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

Good morning. It's Matt Roswell. I'm part of the payments, processors and IT services financial analyst team here at RBC. Apologies for the delay. We were having some technical problems. Joining us this morning is Dave Foss, who's the Chairman and CEO of Jack Henry & Associates. Good morning.

Good morning, Matt.

I guess as my first question for sort of level-setting purposes and investors who are sort of unfamiliar with Jack Henry, can you sort of describe the 3 segments? What each one does, and kind of the major products?

Sure. So Jack Henry, we describe ourselves as a well-rounded financial technology company. And our target markets are regional and community financial institutions in the United States. So just to clarify, we do not serve the really tiny banks and credit unions in the United States. We do not serve the very largest banks. So we don't go after BofA, Chase, Wells. But everybody in between, that's the target market for Jack Henry banks and credit unions. And we essentially provide one-stop shopping from a technology point of view. So if you are running a bank or credit union in the United States in that range, almost any technology need that you have, Jack Henry can satisfy that need. And there are a myriad of those different things. And so we classify them into 3 different segments: core; complementary; and payments. And you can kind of think of them as 1/3, 1/3, 1/3. It's not literally correct. Payments is larger than the others. Complementary is smaller than the others. But kind of think about those 3 buckets as 1/3, 1/3, 1/3 when you think about the revenue contribution at Jack Henry. So first off is the Core segment. So when we talk about core at Jack Henry or in the industry, a core solution is that primary kind of heart and soul accounting system that a bank or credit union depends on to run everything, the entire operation. So it's tracking loans, deposits and general ledger, accruing interest, posting payments, computing, amounts due on loan as far as interest, all that kind of stuff happens in the core system. And so that's the first segment that we have. We offer 4 different core solutions, one on the credit union side of our business and 3 on the banking side of the business. But that's what the core is. And then the Payments segment is just that, payments. For Jack Henry, we have 3 primary offerings when it comes to payments. We have a full suite of debit and credit card processing offerings. We have a robust bill pay solution in the Payments segment where we handle consumer bill pay. And then we have an ACH origination and remote deposit capture component of that business. We're the largest provider of remote deposit capture technology in the U.S., which is, of course, taking a picture of a check and depositing a check through that technology or scanning it at the point of presentment at a merchant site. And then the other piece of that business is ACH origination, and we do lots of ACH processing for our customers. So that's the Payments segment. And then the third segment is what we refer to as Complementary Solutions. That's with an E, not an I, so they're not free, but they complement all the other things that we offer at Jack Henry. So if it's not a core solution and it's not specifically a payment solution, it's in that complementary solutions bucket. So it includes digital banking, loan origination, teller systems, check capture systems, document imaging, all kinds of other solutions, including fraud and security as well. So we offer security solutions to monitor for our banks and credit unions their entire infrastructure, cybersecurity infrastructure, and then also fraud solutions, anti-money laundering and so on. So a very broad suite of solutions in that Complementary segment. So if you put the 3 of those together, you need a core solution to run the business if you're a bank or credit union. You, of course, need payments technology to offer all the different things that your customers are expecting. And then all those other solutions round out the suite of offerings that we have for our customers.

I guess as we come out of the pandemic, I mean, what are you hearing from your banks and credit unions? Tend to be sort of -- I think a view as kind of non -- is getting a broad base of sort of the U.S., not just the major cities. So what are you hearing from your banks in terms of the economic situation? And what are your banks doing in terms of their CapEx budgets?

Yes. Our customers have really weathered the storm pretty well. And obviously, it isn't over yet, but they're in pretty good shape financially. They were well capitalized going into the pandemic and the financial implications that happen. Their book of business on the loan side, their credits are sound generally, so they didn't write off a lot as a result of the impacts of the pandemic. And certainly, I think PPP and the support that small businesses in the U.S. got was really helpful to our customers. And so now as they -- if they see a light at the end of the tunnel, we're not there obviously, but as they see a light at the end of the tunnel, they're pretty optimistic about the future in general. I just got a survey a couple of weeks ago that indicated that customers in our target markets were, on average, predicting to increase their technology spend in 2022 by 10% or more. That's the highest average number that we've seen in many years. And I think part of that is a reflection of the fact that they scaled back as they were really doing with pandemic in 2020 and into 2021. And so there is some pent-up demand there as far as technology. The other thing that's driving that is they have recognized now that for them to be successful, if you're running a regional community financial institution in the U.S., for you to be successful in the future, you have to offer an outstanding digital experience for your customers. You have all kinds of other players out there trying to chip away and chew away at your customer base, and so you really have to focus on delivering a great experience for your customer. Assuming they're not going to walk into the branch, what is their experience, when they want to open account, when they want to interact with the financial institution, when they want to check their balance, all those things. They have to have a really nice digital experience, which implies upgraded technology for many customers. So I wasn't shocked to see that average of 10%, but it was nice to see that average expectation of an increase in technology spending of 10% or more across the board.

Are there any particular areas of strength or solutions that really seem to be in demand?

Yes. So certainly, digital is one in creating the experience. And I've said in many environments here, during the pandemic, most banks and credit unions in the U.S. do not have an outstanding digital experience. Most have an Internet banking offering and a mobile banking offering. And they are 2 different things. And so most in the U.S., whether they're Jack Henry customer or a competitor's customer, most of them are trying to figure out, what do we do with our digital experience? They have to bring Internet banking and mobile banking together to create one experience for the consumer or the business customer. And so many customers are kind of wrestling with that. So that's one area of focus. Another is around the topic of efficiency. So particularly in the banking space, a lot of banks are trying to figure out how to become more efficient in their operations, which also leads to a discussion about upgrading technology and reexamining process. And so for us, we have a number of solutions that help them when it comes to the topic of efficiency. Even things like turning paper documents into digital documents and routing them throughout the enterprise as digital as opposed to paper documents introduce efficiency. We have workflow of solutions that help them reengineer process and create efficiencies. And so part of that is driven by the need just to improve their operation because not everybody is in the office anymore. But the other part is where -- all companies in the U.S. today are a little bit challenged with finding talent. And so if you can't find the people that you need and certainly at the price point that you're hoping for, they're looking for technology to increase efficiency so they don't have to go and hire more people as they emerge from the pandemic. So I think those are a couple of key themes that we're seeing here that are good for Jack Henry, certainly create an opportunity for Jack Henry and are going to be transformational for a lot of customers in the U.S.

And what role is sort of the shift to the cloud playing? It seems like more banks and credit unions are kind of willing to go that route now. Am I right in that perception?

You are correct. It's been interesting. And by the way, the push really started with banks and credit unions because they -- as compared to banks, credit unions generally spend more on technology. So a percentage of their overall budget, they spend more on technology. They tend to have developers on staff in credit unions, where most banks in the U.S. today do not have developers. And so we saw a real shift start in the banking business, and now credit unions are kind of coming along. And the drivers are a few. So one is the pace of technology changes faster than it's ever been. So it used to be, if you were doing everything yourselves, you were hosting it in your institution, you would buy your hardware. You would amortize it out over -- expense of over 7 years. And then you would upgrade your hardware. Well, today, it's about a 3-year life for hardware. So you're looking at a hardware refresh much more frequently than you were before. So the capital outlay required there. The examiners on the banking side have been really, really tough on bankers who insist on managing everything themselves because they feel that those bankers are putting themselves at risk. They don't have possibly the proper security infrastructure. It's really hard if you're running a bank yourself to have enough talent on staff and enough expertise on staff to manage all the things you need to manage in the areas of fraud and cybersecurity and all that kind of stuff. So bankers were getting a lot of pressure from examiners around that topic. And then even before the pandemic, for banks and credit unions to find the tech talent they needed and hire them in, as people were kind of retiring out on one end of the funnel, how are we finding those people and where are we finding those people to fill the other end of the funnel to bring that technology talent that we need to run everything ourselves, that had become a challenge. So that had been driving banks originally into cloud, either private or public cloud offerings. Credit unions started to experience the same thing about a year or so, 2 years before the pandemic. And then the pandemic has just exacerbated that whole situation. So now with the challenge in finding people in particular and the recognition by banks and credit unions that they're going to have to live in a remote environment for the long term. This isn't a short-term thing. That's really continued to push them to look at that. So we don't see some huge spike in movement to the cloud because it was already rolling along, but it is definitely a topic with pretty much every bank and credit union out there today.

You mentioned earlier remote deposit capture. And I can remember, 5, 10 years ago, that was sort of new cutting edge, and now it seemed to have become mainstream. When you look at the technology for banks today, what do you think is not talked about a lot among investors in the press currently that you think in 5 years is going to be the next remote deposit capture or digital bank?

Yes. It's an interesting question. So you say not talked a lot about among investors. I think the first thing that comes to mind when you ask me that, there are 2 topics that are talked about a lot, but I don't think understood among investors. So people are talking about open banking. They're talking about banking as a service. But most people don't really understand what does that mean and what are the implications of that. I think as we look forward 5 to 10 years from now, and by the way, this is great news for Jack Henry. We are very excited about this. Open banking and banking as a service are really going to be differentiators for us in the future. We have been committed at Jack Henry to the idea of open connectivity. And we would talk about legacy technology in the past and creating connectivity -- freely creating connectivity. So if a banker decides to -- that they don't want to buy digital banking from Jack Henry. They want our core, but they want to buy it from somebody else. Most companies in our space, when somebody bid that, most core providers, when somebody would want to do that, they created these really hard walls to make it really difficult to integrate those solutions into the core. At Jack Henry, our philosophy has always been the opposite. We have always tried to create an environment that would allow easy connectivity of solutions into our platform. So we have a long history of philosophically approaching this as it's better for our customers if we create these open platforms. Well, now that's the hot topic. All these bankers are talking about, for the future, they need an environment that supports open connectivity. And again, it's not just about the technology. We have this very broad suite of APIs that creates that ability to connect solutions together. But the philosophy, the support of that idea is key for that to be successful. So we strongly believe that 5 years from now, open banking, and along with it, banking as a service, which is facilitated by open banking, those are going to be key to be successful in our industry. And we know that we are much better positioned today than any of our -- certainly, our major competitors, the names that everybody always throws around when they talk about Jack Henry. We are absolutely better positioned than them to support that environment as we look forward 5 years from today. And so what you'll see is -- so a bank -- in fact, I'm doing a conference in January where this is the topic, and I'm the speaker on stage to a couple of thousand bankers. What you'll see in the future is a bank will want to support some fintech offering. They'll support that fintech offering through their digital experience and give the customer options to do banking services that the bank would never be able to do on their own. But they'll support some fintech through this open banking approach to offer to their consumers or small businesses things that the bank can't do on their own. So it's banking as a service where the bank is providing the infrastructure, but they're housing a fintech provider in the same environment as Jack Henry to provide services that the bank wouldn't otherwise be able to offer. So we think that's going to revolutionize banking for our customers in the future. And we are very happy with the way we're positioned to support that as we look forward.

You mentioned fintechs. Are they competitors or partners or acquisition candidates, all of the above?

Yes. I'd say all of the above. We tend to view fintechs -- rarely view them as really competitors. Sometimes, they are competitors to our customers. So there is the potential that some of them trying to disintermediate the consumer or small business away from our customers. So there is that going on. But for Jack Henry, more often, a fintech is a potential acquisition candidate, and we've done a number of those over the years. A potential partner, and I use that word probably not the way most people think about it. So back to my open banking conversation. If you want to connect to Jack Henry, we're not going to expect you to pay us a quick fee for everything that you do. That is not our model if you're fintech. We want to make that easy. We want to partner. But again, it's not about us taking a dollar out of their pocket every time they do something. It's more about creating an environment, creating an infrastructure that helps support our customers to be more successful. So we generally view them as partner, opportunities and possibly acquisition candidates. Sometimes, competitors, but not really, not really.

And I guess as we look around at a lot of the newer fintechs that have either been created or come public in the last couple of years, is there anything you would highlight as like doing really well in terms of a solution or a business model or anything you would highlight?

Yes. I think there are a number out there that are kind of fun to talk about. One that we have zeroed in on is a company called Autobooks. So Autobooks, a stable provider, really outstanding digital experience. And a different model in that they work with banks and credit union partners to help create a differentiated story for the bank or credit union. So they're not going over at us, an individual provider out there trying to do business with a small business directly. They work through the banking partners to create a differentiated experience for the bank to offer to their small and medium business clients when it comes to [ accounts payable ] management. And really, a great technology, great company. So I would highlight them as a company that's doing things. That for us -- it's important for us to deliver technology that help the community financial institution differentiate and remain relevant, frankly. Our customers are always trying to differentiate against BofA, Chase, Wells. That's a big part of their mission. And so what we're doing with these fintech partners is enabling that. So that the regional bank, the $10 billion, $12 billion regional bank, has a solution set that is better and totally differentiated from anything they could get from one of the majors. And so a company like Autobooks is committed to that same ideal as a fintech. And so that's one that I would highlight as doing really, really interesting things.

One of the major topics, certainly around the payment space, has been the buy now, pay later space. Is that a competitive threat to your banks? Or how has that sort of fit in?

It's actually a great opportunity for our bank. So think about what that is. Buy now, pay later, it's essentially a short-term loan, right? I mean that's what you're doing. It's a short-term loan. That's what banks do all day long. Now that is their business. And so the underlying technology to support BNPL is there in our solutions today. Any bank can do that today. What they need is that front end that enables the consumer to find them as a buy now, pay later provider. So we view this as an opportunity for our customers. A number of customers that we're working with to figure out how they facilitate that through their digital experience to their consumers. And that will settle in, but that is, frankly, of all the things that have been happening in the last 2, 3 years when it comes to kind of disruptive technology, that's probably the easiest for a bank or credit union to solve because they do that all day long. It's just a different point of presentment of that solution for a consumer.

I guess that opens up the question that's, what's been the hardest over the last 2 years for banks and credit union standpoint?

Yes. I think -- there are several things I could probably talk about. I think the move to online digital commercial lending. So think about commercial lend, not consumer lending, but commercial loan. Very complex. Banks were very set in their ways about how that should work, right? Because the small business comes into the bank, brings their tax returns, all their forms. We evaluate this in loan committee. It takes 2 weeks. I mean it's a very laborious process. Well, 4, 5 years ago, when OnDeck and Kabbage launched and they were going to do online, quick decision commercial loans, not consumer loans, a lot of banks have kind of stood back and said, "whoa, whoa, whoa, that's not the way we do things." We quickly executed to create a technology solution that was every bit as solid and better over a couple of years. Better than what OnDeck and Kabbage were doing, but it allowed the bank to play in that game. So the bank could stand up a online presence, accept every -- the entire application, all the supporting documentation, all of that online. Quick decision engine if they wanted to use it, or we had 3 different levels, so it can be a quick decision with no human intervention. There was kind of this medium decision where somebody had to approve the loan. And then for a larger credit, more complex, they can do everything online. But it went to loan committee for decisions, so that took a little longer. So we created this entire solution and model to facilitate all of that. And several banks adopted that quickly because they want to make sure that they could compete in that game. But philosophically, for a lot of bankers, that was -- we don't do things that way. We want to make sure that we manage those credits very closely. And so that was, I think, the hardest transition for a lot of bankers to go through. And many still haven't made that transition. Many still are really leery. They'll take everything online, but they want to go through kind of the more formal approval process and make sure that they're not extending themselves from a risk point of view. And that's certainly smart for a banker, but they have to evolve to make sure that they're living in the world where the consumer or the small business wants them to live in.

Switching gears a little bit. On the last quarterly conference call, you mentioned that it seems like bank M&A have -- has accelerated. What role does that play? Is that -- I mean, I guess the pushback we obviously had is -- the TAM per core is shrinking because the number of banks in the U.S. is shrinking. What's happening?

Yes. So technically, that's true, but it's not -- if you really understand our business, you understand that's not really true for Jack Henry. So M&A has certainly picked up. Post-pandemic, M&A has picked up. But what happens generally is -- and that there are exceptions to this. I'm not talking in absolutes. But generally, when M&A is happening, it's a medium-sized institution, a regional bank or a medium size, so maybe $1 billion bank, a $500 million bank, up to we'll say, $50 billion, certainly. They are acquiring smaller institutions and folding them in. Well, we don't serve. So a bank under $100 million, that is not our target market. We're not serving those banks. There are about 2,000 of them in the U.S. We don't sell core solutions to those banks. There are providers who do, but that's just not Jack Henry's target market. So normally, in the M&A environment, it is a Jack Henry customer, one of those that's greater than $500 million, acquiring a little institution and folding them in. So technically, your statement of, the number of banks is consolidating, is absolutely true. But for Jack Henry, the bank that's being consolidated away normally is not a Jack Henry customer. And normally, we are the beneficiary because our customers are acquiring other customers and rolling them in. And we get paid on asset size when it's a license deal, which we don't have a lot of anymore. But it's normally number of accounts and number of payments processed and those types of things. Well, if one of our customers acquires a small banks and folds them in, customer count goes up, number of accounts goes up, transaction volume goes up. All of those things are good for Jack Henry even though the number of banks is shrinking. And the same thing holds true on the credit union side of the industry. Now certainly, once in a while, one of our banks is acquired, and it happens. And so that is what creates deconversion revenue for us. So when you hear us talk about deconversion revenue, it's when one of our banks has been acquired away. But all in, if you look at a year, normally, in that scenario of M&A, Jack Henry is the beneficiary because it's much more common for one of our banks to be acquiring a smaller bank and folding them in than it is for one of our banks to be acquired away and for somebody to pay us a deconversion revenue. The other thing I'll point out that I shared on the last quarterly call was, our M&A slots for the fiscal year, meaning through June 30, are full now on the banking side of our business. So that is -- there's a lot of M&A activity. Those get filled when we are asked by one of our customers to convert a bank onto a Jack Henry system. That's what leads to us filling a conversion slot. And so we're in the analysis phase right now trying to figure out, do we need to add another conversion team? Maybe 2 teams. What is demand going to be? But we now have deals scheduled into July of next year even for M&A activity. So certainly, it is happening. But again, we don't view this as a great threat to Jack Henry. Generally, it's much more of an opportunity for Jack Henry as M&A kind of heats up.

So what about Jack Henry M&A? Some of your larger peers a couple of years ago made large acquisitions to go international, in the merchant acquiring space. I mean -- because it seems like you all kind of stepped aside from that or stayed away from that.

Yes, we did. And it wasn't an uninformed decision. We spent several years -- before those announcements, we had spent several years trying to analyze whether or not we wanted to be in the merchant acquiring space. The theory, the story is that you're serving your bank customers by being in merchant acquiring. The reality is most of that business is through independent sales organizations, through ISOs. So your customer really is the donut shop or the dry cleaner. You're not really doing that much to serve your banks when you're in the merchant acquiring space. And the other challenge for us was, in merchant acquiring, the real -- and we saw this, as we looked at potential acquisitions, there is a real kind of race to the bottom as far as pricing is concerned. Because if you're running a donut shop, you don't care about the customer service coming from Jack Henry. You care about what is the price. I want the lowest price. As long as the transaction was processed, that's all I care about. And so there's this tremendous churn in that space, where we were witnessing 25% churn per year. Customers jumping from one provider to another just because they were chasing a lower price. That is not the Jack Henry model. That's not who we are. We are a premier customer service provider. Customers oftentimes come and do business with Jack Henry because they know about our service. And they'll pay a premium to Jack Henry because they know about the service that we offer, the outstanding technology we offer. Relationship, partnership is very important to us. It's key to our success. And so when you get into merchant acquiring, all of that goes to the side, right? It's all about price. And that's just not who we are. So the decision we made was that we didn't need to be in that space. That was not a strategic imperative for us. Our customers have options when it comes to working with their small business customers on merchant processing. And we support those things. But we don't need to be in that business trying to chase scale and trying to manage this constant reduction in per transaction pricing. That just isn't a good strategy for Jack Henry. So we support all those things. All of our customers have the same opportunity to support their small businesses. We are just not in the business of processing those transactions and supporting independent sales organizations in that space.

One final question as we push up on time. What should investors expect out of Jack Henry going forward?

So yes, great question. So I think if you look at our history, we are a good constant grower as far as top and bottom line performance. So financial performance, I think, is solid. And you should expect to continue to see that. You will see a leadership team that is very disciplined in our approach to managing the business. So you mentioned M&A earlier. We didn't talk about the M&A activity we have completed. We're a successful acquirer. We've done well over 50 acquisitions in the last 15 or 20 years. We know how to complete acquisitions, but we don't chase the shiny object. When we're out there working on a deal, if pricing gets out of line, and we -- to the point where I wouldn't feel comfortable, or Kevin, our CFO, wouldn't feel comfortable explaining to our shareholders why we completed a deal with kind of an outlandish price, we step aside. We don't chase deals that don't fit our profile. So we're a disciplined acquirer, run a solid business. The other thing you will see in the future is, Jack Henry, we have an outstanding technology strategy that we are executing on for the future. Much of it, we haven't talked about publicly yet. We have been developing a number of very cutting-edge solutions that we'll be talking about in calendar 2022 that really position our customers and prospective customers for the future. And if you add into it all the things we're doing in digital today that we talk about widely, add into it all the things we're doing in payments today with our pay center payments hub, which has revolutionized how real-time payments are handled, you look 5, 10 years forward, Jack Henry will absolutely be a -- continue to be a technology leader in our space.

Excellent. Let's leave it there. Thank you very much for joining us this morning.

You bet. Thank you, Matt.

Good luck.