeds from the sale of assets.
Financing activities used cash of $171,281 for fiscal 2017. Cash used was $130,140 for the purchase of treasury shares, repayment of the revolving credit facility and capital leases of $30,200, and dividends paid to stockholders of
$91,707. This was partially offset by borrowings of $80,000 against our revolving credit facility and $766 net cash inflow from the issuance of stock and tax related to stock-based compensation. Financing activities used cash in fiscal 2016 of $308,462. Cash used was $175,662 for the purchase of treasury shares, repayments of the revolving credit facility and capital leases totaling $152,500, and dividends paid to stockholders of $84,118. This was partially offset by borrowings of $100,000 and $3,818 net cash inflow from the issuance of stock and tax related to stock-based compensation.
Capital Requirements and Resources
The Company generally uses existing resources and funds generated from operations to meet its capital requirements. Capital expenditures totaling $41,947 and $56,325 for the twelve months ending June 30, 2017 and June 30, 2016, respectively, were made primarily for additional equipment and the improvement of existing facilities. These additions were funded from cash generated by operations. At June 30, 2017, the Company had no material outstanding purchase commitments related to property and equipment.
The Board of Directors has authorized the Company to repurchase shares of its common stock. Under this authorization, the Company may finance its share repurchases with available cash reserves or short-term borrowings on its existing credit facilities. The share repurchase program does not include specific price targets or timetables and may be suspended at any time. At June 30, 2017, there were 25,660 shares in treasury stock and the Company had the remaining authority to repurchase up to 4,330 additional shares. The total cost of treasury shares at June 30, 2017 is $1,006,274. During fiscal 2017, the Company repurchased 1,452 treasury shares for $130,140. At June 30, 2016, there were 24,209 shares in treasury stock and the Company had authority to repurchase up to 5,782 additional shares.
Capital leases
The Company had previously entered into various capital lease obligations for the use of certain computer equipment, but has no capital lease obligations at June 30, 2017. At June 30, 2016, the Company had capital lease obligations totaling $200 and property and equipment included assets under capital leases totaling $2,329, with accumulated depreciation totaling $898.
Revolving credit facility
The revolving credit facility allows for borrowings of up to $300,000, which may be increased by the Company at any time until maturity to $600,000. The credit facility bears interest at a variable rate equal to (a) a rate based on LIBOR or (b) an alternate base rate (the highest of (i) the Prime Rate for such day, (ii) the sum of the Federal Funds Effective Rate for such day plus 0.50% and (iii) the Eurocurrency Rate for a one month Interest Period on such day for dollars plus 1.0%), plus an applicable percentage in each case determined by the Company's leverage ratio. The credit facility is guaranteed by certain subsidiaries of the Company. The credit facility is subject to various financial covenants that require the Company to maintain certain financial ratios as defined in the agreement. As of June 30, 2017, the Company was in compliance with all such covenants. The revolving loan terminates February 20, 2020 and at June 30, 2017 there was a $50,000 outstanding balance.
Other lines of credit
The Company renewed an unsecured bank credit line on April 24, 2017 which provides for funding of up to $5,000 and bears interest at the prime rate less 1%. The credit line was renewed through April 30, 2019. At June 30, 2017, no amount was outstanding.
OFF BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
At June 30, 2017, the Company’s total off balance sheet contractual obligations were $633,547. This balance consists of $47,991 of long-term operating leases for various facilities and equipment which expire from 2018 to 2030 and $585,556 of purchase commitments. JHA entered a strategic services agreement with First Data® and PSCU® to provide full-service debit and credit card processing on a single platform to all existing core bank and credit union customers, as well as expand its card processing platform to financial institutions outside our core customer base. This agreement includes a purchase commitment of $559,354 over the term of the contract. The remainder of the purchase commitments relate to open purchase orders. The contractual obligations table below excludes $6,445 of liabilities for uncertain tax positions as we are unable to reasonably estimate the ultimate amount or timing of settlement.
| Contractual obligations by period as of June 30, 2017 | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | TOTAL | |||||||||||||||
| Operating lease obligations | $ | 10,945 | $ | 14,847 | $ | 7,895 | $ | 14,304 | $ | 47,991 | ||||||||||
| Capital lease obligations | — | — | — | — | — | |||||||||||||||
| Revolving credit facility, including accrued interest | — | 50,048 | — | — | 50,048 | |||||||||||||||
| Purchase obligations | 26,202 | 28,518 | 86,875 | 443,961 | 585,556 | |||||||||||||||
| Total | $ | 37,147 | $ | 93,413 | $ | 94,770 | $ | 458,265 | $ | 683,595 |
RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers in May 2014. This standard is part of an effort to create a common revenue standard for U.S. generally accepted accounting principles (U.S. GAAP) and International Financial Reporting Standards (IFRS). The new standard will supersede much of the existing authoritative literature for revenue recognition. The new model enacts a five-step process for achieving the core principle, which is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB also issued ASU No. 2015-14 which deferred the effective date of the new standard by one year, but allows early application as of the original effective date. We do not intend to adopt the provisions of the new standard early, so the standard and related amendments will be effective for the Company for its annual reporting period beginning July 1, 2018, including interim periods within that reporting period. In March 2016, the FASB issued ASU No. 2016-08, which addresses principal versus agent considerations under the new revenue standard. ASU No. 2016-10, ASU No. 2016-12, and ASU No. 2016-20 also address specific aspects of the new standard. Entities are allowed to transition to the new standard by either recasting prior periods or recognizing the cumulative effect as of the beginning of the period of adoption. The Company is currently evaluating the newly issued guidance, including which transition approach will be applied, and continuing to assess all potential impacts of the standard. We expect the adoption of this standard to have a significant impact on our revenue recognition currently subject to Accounting Standards Codification (ASC) Topic 985. We are currently in the process of implementing and testing new software to assist in applying the five-step model to our various revenue streams and comparing the results to our current accounting practices. One of the most significant expected impacts relates to the recognition of license and implementation revenue on our multi-element arrangements. We expect to recognize license and install revenue at the time of the install completion, rather than over the maintenance period of the software on our multi-element agreements. We expect revenue related to hardware, Outlink contracts, payment processing, and professional services to remain substantially unchanged.
The FASB issued ASU No. 2016-02, Leases, in February 2016. This ASU aims to increase transparency and comparability among organizations by recognizing lease assets and liabilities on the balance sheet and requiring disclosure of key information regarding leasing arrangements. ASU No. 2016-02 will be effective for Jack Henry's annual reporting period beginning July 1, 2019 and early adoption is permitted. The Company is currently assessing the impact this new standard will have on our consolidated financial statements.
The FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, in March 2016. The new standard is intended to simplify several aspects of the accounting and presentation of share-based payment transactions, including reporting of excess tax benefits and shortfalls, statutory minimum withholding considerations, and classification within the statement of cash flows. The standard allows a one-time accounting policy election to either account for forfeitures as they occur or continue to estimate them. ASU No. 2016-09 is effective for the Company’s annual reporting period beginning July 1, 2017. Management elected to early adopt this standard as of July 1, 2016 and has elected to continue our current practice of estimating forfeitures. The adoption of this standard had the following impacts on our condensed consolidated financial statements.
| • | Condensed consolidated statements of income- The new standard requires that the tax effects of share-based compensation be recognized in the provision for income taxes. Previously, these amounts were recognized in additional paid-in capital. Net tax benefits related to share-based compensation awards of $2,638 for the year ended June 30, 2017 were recognized as reductions of income tax expense. These tax benefits reduced our effective income tax rate for the year-to-date period by 0.72%, and caused an increase in basic and diluted earnings per share of $0.03 for the year ended June 30, 2017. In addition, in calculating potential common shares used to determine diluted earnings per share, generally accepted accounting principles require us to use the treasury stock method. The new standard requires that assumed proceeds under the treasury stock method be modified to exclude the amount of excess tax benefits that |
would have been recognized in additional paid-in capital. These changes were applied on a prospective basis.
| • | Condensed consolidated statements of cash flows- The Company elected to apply the presentation requirements for cash flows related to excess tax benefits retrospectively; however, fiscal 2015 was not restated due to immateriality. The restatement for fiscal 2016 resulted in an increase to both net cash provided by operations and net cash used in financing of $1,306 for the year ended June 30, 2016. The presentation requirements for cash flows related to employee taxes paid for withheld shares had no impact to any of the periods presented on our consolidated cash flows statements since such cash flows have historically been presented as a financing activity. |
CRITICAL ACCOUNTING POLICIES
We prepare our consolidated financial statements in accordance with U.S. GAAP. The significant accounting policies are discussed in Note 1 to the consolidated financial statements. The preparation of consolidated financial statements in accordance with U.S. GAAP requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, as well as disclosure of contingent assets and liabilities. We base our estimates and judgments upon historical experience and other factors believed to be reasonable under the circumstances. Changes in estimates or assumptions could result in a material adjustment to the consolidated financial statements.
We have identified several critical accounting estimates. An accounting estimate is considered critical if both: (a) the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment involved, and (b) the impact of changes in the estimates and assumptions would have a material effect on the consolidated financial statements.
Revenue Recognition
We recognize revenue net of any applicable discounts in accordance with generally accepted accounting principles and with guidance provided within Staff Accounting Bulletins issued by the Securities and Exchange Commission. The application of these pronouncements requires judgment, including whether a software arrangement includes multiple elements, whether any elements are essential to the functionality of any other elements, and whether vendor-specific objective evidence (“VSOE”) of fair value exists for those elements. Customers receive certain elements of our products and services over time. Changes to the elements in a software arrangement or in our ability to identify VSOE for those elements could materially impact the amount of earned and deferred revenue reflected in the financial statements.
License Arrangements: For software license agreements, the Company recognizes revenue when persuasive evidence of an arrangement exists, delivery of the product or service has occurred, the fee is fixed or determinable and collection is probable. For arrangements where the fee is not fixed or determinable, revenue is deferred until payments become due. The Company’s software license agreements generally include multiple products and services or “elements.” Generally, none of these elements are deemed to be essential to the functionality of the other elements.
For multiple element arrangements, which contain software elements and non-software elements, we allocate revenue to the software deliverables as a group and the non-software deliverables as a group based on the relative selling prices of all of the deliverables in the arrangement. For our non-software deliverables, we allocate the arrangement consideration based on the relative selling price of the deliverables using estimated selling price ("ESP"). For our software elements, we use VSOE for this allocation when it can be established and ESP when VSOE cannot be established.
The selling price for each element is based upon the following selling price hierarchy: VSOE if available, third-party evidence ("TPE") if VSOE is not available, or ESP if neither VSOE or TPE are available. Generally, we are not able to determine TPE because our go-to-market strategy differs from that of our peers and our offerings contain a significant level of differentiation such that the comparable pricing of products with similar functionality cannot be obtained. ESP is determined after considering both market conditions (such as the sale of similar products in the market place) and entity-specific factors (such as pricing practices and the specifics of each transaction).
For our non-software deliverables, a delivered item is accounted for as a separate unit of accounting if the delivered item has standalone value and if the customer has a general right of return relative to the delivered item, delivery or performance of the undelivered item is probable and substantially within our control.
For our software licenses and related services, including the software elements of multiple-element software and non-software arrangements, U.S. GAAP generally requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on VSOE of fair value. VSOE of fair value is determined for implementation services based on a rate per hour for stand-alone professional services and the estimated hours for the bundled implementation, if the hours can be reasonably estimated. VSOE of fair value is determined for post-
contract support ("PCS") based upon the price charged when sold separately. For a majority of the elements within our software arrangements, we have determined that VSOE cannot be established; therefore, revenue on our software arrangements is generally deferred until the only remaining element is PCS. At that point, the entire arrangement fee is recognized ratably over the remaining PCS period, assuming that all other criteria for revenue recognition have been met. The amounts deferred are included in the balance sheet as deferred revenue and recognized as Bundled Products & Services revenue within Support & Service revenue in the consolidated statements of income.
For arrangements that include specified upgrades, such upgrades are accounted for as a separate element of the arrangement. For those specified upgrades for which VSOE of fair value cannot be determined, revenue related to the software elements within the arrangement is deferred until such specified upgrades have been delivered.
Support and Service Fee Revenue (Non-software): Maintenance support revenue contracted for outside of a license arrangement is recognized pro-rata over the contract period, typically one year.
Outsourced data processing and ATM, debit card, and other transaction processing services revenue is recognized in the month the transactions are processed or the services are rendered.
Hardware Revenue: Hardware revenue is recognized upon delivery to the customer, when title and risk of loss are transferred. In most cases, we do not stock in inventory the hardware products we sell, but arrange for third-party suppliers to drop-ship the products to our customers on our behalf. The revenue related to these hardware sales is recorded gross, as we are the primary obligor in the contract with the customer. The Company also re-markets maintenance contracts on hardware to our customers. Gross hardware maintenance revenue is recognized ratably over the agreement period.
Revenue-based taxes collected from customers and remitted to governmental authorities are presented on a net basis (i.e. excluded from revenues).
Deferred Costs
Costs for certain software and hardware maintenance contracts with third parties, which are prepaid, are recognized ratably over the life of the maintenance contract, generally one to five years, with the related revenue amortized from deferred revenues.
Direct and incremental fulfillment costs associated with arrangements subject to Accounting Standards Codification ("ASC") 985-605 (for which VSOE of fair value cannot be established) are deferred until the only remaining element in the revenue arrangement is PCS at which point the costs are recognized ratably over the remaining PCS period with the related revenue. Deferred direct and incremental costs associated with arrangements not subject to ASC 985-605 consist primarily of certain up-front costs incurred in connection with our software hosting arrangements and are recognized ratably over the contract period which typically ranges from 5-7 years. These costs include commissions, costs of third-party licenses and the direct costs of our implementation services, consisting of payroll and other fringe benefits.
Depreciation and Amortization Expense
The calculation of depreciation and amortization expense is based on the estimated economic lives of the underlying property, plant and equipment and intangible assets, which have been examined for their useful life and determined that no impairment exists. We believe it is unlikely that any significant changes to the useful lives of our tangible and intangible assets will occur in the near term, but rapid changes in technology or changes in market conditions could result in revisions to such estimates that could materially affect the carrying value of these assets and the Company’s future consolidated operating results. We consider whether there is potential for impairment of any long-lived assets, and perform testing for valuation if it is determined that there is a triggering event causing risk of impairment.
Capitalization of software development costs
We capitalize certain costs incurred to develop commercial software products. For software that is to be sold, significant estimates and assumptions include: establishing when technological feasibility has been met and costs should be capitalized, determining the appropriate period over which to amortize the capitalized costs based on the estimated useful lives, estimating the marketability of the commercial software products and related future revenues, and assessing the unamortized cost balances for impairment. Costs incurred prior to establishing technological feasibility are expensed as incurred. Amortization begins on the date of general release and the appropriate amortization period is based on estimates of future revenues from sales of the products. We consider various factors to project marketability and future revenues, including an assessment of alternative solutions or products, current and historical demand for the product, and anticipated changes in technology that may make the product obsolete.
For internal use software, capitalization begins at the beginning of application development. Costs incurred prior to this are expensed as incurred. Significant estimates and assumptions include determining the appropriate amortization
period based on the estimated useful life and assessing the unamortized cost balances for impairment. Amortization begins on the date the software is placed in service and the amortization period is based on estimated useful life.
A significant change in an estimate related to one or more software products could result in a material change to our results of operations.
Estimates used to determine current and deferred income taxes
We make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes. We also must determine the likelihood of recoverability of deferred tax assets, and adjust any valuation allowances accordingly. Considerations include the period of expiration of the tax asset, planned use of the tax asset, and historical and projected taxable income as well as tax liabilities for the tax jurisdiction to which the tax asset relates. Valuation allowances are evaluated periodically and will be subject to change in each future reporting period as a result of changes in one or more of these factors. Also, liabilities for uncertain tax positions require significant judgment in determining what constitutes an individual tax position as well as assessing the outcome of each tax position. Changes in judgment as to recognition or measurement of tax positions can materially affect the estimate of the effective tax rate and consequently, affect our financial results.
Assumptions related to purchase accounting and goodwill
We account for our acquisitions using the purchase method of accounting. This method requires estimates to determine the fair values of assets and liabilities acquired, including judgments to determine any acquired intangible assets such as customer-related intangibles, as well as assessments of the fair value of existing assets such as property and equipment. Liabilities acquired can include balances for litigation and other contingency reserves established prior to or at the time of acquisition, and require judgment in ascertaining a reasonable value. third-party valuation firms may be used to assist in the appraisal of certain assets and liabilities, but even those determinations would be based on significant estimates provided by us, such as forecast revenues or profits on contract-related intangibles. Numerous factors are typically considered in the purchase accounting assessments, which are conducted by Company professionals from legal, finance, human resources, information systems, program management and other disciplines. Changes in assumptions and estimates of the acquired assets and liabilities would result in changes to the fair values, resulting in an offsetting change to the goodwill balance associated with the business acquired.
As goodwill is not amortized, goodwill balances are regularly assessed for potential impairment. Such assessments require an analysis of future cash flow projections as well as a determination of an appropriate discount rate to calculate present values. Cash flow projections are based on management-approved estimates, which involve the input of numerous Company professionals from finance, operations and program management. Key factors used in estimating future cash flows include assessments of labor and other direct costs on existing contracts, estimates of overhead costs and other indirect costs, and assessments of new business prospects and projected win rates. The Company's most recent assessment indicates that no reporting units are currently at risk of impairment as the fair value of each reporting unit is significantly in excess of the carrying value. However, significant changes in the estimates and assumptions used in purchase accounting and goodwill impairment testing could have a material effect on the consolidated financial statements.
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