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

All right. I guess, in the interest of time, let's get started. Good afternoon, everybody. My name is Chris Zhang, and I'm part of the Credit Suisse Payments, Processors and FinTech research team. Today, we're thrilled to have David Foss with us today. He's the Board Chair, President and CEO of Jack Henry & Associates.

And I guess to kick things off, it would be great to hear about how you would characterize the tone in the C-suites of the community banks today and what means for the bank the technology spend in 2022 and '23?

Okay. Thank you, Chris, and welcome, everybody. So 1 of the things I talked about on the last earnings call here in November was that bank director had just published their annual spending, they cover spending in a few other topics. They published their survey in September. And it's a relevant survey for us because they survey banks in our space and they talk to CEOs and Board members in our target market. And just to make sure everybody is on the same page, we do not sell to the little tiny banks and credit unions in the United States. So if they're less than $100 million, that is not our target market. We also do not market to the largest banks. So BofA, Wells, Chase, they are not in our target. But everything in between, those are potential targets for Jack Henry, both bank and credit union. So on the banking side, in the Bank Director survey, what they published was spending expectation for calendar 2022 was on average increase of 10% year-over-year. That was the average expectation, again, for banks in our target market. This didn't touch on credit Unions, Bank Director only surveys banks. When we get to December, we'll get another survey that we reference pretty regularly from Cornerstone consultants. And so we'll be quoting their numbers when those come out. But right now, the published results look pretty good for 2022 as far as spending. And then anecdotally, what I'm hearing as I talk to CEOs of banks and credit unions, is kind of in line with that. The expectation is that spending will tick up, really focused on a couple of themes. One is introducing efficiency into the bank or credit union. So what technology can they use that will make them more efficient. And the other is introducing a higher level of experience for their consumer on the digital side, whether it's normal digital banking, checking your balance, those types of things or online account origination, commercial lending, all of those things fall into the digital suite for us as far as what a bank's customers, whether they're commercial customers or consumers, what they can do through the digital channel. And I think the digital piece is probably self-evident as we've been going through the pandemic. Of course, all the consumers, all the businesses are trying to do business without ever walking into a branch. And so a lot of our customers now are looking at where are those opportunities to upgrade their technology to enable those -- their customers to interact with the bank or credit union using a digital channel.

That's a great answer. It's not just from the Core Director survey results, but also the additional color, I guess, that just reinforces your confidence in hitting the high end of the 3% to 5% fiscal 2022 sales pipeline. And that's 1 area I want to dig into a little bit more. And as you mentioned that 1 of the priorities of the -- from the Core Director survey result is the increased focus on operational efficiency and improved digital experience. And should we read that as increased movement to the cloud and just continued strength in the Banno sales?

Yes. So definitely an increased movement to the cloud. Cloud movement for most institutions introduces efficiency into their model. And then, of course, on the digital side, Banno is our primary digital platform. We have a variety of things we do, but Banno is the solution -- the brand name for the solution that we offer to our banks and credit unions to offer to their consumers to do digital banking. We'll be rolling out the business side of Banno in 2022, so then we'll have both consumer and business through that single digital experience. And when we refer to digital banking, by the way, we don't use the terms mobile banking and Internet banking anymore. We talk about digital banking as a single experience. Consumers today expect that regardless of form factor, whether I'm working on my phone or on my tablet or my PC, the experience should be the same. And so with the Banno platform, that's what we deliver. It's a single experience regardless of form factor, and they'll see the same type of interaction with their bank or credit union. So that's what we're looking forward into this year.

All right. Great. That's very helpful. And 1 matter to follow-up is the CSBS Community Bank quarterly survey showed a big dip in the profitability outlooks for community banks in the third quarter. So just wondering if the increased focus on the efficiency relating to just a tough environment for banks? Or is there something else to it?

Yes. It's -- the efficiency topic is -- has been top of mind here for a while now, and it really has been driven by the lower interest rates. And of course, we've been living in a low interest rate environment for quite some time. So as net interest margins have compressed over the past couple of 3 years, this topic of efficiency has been top of mind for most institutions trying to figure out where is that opportunity for us to eliminate some costs, eliminate some expense, so we can boost profitability for the institution overall. So I'd say that really feeds into that point about their concern -- a potential concern about profitability. But CEOs -- anecdotally, the CEOs I talked to today, very bullish. Pending any major change with the pandemic, none of us can predict what's happening there, but assuming things kind of keep going where they're going today, they're very optimistic about the coming year. Thus, the 10% average expectation in spending year-over-year increase regarding technology. I think that's being driven by that optimism.

All right. Thank you, David. That's a great answer. And we always appreciate the color and the detailed explanations you gave. Another thing related to American environment is the inflation, and that's on top of mind of everyone that stays, particularly your customers in the -- I guess, amidst the increasingly negative real interest rates. So how is inflation affecting Jack Henry's financials?

Yes. So it affects us like any other business. So wage inflation is a real thing. The great resignation that's happening in the United States, it's a real thing. It's impacted our company, like it's impacted pretty much everybody else in the United States. I think the good news on that front when it comes to the great resignation and wage inflation, that kind of thing, that seems to have kind of settled down now. In the spring of this year, in the summer, there was a lot of churn. And we saw it at Jack Henry. We normally -- our attrition is normally half of the industry average, but we were up to about the industry average during the summer. And our competitors, we knew were about double that. So we saw some impacts, but that's all settled in today. So -- but that has been kind of a part of that -- the inflation topic. But as far as just general inflation, I don't -- we're not seeing any other major impacts to the company today or anything of any significance today. We've dealt with the wage inflation issue. I think we've handled that appropriately. But we're not seeing any other major impacts to the company today, specifically around the topic of inflation. And I don't think our customers, at least I'm not hearing from the CEOs that I talk to that there's any major concern that they're seeing today. But inflation is really, all you going to do is turn on the news, and you can see what's happening in the overall economy, the question is how long does this prolong? I saw a report yesterday where they were speculating about are we going back to the 1970s where inflation was rampant and totally out of control, and you have home loans at 12% or 15%. I think the common consensus is that's not going to happen. I'm no economist. But how long does this happen, how defined does this get? I can't predict that right now. But our -- again, our bankers are pretty bullish on the near term and through calendar 2022 at this point.

Got you. Got you. And I guess, on your pricing front, there's some offset from the contractual CPI accelerators, right?

So we don't depend a whole lot on CPI. Yes. We have CPI accelerators in some of our contracts. But most of our contracts, the improvement in pricing, the improvement in revenue that we see comes on growth. So our contracts are built mostly around growth as opposed to CPI accelerator, but we certainly have CPL accelerators in certain areas of our business, but that's not a primary driver for growth of the company on the revenue side.

Got it. So I guess let's shift gears to the core wins. Should we still expect about 50 new core wins for fiscal '22? So maybe still on track for about 1 per week?

Yes. So that's an important number for us. So when we talk about core wins, a core win for Jack Henry is taking a logo from 1 of our competitors to Jack Henry. So it's a new customer on the core side that hasn't done business with Jack Henry before, moving over to Jack Henry. We were -- pre-pandemic, we were on a run rate of about 1 per week, so 50 to 55 per year customers moving to Jack Henry. During the pandemic, that slowed down just because decisions weren't being made at all. People just kind of stopped. But now we're back to that run rate again. So that's a pretty comfortable rate for us to assume about 50 to 55 per year new customers, leaving a competitor and coming to Jack Henry on the core side of our business. And of course, that's new revenue to the company. And generally, when they buy a core system, they also buy a number of other solutions to wrap around the core. And so that is a -- certainly a key component of our growth strategy.

So while we are on this topic, I think it would be great to review the factors that are driving Jack Henry's share gains in the core processing market. And I guess, can you discuss your thoughts on why they should continue?

Yes. So the question or the reason that people come to Jack Henry, there are several. Usually, when they make a decision to come to Jack Henry, it's 1 or more of these factors. They know that we have a very focused strategy at Jack Henry. So we serve community financial institutions in the United States, banks and credit unions in the United States and we serve them with -- on the credit union side of our business, one core solution and on the banking side, we have 3 core solutions, but we really focus on 1 as our flagship solution. So it's a very focused strategy when it comes to the core side of the business, very different from our major competitors in the way that we approach the market with that level of focus. So that's 1 reason and 1 thing that is a consideration when people come to Jack Henry on the core side. They know that we're pouring our investment into Episys of your credit union, SilverLake if you're a bank, they know that we're committed to those solutions. They know that we're putting R&D investment into those every day, and we're totally committed to the success of those solutions. That's, like I say, different from our major competitors. Beyond that, we oftentimes have people come to us and say the relationship with their existing provider is broken. Meaning they don't feel like they're getting the service anymore that they used to get. They don't feel like they have a relationship there that they can depend on. And Jack Henry is known for outstanding service. We have several analysts in our space who do surveys every year. They call our customers and our competitors' customers and ask them about service levels and then they report on those. They publish those reports. And we know that Jack Henry in those reports shows up as having the best service in the industry. And from our own reporting, our own surveys of our customers, and that is a real influencer when people make a decision to change their core system. Another thing that helps is the fact that we have all these innovative solutions that we've been rolling out. So it's very helpful when you're looking to sell a core deal, if you can point to the #1 rated digital application in the App Store, which we have, Banno, #1 rated application. You not only give this great core from Jack Henry, but you can get the #1 rated digital application from Jack Henry, a single provider, and you have this other wealth of solutions, that breadth of the solution set, but also the innovative technology that we've been delivering in the past several years, that gets people's attention. And you put all those things together, we're in a reference selling business. All of our bankers know each other, credit union executives know each other and so they regularly will refer us to their friends and say, you ought to be doing business with these guys. And so you kind of boil all those things together, that's what's leading to this tremendous win rate that we're seeing today on the core side of the business.

That's awesome, David. So not just customer service, but also capable. I guess, maybe these days when you're in the core RFPs, who are you seeing coming up against your most frequently? And are you seeing any new faces in that?

Yes. So the players that we compete against, there are many of them, they have been around for a long time. But 1 of the questions I get a lot is about the new faces, the new players, and there are certainly a number that are trying to get into the space. The challenge in our space is there's a wide moat to get into the business that we're in. The regulatory burden is intense, because not only do you have to comply with all the federal regulations, each state has its own set of regulations, you have to comply with those regulations as you start to roll out into each state. And so if you're a startup trying to get into this space, just the regulatory burden is pretty daunting. Add to that the fact that most banks and credit unions, when they buy a core system, they expect to be able to get a number of the other complementary solutions, the ancillary solutions wrapped around that from a single vendor. Why? Because they are under a lot of pressure from the regulators around vendor management. Regulators don't want them dealing with 52 different vendors. They want them to deal with maybe 5 vendors. Well, then it's important for the core relationship to also bring to the table a variety of other pieces of the puzzle as far as the technology that they need. So of course, that works in our favor. And if you're a startup, that's pretty tough. That's a tall order for them to try and fulfill those needs. The other challenge that some of the new entrants face as they're trying to establish a foothold in the market in the U.S., and some of these are start-ups, some of these are trying to come in from international, is the U.S. buyer in our market, again, $100 million up to, say, $150 billion, so that middle market. The U.S. buyer in that market is looking for technology that is primarily off the shelf. They want to be able to customize, but they don't want to have to have programmers on staff where they go and customize everything and write all the software themselves. Well, many of the new entrants and almost all the international players that have tried to get into the U.S., they don't deliver with that model. They deliver a little bit of software and a great, big customized development project that customizes everything to the nth degree. And that's not what buyers in the U.S. are looking for. So we watch the competitors closely, both the established competitors internationally and the startups in the U.S. We're constantly evaluating what are they doing, and are we positioned effectively to compete. But so far, there isn't really any great threat among those players.

And as you win the RFPs, can you just share with us briefly maybe how important do you think the core wins are to the growth algorithm of Jack Henry, given the dozen or 2 products in your other segments, those deals also come with?

Yes. So it's an important part. It's certainly not to be on the end all for our growth algorithm. I mean, core is an important part of our business and not only making the core sale, but all the additional pieces that we wrap around the core that come with 1 of those deals, those are important. But there are a number of other important pieces in an algorithm. We're selling a lot of solutions incrementally. So cross-sell is a big piece of our sales puzzle. We are innovating new solutions that we're rolling out that are brand new revenue opportunities for Jack Henry. And then we have this big group of products that we sell outside of our core base. So the branding that we've used historically is ProfitStars. We have this broad suite of solutions and a sales organization that is only allowed to sell to non-Jack Henry core customers. And so that creates a growth opportunity for us, where we go to a non-Jack Henry core customer, sell him a solution, sell him the next solution, sell him the next solution, even though they haven't decided to make the core move to Jack Henry, there is this great cross-sell opportunity outside the core base that we leverage as well. So when you add all those pieces up, that's what creates the story as far as revenue growth at Jack Henry.

All right. Thank you, David. And let's maybe we can move to 1 more big topic before just opening up for a couple of questions. And of course, we have a lot more to go through that we're really interested about. One of the big takeaways from the earnings call is the revival of bank M&A that started to accelerate towards the end of the quarter in terms of Jack Henry's customers reserving all of your converted merge slots. So I guess 1 question if we will have to ask on behalf of all the investors is, is there any update from a month ago? And does it look like you'll need to increase the capacity to meet the demand for fiscal '22?

Yes. So M&A is continuing at a rapid pace. And for Jack Henry, we tend to normally be the beneficiary in those situations. Because usually, M&A is kind of a midsized bank acquiring a little bank or a credit union for that matter. You don't hear a lot about Chase or Wells or BofA or anybody doing acquisitions of other banks. So it's those mid-tier institutions that are acquiring the small ones, and we are normally the beneficiary in that situation. So when we talk about M&A or convert merge, as you referenced it, convert merge is when 1 of our customers contact us and says, "Hey, we're acquiring another bank, we need you guys to help us. We need you to execute the conversion of their system over to the Jack Henry system and help us with training" and that kind of stuff. So we have definitely seen a significant uptick in that activity here in the past 3 to 6 months. I referenced on the earnings call that our convert merge slots were filled now into July of next year. And so we were investigating whether or not we needed to add another team to facilitate those conversions. We have done that now. So since the earnings call, we have added another team, and we're looking at possibly adding another team, because there is so much demand in that space. And I don't see that slowing down. I think 2022, we're going to continue to see that kind of activity based on what we're seeing today. Now of course, the pandemic may throw all those sticks in the air, but assuming things kind of continue to go the way they are today, I think that's not going to slow down here as we get into 2022. There's a lot of interest and a lot of activity out there currently.

I appreciate the update. And a follow-up is, how should we think about the number of customer accounts that are lost from the M&A activities in terms of term fees versus the customers or accounts gained through the convert merge?

Yes, we lose a customer once in a while that's being acquired away. Some bank is acquiring 1 of our customers. So we lose a customer in that case. And they pay us a termination fee. The way termination fees work is they have to essentially buy out the remainder of their contracts. So if they get acquired and there's only 1 month left on their contract, they're only paying us for 1 month. If they get acquired, and they're -- and we've had this happen recently. There was a customer, who signed a 7-year agreement, 6 months into it, they got acquired. They had to buy out 6.5 years of that contract in order to end the contract. So it's -- a, it's hard to predict the size of those termination fees, because, like I said, you can be paying maybe 1 month or 6.5 years into the buyout that you need to make. So those are hard to predict. The other thing that is a challenge for us is we don't know in advance when somebody is going to deconvert. On the opposite side, when 1 of our banks is acquiring another bank, they tell us before anybody else knows. The employees of the bank don't. They're months away from knowing, but they call us, because they need to reserve that time to do the conversion. On the other side of the equation, if 1 of our banks is being acquired, we don't know that until after the fact. And then we have to facilitate their deconversion, but they're not dependent on us for that deconversion work. And so we can't predict very accurately when deconversion fees will happen. We can predict very accurately when convert merger revenue is going to happen. So that's kind of the dynamic that happens there. But all in all, as I said before, Jack Henry tends to be the winner. We are net gainer as opposed to the ones that we lose over time.

All right. This is super helpful. I guess, before we continue, are there any questions from the audience? All right. Maybe let's just shift gears to Banno. So the platform continues to deliver very impressive growth as you alluded to earlier. So now at about 6 million users, adding about a run rate of $1.5 million a year. Does Jack Henry have any longer-term high-level aspirations of how many users that could reach?

Well, I think it will be many millions by the time we're done. The interesting thing with Banno. Banno, for those of you who don't know, we acquired this little company about 6 years ago called Banno. They were -- they had almost no revenue. They were losing money. But the technology that they had, we thought was really revolutionary. So we acquired the business. We've invested a lot in that business, and now it's really starting to pay off. And so as you point out, I shared that we were at about 6 million users at the end of September. We're adding about 125,000 to -- and I think it's going to go up here, so I'd say between 125,000 and 175,000 users a month is kind of the run rate. And the importance of that is we get paid by number of users that are acting in the system -- that are using the system. So we may sign a bank or credit union. You could sign a really large bank or really a small bank, well, each of them count as 1. But the 1 that brings you a whole bunch of consumers, that's the 1 that's going to pay you more just intuitively, because we're getting paid based on number of active users. So we're very happy with that platform. We're happy, as I mentioned earlier, Banno is rated #1 in the App Store from consumers that are using that application every day. We have technology that is totally differentiated from anything else out there. And people are really starting to notice that and pay attention to the fact that it's a differentiated solution. It's not just the same thing as what BofA has or what any other institution has. And so we expect that's going to continue to grow. And we're doing all of this today without having the business side of the equation. So it's all consumer today. The business side of Banno, we roll out in 2022, and so we expect an uptick in usage once we get the business side rolled out. So I think the future is very bright for that platform, great reputation, very usable. We've had bankers go on do podcasts on the fact that their customer engagement for them as a financial institution has increased significantly since they installed Banno. And they can cite specific metrics about how it's improving and why. And so we know that it's changing the game for our customers.

Yes. So I think that definitely drives your customers to pay for it. And a question related to that is, how should we think about the user growth to the revenue growth or is the customer paying a similar amount for a better solution or...

So with Banno as compared to what?

With the Banno compared to without the app -- before the upgrade -- what's the upgrade part?

Yes. So yes, they're paying significantly more when they go to the Banno platform, because of the functionality in the Banno platform and because of the -- I mean, like I said before, we have customers who will cite specifics about user engagement. And so it's a more valuable solution for the consumer. So they pay significantly more for the Banno platform than they would pay for a traditional Internet banking platform, and they pay by per user on the Banno platform. And so as they grow the engagement, as they grow their user base, Jack Henry gets paid more per interaction. So it's a strong model for us going forward.

All right. That's great. That's a great answer. And I think in terms of capability, just outside of the engagement and the functionality of the platform, we're seeing new banks and the big banks are like adding new features and increasing clips, stock trading, budgeting, account aggregation, direct deposits switch. How does that influence your product road map for Banno?

So interestingly, every 1 of those things you just listed, we already have available at Banno in the platform today. But it is something that we're paying attention to. So -- but we've taken an approach that I think is going to be really healthy for our customers and for our company. We have -- as part of the Banno platform, we've created this really robust API infrastructure layer, so that the bank, if we are not creating a component or widget that they would like, but they find some fintech that has that widget, we're making it really easy for them to connect that widget into the Banno platform, into the Banno experience, so that their consumers can use Banno to do all the things they want to do. I'll give you an example, cryptocurrency. So we have Nidec, for example, integrated into the Banno platform. And so if 1 of our customers' customer wants to buy, sell, hold cryptocurrency, they can use the Nidec app, but it's right there embedded in the Banno experience. So the balance isn't held on the bank's balance sheet because banks aren't allowed do you do that yet except in the state of Texas. But other than that, banks can't hold that balance, but the customer gets the experience as though the crypto balance is held at their bank, even though it's not. It's held with Nidec, but it's integrated directly into that experience. And so you'll see more and more of that happen in the future, and we're very supportive of that. We can't possibly develop every single bit of technology that everybody wants. So the answer for us to make sure that our customers get what they're looking for is to create this integration layer that allows them to easily integrate fintechs into their customer experience.

That's great. Thanks for sharing your thoughts on the -- your build versus partnership approach. And also, we can -- I think we can clearly see a path to making the platform future proof by adding whatever additional functionality that makes sense for the current market and to see the consumer needs. Maybe let's pause for any additional questions for now, and I have probably just 1 more to wrap it up.

Can you speak also the percentage number for Banno on as high as of the percentage customer spending and what the penetration is so far within the installed base?

Within the installed base, so the penetration is -- we're probably into the core base, we're probably about 25%-ish, and I'm just doing that off the top of my head, keep me honest. Yes, that's about right. 25%-ish into the core base as far as penetration. So a lot of run room to continue to penetrate the core base. And I think a good rule of thumb, and this is just kind of general moving from an Internet banking platform to a full-service digital platform like this. The revenue is essentially double per customer, per user. Now that's a hard comp, because the old technologies, the Internet banking technologies weren't priced that way. There was no such thing as you're paying per customer on the Internet banking platforms in general. But it's -- you can kind of think of it that way. That's a kind of a good way to model it and think about how it translates.

All right. Thank you, David. And maybe I'll take 1 more question or -- all right. Maybe just a quick follow-up for the Banno businesses. So you mentioned it's still on track for early fiscal calendar '22, right or is it the same for Banno, yes?

It's later in calendar '22. It won't be right at the beginning. It's later in calendar 2022.

All right. Got it. Thanks for the clarification. So I think we're running against the 30-minute mark. Thank you so much, David, for your insight, it's truly helpful, and we appreciate you coming here. And please join me in thanking Jack Henry.

Okay. Thank you, Chris.

Thank you very much.