Jack Henry & Associates, Inc. (JKHY) Earnings Call Transcript & Summary

Good morning, everyone. This is Pete Heckmann. Thank you for participating in today's conference, D.A. Davidson's Software and Internet Conference. Today, we have Kevin Williams, the CFO of Jack Henry. Kevin, good morning. Thank you for participating.

Good to be here.

Great. Hey, listen, I wanted to start with current conditions. I've been impressed. Jack Henry has had a string of fiscal years here with very, very strong bookings for fiscal '21. You talked about record bookings in the fourth quarter. You talked about 41 competitive core takeaways compared to like 43 last year. And within that 41, I think 8 of those were FIs with above $1 billion in assets. What are some of the commonalities in these core competitive takeaways in terms of either what the banks are trying or what the financial institutions are trying to achieve or where Jack Henry might be providing more differentiation?

Yes. So Pete, I mean, if you remember back before pre-COVID, it seems like [ you can turn it go ], but 18 months ago, we were averaging a new core win a week for about the previous 2.5 to 3 years. So COVID hit. We only signed 43 last year. We signed 41 this year, which I think is pretty good. The commonality is -- hasn't changed much now from where it was pre COVID. I mean there's still a lot of FIs out there. I mean they switched to us for 1 of 3 reasons. Either their technology is not aligned to be competitive with the big boys and the Tier 1 banks out because they're on older platforms. Some of our competitors have a lot of different platforms, and they're not all go-forward platforms. So a lot of them are coming from old technology or it's a lack of customer service, and we actually ask these prospects and customers when they sign up why they're coming over. And it's typically either the technology is pulling them back or the lack of customer support. Or the third, we started hearing a lot just pre COVID was their vendor relationship was just broken. And so there's -- it's always 1 of those 3 reasons why we're bringing them over, that plus the fact that we are extremely open. So if they don't -- if they want other third parties, we're very open. We'll allow any third-party integrate into us, and that's something that some of our larger competitors don't -- are not as freely to do. and some of the -- and all of the technology that we've rolled out in the last 2 years with digital and online lending, digital lending and treasury management and all the other solutions we have that are so tightly integrated into our core allows us to look extremely good compared to a lot of the solutions out there. So I think -- we were in a very good position going into COVID. We have not slowed down on development and developing our products and make them even better with future functionality like online account opening, different things, which came from an acquisition a couple of years ago, Geezeo. So everything we've done to beef up not only our Banno digital platform but also our digital lending solutions has put us into extremely good position going forward as we come out of whatever we're coming out of. I don't know if we say we're coming out of COVID or not. I think there's another variant coming out now. So -- but we continue to be in an extremely good position on a competitive landscape.

That's great. That's great. And really for the past several years, 100% of those competitive core takeaways have been cloud deals, but you're also seeing in-house customers migrate to the cloud. Can you talk a little bit about the revenue margin dynamics of those deals that migrate from an on-prem or in-house installation towards the cloud? And then in terms of -- and thinking about where you are in terms of the legacy customer base that might still be on on-prem systems?

Yes. So good question, Pete. So actually, I'm getting ready for another presentation for the AFT here in a couple of weeks, and that's why I was doing some research and in the last 3 years, we've signed over 130 new core wins, and over 98% of them went into our private cloud. The ones that didn't go a private cloud are very unique. They're either -- they were either a $5 billion-plus bank that was in a location where they can get talent, so they weren't worried about it, and they can actually be more efficient. And I think there was 2 of those and then there was 3 -- the in-house Core Director that were all in the Caribbean. Everybody else went into our private cloud. But you're right. So we've -- since the financial crisis, we came out of financial crisis in 2010, we've averaged about 40 to 45 banks and credit unions that were currently on-prem customers moving into our private cloud. And right now, we're at 65% of all of our banking core customers in our private cloud and 61% of all our credit unions are in our private cloud for a blended rate of 64% of all of our customers in our private cloud. Now you think about -- you think about that transition. So in -- 20 years ago, in 2001, we had 0 credit unions in our private cloud. And we had less than 10% of our banks in our private cloud. So that has been a huge transition over the last 20 years, and we still got 35% to go. Or will they all ever move? No. because if they're a large enough bank credit union, and again, if they're in a geographic area where they can get IT talent, then they can be more efficient to stay on-prem. But the vast majority of -- eventually are going to move into our private cloud for a number of reasons, either regulatory compliance. They can't find the resources. They're tired of paying for hardware upgrades, disaster recovery and avoidance, just security, cyber and everything, all the noise that's going on out there. So there's a long laundry list of reasons why they move. Now when they do move, the typical bank or credit union, the revenues that they will -- or the revenues that we will get out of them or they will pay us essentially is 2x than what it was when they were on-prem, and some kinds, it can be 3x depending on what products they take when they move over. And the margins are very comparable because it's the exact same software. The infrastructure is in place. It's the exact same support organization that's in place. So it's additional revenue that actually increases margins slightly as they move over. So it's a very good move for us. The other thing, Pete, you got to remember is when they're on-prem, the vast -- the typical customers that are on-prem there are a 1-year annual maintenance agreement. When they move into our private cloud, they typically sign up for a 7-year or longer contract. We actually had a couple of sign-up for well over 10 years, which I have no idea why, but well, I do know why, but well over 10 years. And so that gives us a lot of visibility into our revenue, and it's all recurring revenue and makes it very easy for me to forecast and budget what's going to happen in the next year. So -- and when they move into our private cloud, it's easier to sell them additional products because it now is an operating spend instead of a CapEx because they're on-prem. It's a licensed product. So they have to get Board approval. They provide a big check on license upfront. Or when they're a private cloud, they just say, "Hey, Kevin, I want this fraud solution, turn it on, send a contract, make it in terms of our existing contract and start billing me monthly the extra $1,500 a month worth of this additional product." So there's a lot of reasons other than just revenue -- initial revenues that we like to get and move into our private cloud.

Right. Anything that we should be thinking about in terms of potential sunsets of operating systems or type of mid -- support for mid-range servers that might catalyze a step-up in migrations to the cloud?

For us?

Yes.

No. Because it's the exact same system, whether they're on-prem or in a private cloud. So that's the beauty of it because when our developers are developing new feature functionality, [indiscernible] on-prem or in a private cloud is the exact same solution, whether it's SilverLake 2020, Core Director or Episys.

And yes, and I was just referring to more like a P-Series or some sort of hardware that was going to be going away that they would make it more difficult to be on-prem.

No. And the other thing is with the rewrite of the database that we did for Episys over the last few years is now complete, they don't really have to be on a P series. I mean, they can use a SQL database. They can run on different hardware if they want to. But the thing about it is, when you think about IBM, the AS 400 is the most used mid-range box in the United States. I mean they'd be shooting themselves in the foot if they decided to sunset that. So that's not going to happen. So we're in a very good position. There's really no motivation other than the list of things I said for a bank or credit union to move from on-prem to our private cloud. Now I would tell you something else, Pete, is things like [ IDA ], we're a banker create union that's on-prem and all of a sudden, now they're down and their customers can't access their banking facility because the banks out of power or down. If they were in our private cloud as long as their customers could get access to the Internet, they can do -- they can continue banking like nothing ever happens. So someone we could treat a hit, we saw several banks and credit unions who decide to move into a private cloud for the exact same reason, there's probably going to be some more because as a result of [indiscernible] same thing.

Got it. Got it. Okay. And you mentioned the financial crisis, I remember you had a conversation, something like 900 problem banks in 2009. I saw the FDIC quarterly banking profile come out this week. We're down to 51 problem banks, and the industry makes -- the profitability [ is good ] despite record low interest rate spreads. Where -- what are the motivations or where are the top 3 or 4 areas that have the hot buttons for the new technology or the high priority type tech spends, whether or not Jack Henry is playing there? But certainly, that's more germane to our conversation is what are you seeing in the banks coming to you and wanting highest priority today?

Yes. And that's a good question, Pete. So when the -- when COVID hit, there was things that I'm sure every bank or credit union had on their road map of technology they want to do. I think what COVID did was actually forced them to change the timing of some of those things. So I mean I'm well aware of several banks that have signed up for Banno that had not planned on upgrading their digital platform at least for 2 more years. But they accelerated because with COVID, what a bank or credit union has to be able to offer is the ability for a business or an individual to do 100% of their banking from their couch in their living room. They have to be able to open accounts. They have to be able to take out loans. They have to be able to move money and transfer money and do stock payments. And so if they're on an older system, an old -- an older home banking platform that doesn't have everything on one platform, it's not efficient. It's not effective, and they're going to have to go into 3 different systems and sometimes 4 to do some of the banking things they want to do, where if Banno, it's all on one single platform. So that's probably one of the biggest motivators. And I will tell you, since we are only selling Banno currently inside our core base, we have actually won some core deals just because they wanted Banno. I mean they're the Tier 3 of them. They weren't that upset with their current core vendor, but they were upset with their current Internet banking solution and they want Banno so bad, they were willing to sign up for SilverLake to get Banno. So that's probably one -- that's probably the biggest driver out there and then also the digital lending, so they can do all their lending and take their loans and all the last probably 5 acquisitions that we've done were all pretty small, but they were all either to beef up Banno platform or beef up our digital lending solution. Now both those products, I mean, Banno's -- the one little piece that Banno's missing is Banno business, which will be rolled out, I believe, in the next 4 to 6 months, and then it's going to have 100% of anything out there. But it has other things that nobody else has out there, like Banno conversations and some different things like that. Our digital lending solution is on par or above any other solution out there in the industry today. So those are probably 2 of the big drivers. And then just the integration and openness that we provide, so if somebody does want a third party, I mean if you think about how this company started with Jack and Jerry back in 1976, all they were was a core provider. And up until '92, that's all they were was a core provider. And so they always had to be open to third parties to do that. I mean from '92 today, we went from a best-of-breed core provider to the best of suite provider. So now we've got basically everything a bank credit union would want. But if they want a third party as long as the third parties want to go through the integration certification process, they can integrate right into our core.

Okay. Okay. Well, I just -- I wanted to talk about Banno just a little bit more, and you referred to it, but really very impressive success. Was that 3 years ago that Banno was introduced? I think in 2019 but -- I think last year, you signed up 219 deals, including 87 in the fourth quarter. You had 5.5 million registered users at the mid-summer, up 75% year-over-year. It really seems like this solution has a lot of momentum and certainly would be on par or, as you say, in some areas, maybe better than some of the best-of-breed providers out there. Do you think you can have 1,000 financial institutions on Banno in 5 years?

Yes, Pete, I think we'll have 1,000 FIs on it even without considering taking Banno outside of our core base. And the reason I say that is we're probably going to -- we'll add -- in the next 5 years, we should add close to 250 new core customers just competitive takeaways. And 95% of those will take Banno. And we still got, I believe, over 500 FIs on NetTeller that over the next 5 years, probably half of those will move over to Banno as well. And just for the listeners out there, NetTeller was our original home banking solution, and we've got a mobile application called goDough that's tightly integrated that but they're actually 2 different platforms, but they can also have online bill pay through our iPay solution that's tightly integrated into that, but it's still 3 different platforms, where Banno has all of that plus online account opening and marketing and financial performance through the Geezeo piece all on one single platform. But if you're a small community bank out in the middle of nowhere and you're not competing with BofA or JPMorgan Chase, NetTeller's goDough is probably all you need for your customer base. So we're never going to have -- we'll probably never have 100% of them. Now in 5 to 10 years, will Banno and NetTeller eventually come together? Probably. But we're not in any hurry to do that because Banno is doing so well, as you just mentioned.

Okay. And then last item on Banno. You talked about the small business banking. When would you expect to start marketing Banno outside the core?

We really haven't picked a date, but I would be shocked if we aren't doing it by this time next year.

Okay. Great. Great. Okay. And then on to the commercial lending solution. And you noted you made a couple of smaller acquisitions, if memory serves. Like Vanguard was one of them. And yes -- and so in digital lending, I think management recently noted they're going to had about 200 financial institutions that were contracted and ramping up. Where do you see the opportunity here. And within digital lending, where are you most competitive, commercial, consumer? Where are you winning?

Yes. So the vast majority of win right now is commercial because that's really the strength of our solution, but it will do consumer lending as well. So we are winning and like I said, COVID kind of changed the way banks FIs look at things like that. So there is a very good backlog and sales pipeline for our digital lending solution both inside and outside the base because that is a ProfitStars solution. So yes, we feel pretty bullish about where that solution will go in the next few years. And you're right. I mean just like Banno, I mean, the acquisitions we did, Bayside and Vanguard, were just kind of the missing pieces to have the complete solution. If you remember, that solution originally came from the Goldleaf acquisition back in 2010. And so we've done 3 other acquisitions that just rounded that solution now and gave us a complete solution. Vanguard was the last missing piece, which is the quick decisioning piece, to compete with all the payday lending solutions out there.

Right, right. And the rationale in terms of customers adopting this solution, or do you find that it's more of a like mid-tier banks they're looking at it? Or is it fairly broad-based banks, credit unions, all sizes?

It's pretty broad-based. But I would tell you the vast majority of them they're looking at are banks over probably $700 million or $800 million in assets up to $5 billion to $10 billion. That's probably the sweet spot for that solution right now.

Okay. Let me hit you on a couple of other point solutions, and then we'll go back out to the big picture. But you did gain the ability to provide credit issuing products to your financial institutions with your recent card platform migration. And it sounds like you had a real good success with that so far. Generally, can you talk about that size a little bit about how many FIs have signed up for credit issuing so far? And then talk about whether those are a new offering for the financial institution or whether that's a competitive takeaway from another vendor?

Yes. So the vast majority of those are a new offering because most of these credit unions were -- or banks were outsourcing to a third party, their credit card processing. So it's really starting from 0. So unlike the debit card processing, where we're actually taking a competitive win and migrating a book of business over to our payment platform and you get an immediate uplift in revenue, the credit is a little bit different. We're going to win some of those but the vast majority of it are starting to 0. So it gets you [ a base of ] slow growth. But you're right, we've had some good success. I don't know off the top of my head the number that we sold. I think we've got 25 or 30 installed now. But I know the installed backlog is actually full for this year.

Got it. Okay. That's great. For the calendar year, the fiscal?

Fiscal.

Wow. Okay. We're about 5 minutes left. I did want to just cover real quickly the management's guidance for fiscal 2022, looking for 8% to 9% GAAP revenue growth but that's boosted a bit by an increase in the -- in onetime deconversion fees. Just how do you forecast that? I mean how much of it is announced deals versus rumors versus just a good guess?

It's just a guess. I mean it's like throwing a dart at a dart board, Pete, because we have no insight into what banks are getting acquired until they actually let us know. And until that happens, we don't know which banks are going to get acquired. But we know that last year was unusually low because M&A just dried up because of COVID. I mean, we predicted to be down $33 million going to this year. And guess what, we were down $33 million. So we're predicting it to be up. I mean could our projections be $5 million higher or $10 million low? Absolutely because you're absolutely right. I mean it's truly a guess game, but we have to forecast something for The Street.

Right. Right. And remind me, I think last time I asked you this question, I think maybe Jack Henry's largest customer was contributing 40 bps of revenue, less than half -- 0.5% of revenue. Is that where you would size the largest customers at this point?

Yes. We don't have a single customer anywhere near 1% of our revenue.

Got it. Got it. Okay. And you talked a little bit about acquisitions. Management has been more careful, I think, on acquisitions. I'm more focused on the smaller deals that provide some important technology to fill a hole. Last year the company stepped up the buyback and bought back $400 million for the stock, you have a really solid balance sheet here. How would you prioritize capital allocation? And I assume the primary issue on M&A is a combination of whether you really need it and valuation. But how are you thinking about capital allocation here over the next fiscal year?

Yes. So Pete, I mean I don't think that our view on capital allocation has probably changed very much in the 21 years I've sat in this chair. It is a different chair, but -- So I mean, we've always thought the best use of our capital on our balance sheet would be to do acquisitions. And we'd love to do a large acquisition. The challenge is there's just not -- there hasn't been a lot of really good assets out there that's even been on the market. So I mean, we continue to look at them. I mean, Vance Sherard works for me and he looks at the teasers. I mean he probably gets several teasers a week, but most of them go straight to the trash. I don't even know he gets them because they're just not something that fits with our strategy. And if it's not going to fit with our strategy and makes sense for us and our shareholders, there's no sense in chasing them and we're going to chase the shiny object. But you're right, the valuations are just ridiculous. I mean I'm going to age myself a little bit here. But I mean, when I first started with Jack Henry, it was basically us and Fiserv competing for deals. And the average valuation was 7 to 9x EBITDA. When FIS came in the market 20 years ago, they started throwing down bigger checks. The valuation jumped up to 12 to 14x EBITDA, which was still good. Look, now the valuation for some of these assets is 25x revenue. And it's like how can a public company justify buying one of these, that it may not be accretive for 3 years?

Right. Yes. No, I hear you. And I think we're running out of time here, maybe just 1 or 2 minutes left. But when you think out 5 years and you think about changes that might occur from neo banks, challenger banks, fintechs, where do you think Jack Henry will need to be allocating investment spend in order to keep the financial institutions competitive with this growing list of competitors?

Well, so the fintechs, Pete, I mean we've worked closely with fintechs our entire lives. So I mean if fintech comes up with a solution that we don't have or a solution that our customers want, they can integrate into our core solution. I mean we're very open and we're fine with that. So we'll work very close with the fintechs, and we're not too worried about then competing because they're not really going after our core. They're not coming after our payments and other things. So that's not a real concern. As far as the neo banks, I mean unless they change completely, I mean they are currently just a deposit gathering solution, and they're primarily taking customers away from BofA and JPMorgan Chase. I mean I don't hear any of our customers complaining about the neo banks or even worried about the competitors. So I mean unless really changing the landscape, I can't see either one of those having much impact on us or our customer base in the next 5 years.

Okay. Okay. Well, that's great, Kevin. I wish we had more time, but this is a great update on the business. Again, I thank you for participating. For those in the audience, if you want to reach out directly to Kevin at [email protected] or myself, [email protected]. Happy to help you with those questions. Kevin, have a great day.

Thanks, Pete. Appreciate it. Thanks, everybody.

Thank you.