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

Welcome back to Evercore ISI 6th Annual Payments & Fintech Innovators Forum. I'm David Togut, I lead the Payments, Processors & IT Services research team at Evercore ISI. Delighted to welcome Kevin Williams, Chief Financial Officer of Jack Henry to the conference. Kevin, thanks so much for being with us here today.

Thanks for the invite David. I'm happy to be here. We just wish we could we do it in person.

I hear you. Well, I'd like to say we will be, but I know you're going to be retiring soon. So I guess congratulations are in order.

Well, thank you. Of course, let me just point out there, there is no specific time on that, which is why there is no date in the press release because until we find my successor, which I have no idea how long that's going to take. And the Board and I and Dave are all convinced that the transition is complete, I'll still be around. So I'm committed to stick around until the transition can be smooth and complete. So if that takes until next fall then it takes us to the next fall.

Great. Well, hopefully, it will, and we'll be able to host you live and in person at next year's conference. Just kicking off, Kevin, on your December quarter call, CEO Dave Foss focused on your multiyear development of cloud-native modular technology solutions or your credit union and bank customers. What's the time line to roll out some of these new solutions? And when will some of the revenue and earnings from these new solutions be material?

Yes. So David, so we've been working on this. We started this project about 3 years ago. We've been in development stage for about 2.5 years. We've got the platform complete, which is all written in native cloud language. We've got the first componentized solution in beta right now with 6 different customers, which that should be rolling out into GA in the not-too-distant future. And then we've got a list of other products that are coming right behind that one. As far as a revenue generator, it's going to be a slow build because this is -- again, this is not a product rollout. This is a long-term strategy that we've laid out. I mean, this is a multiyear project to get all these solutions componentized.

Understood. How much have you been spending annually on R&D to develop these solutions? And what's the go-forward spend look like for fiscal '23?

Yes, it's a good question, Dave. So we have -- like I said, we started this 2.5 years ago. We got fully staffed for this project about a year ago. So the development cost of this solution is part of the 14% of our top line revenue. And that's the guide that I haven't given it yet, but that's the guide I will be giving for FY '23 that our total R&D spend, which is R&D on the P&L and cap software will continue to be right at that 14% top line revenue growth, which allows us to grow R&D in just about every area.

Very clear. Once you've introduced some of these next-generation technology solutions, how will your offerings compare to your closest competitor? For example, Fiserv announced the acquisition of Finxact. How does your next-gen platform stack up against Finxact?

Well, I mean, Finxact is primarily a core in the cloud solution right now. with no third-party solutions. So I mean, once we get ours rolled out, it will stack up extremely well. But ours -- and Finxact, I think, is pretty early in their development stage as well, because they've got a lot of other solutions and components that they will have to develop in the cloud. So with us having the platform in place and being able to now componentize different solutions, we're in a very good position, and we'll be very competitive with them once we get everything rolled out.

Understood. Greg Adelson was just promoted to President and Chief Operating Officer of Jack Henry. Based on his track record at the company, what changes should we expect him to make?

David, I don't know that you're going to see many changes. I mean, what Greg was a COO because we just promoted him to President, he was COO. So he already had all the operating units reporting up to him. So he had the President of Jack Internet Banking, President of Symitar, President of ProfitStars, the VP in-charge of all of our call centers, we're all reporting up to him. By making him present CO, he retains all that and our new CTO, Ben Metz, will now be reporting up to him. So Greg will have all that, which allows Dave, the freedom to focus more on the G&A type stuff and more focus on sales and different things. And it really brings the R&D efforts with all the operating units more closely combined under 1 reporting unit, which is going to help unify our broad solutions even better.

Understood. On your recent earnings call, you guided fiscal '22 revenue growth to 9%, driven by strength across all of your businesses. For the second half of fiscal '22, are there any notable call-outs you'd make on growth expectations for specific businesses? For example, payments where you've completed the back-end conversion of debit card processing over to the First Data platform.

Yes. So I think we're going to see very nice growth in all 3 segments, David, and I mean, in the core side, it's -- we continue to have competitive wins. We continue to see a nice movement of our on-prem customers moving to our private cloud, which that's a nice lift in organic revenue. And then just our average size of our banks continue to get larger. And with the way we do revenue, which is either based on asset size on-prem or based on number of accounts or members process on a private cloud solution as those grow, that also drives our organic revenue growth. So very excited about what we're seeing going in the core activity. On the payment side, you're absolutely right. We finished the migration to the new payment platform this month a year ago. And we have seen very good success from our sales teams in contracting new business. We still have over 50% of our core customers that have the opportunity to cross-sell our debit card processing. We literally have 100% of our core customers to cross-sell our -- the new full-service credit that we just were able to roll out because we got on the new platform. So there's a lot of opportunity there. We will eventually take that offering outside the base, but the date of that is yet to be determined. Our Online Bill Pay, it's growing in the low single digits, but it's -- we're in almost 4,000 FIs using our Online Bill Pay. So almost 40% of the FIs in the United States use our Online Bill Pay. So it's low single-digit growth is good. And then the third component in there is our Enterprise Payment Solution, which has grown in the high teens. And it now represents 20% of the revenue in our payments segment. So -- and I don't see any slowing in either cards or EPS. So continued very solid growth in revenue in our payments segment. And then when you look at our complementary solutions, I mean, we've got so many cross-sell opportunities in there with low penetration. I mean Banno Digital Platform. I mean we've only got about 20% of our core customers on that solution today. Huge opportunity there. We still got a large number of customers on NetTeller that many of those will be migrating over to Banno in addition to that, to the new sales. So -- and that will be a lift in revenue. Our digital lending is growing really nicely. We're rolling out some new fraud solutions later this summer. That will drive some nice growth. So we've just got opportunity in all 3 segments for continued growth in the next year.

Understood. On the December quarter call, you had $25 million incremental contract termination fees year-over-year. What are your expectations for contract term fees in the second half of fiscal '22?

Yes. So we guided to about $50 million for the year. And like I said, I even said this on the November call for Q1 that we raised expectations then. And at that time, I said that Q2 and Q3 were going to be heavily weighted, which they really were. So we had about $25 million or so in Q2. And the guide I gave on the call was we're going to have about half that much again in Q3, which means Q4 will be much smaller. But yes, it's heavily weighted in Q2 and Q3. Obviously, I have no idea what FY '23 looks like at this point.

Is the loss of revenue and earnings from these customers material when we model forward FY '23?

Yes. It's hard to say, David, because I mean, the deconversion fee cannot be equated to the revenue we're currently getting out of a customer. So if a bank is 2 years into a 7-year contract, and they have a lot of our products and they get acquired. I mean, that could be a huge deconversion fee or you can have an extremely large customer that's paying us a lot of monthly on a monthly basis that gets acquired in year 7 of a 7-year contract. So the deconversion fee doesn't really represent the revenue we're losing. So I mean it's a mixed bag out there. But the 1 thing I would say, David, is we are seeing, and we talked about this on the last call. We are seeing a huge increase in convert merge. And I'm happy to say that our banks are doing more acquiring than our banks are being acquired. So at this point, the M&A activity should be a slight tailwind for us going forward rather than a deterrent.

Got it. Going forward, you've guided for 50 basis points of non-GAAP operating margin expansion for FY '22. Now that we're past the conversion of kind of debit card processing customers over to the First Data platform, is 50 basis points of annual margin expansion, a sustainable number when we think about Jack Henry's operating leverage.

Absolutely. I think for FY '23 and beyond, for the foreseeable future, we should be able to get 50 to somewhere between 50 and 100 bps of margin expansion as we continue. And there are so many things that drive that, David, as I kind of just referred to. But I mean, obviously, growth in the payments business because the infrastructure is in place. The continued move of our on-prem customers moving to our private cloud, which we still have 35% of our core customers eligible to make that move. They won't all make that move, but they're eligible. Both those are nice drivers and then all the complementary products that we've rolled out and that we will be rolling out in the near future. So all those should help to drive both, not only top line revenue growth, but also the margin expansion.

Understood. Shifting gears for a minute to inflation, which is top of mind. Can you walk us through the impact of inflation both on Jack Henry's revenue and your operating expenses? And if you could just remind us, when we look at your contracts, what percentage of your contracts have CPI escalators versus other pricing mechanisms like the assets of the bank overall.

Yes. So you're right. I mean as the assets grow, our annual maintenance goes up and then part of the annual maintenance, there is a lesser of CTI or some percentage that we can actually apply to increase what we build in. And that same type of CTI accelerator is in just about every 1 of our contracts out there. Obviously, we have to -- there's a time period within our contract that we have to give advanced notice and notification that we're making those increases, but that will be in the work shortly. So I think from a revenue side, we're in good shape. On the expense side, just like most centers like us, we have a lot of maintenance and license agreements with third parties, but most of those are long term. So they're going to have to wait and do CPI increases on us like we do our customers. So I don't see much impact there. Probably the biggest impact from inflation and just the market we're in today, David, is compensation expense. I mean there is a huge demand out there for resources. And we've seen some crazy offers to some of our employees. So we've had to do some adjusting of salaries, and we started using RSUs, a little broader to as a retention tool to keep our employees, which has worked. We've seen that in several cases work. So that's probably the biggest impact, and especially when your compensation is roughly half of our total expense anyway, when we see those type of impacts, that's probably the biggest short-term impact we'll see from inflation. Obviously, if inflation stays at 7% for the next 2 years, if things will be impacted, but if they increase interest rates like they're predicting, then hopefully, that will slow the inflation down a little bit.

Thanks for that, Kevin. In Evercore ISI's 2022 Bank Tech Outlook, we conducted proprietary surveys of 52 bank and credit union CEOs, CFOs and CTOs, including 9 Jack Henry customers. And on balance, they expect to increase their spending this year with their core bank processors by 3.3%, which is up pretty significantly from 1.5% a year ago. When you survey your customers for your head demand trends, and I know Dave calls out, I think Cornerstone Advisors as one of the services that you look at. What are you seeing in terms of their spending intentions for calendar 2022?

Well, the Bank Director survey last August, they came out and -- I mean, they interviewed. I believe it was 1,500 bankers or something like that. And they were talking an average of anywhere from 5% to 10% uptick this year from last year. And based on what we're seeing in sales, contracting this year over last year. I would not disagree with that. I think that the spending pattern out there is very strong. I will say, David, that I think the spending is different now than it was pre-COVID. You go back pre-COVID, and I'm pretty sure that every bank and credit union in the United States had a digital upgrade somewhere on the road map. And I think when COVID hit, what that did was realign their necessity to have a digital upgrade. And you saw, I'm sure some banks had it on the road map 5 years out. Now they're wanting to get it as quick as they can, which is why we're seeing the huge interest in our Banno platform and our lending -- our digital lending platforms. So we've seen some really strong spending, as Dave said on the call, Q2 that we talked about in February was our second largest contracting quarter in the history of the company, followed only by Q4 of last year, our June quarter. But the really nice part of that, David, is -- and Dave said in his call is even though it was the second largest contracting quarter in the history of the company, obviously, the sales pipeline was depleted a little bit by the end of December. But by the end of January, it was back up to record highs. So our sales team are doing an excellent job of replenishing and putting opportunities in the top of the funnel as we're taking it out of the bottom in contracting. So I feel -- I don't disagree with what you're saying on the 3-plus percent average spending. And I think it depends on the institution. I think you're going to have some institutions that are not going to spend a whole lot more, but you're going to have some that are going to spend a whole lot more than they did a year ago on technology.

Understood. Just shifting to Banno Digital certainly, since the beginning of COVID, that seems to be the brightest area of demand for Jack Henry. We saw the rate of core signings dip for a few quarters and then they've come back. What's the main appeal of let's say, Banno Digital versus another suite of solutions from Jack Henry, let's say, versus just going with the core? Or is Banno Digital just complementary to the core?

Well, currently, they can't have Banno unless they have our core solution because we only sell Banno in our core base currently. Eventually, we'll take it outside of the base. And as far as the hotspot, David, and I'm sure you remember this, but our timing of Banno could not have been any better than it was because when we went into FY '21, we were signing 1 or 2 -- or installing 1 or 2 Bannos a month. And by the end of '21, we were up to installing 30 to 35 a month, and we have kept that pace all the way through currently through this fiscal year. So the timing couldn't be better. We hit prime time and ready for the -- the product was right for prime time ready to go and it's just continued to evolve. And you're absolutely right. There is a huge demand out there for it, and there's not -- there's really not another product in the industry that offers what Banno Platform offers to our customers. Because it's got things like -- I'll give a good example. We developed what's called a Conversations. So if you're a customer, which I'm a customer of 1 of our banks here in Springfield, Missouri. And I actually did this last week. I mean I actually -- my daughter lost her -- she -- her laptop got destroyed. So I actually went through the online chat, which is encrypted chat. And ask them if they could remind me what my daughter's password was for her online banking. And because it was an encrypted chat, they could send me not only her user name, but her password, through this line, which if -- without that Conversations, bank people cannot send that sort of information just through an e-mail or a text. So those are the type of things and special things that we have in our solutions that nobody else in the industry offers.

Understood. One rapid area of growth, at least in Europe is open banking, and we're seeing a lot of initiatives in the U.S. to build out open banking, especially areas like bank-to-bank payments, Square, Stripe and Plaid have a JV in this area. I think Dave Foss for a while has talked about Jack Henry's open APIs. Where do we go with open APIs in terms of your strategy? Is this going to be a big part of your strategy going forward, kind of allowing some of the smaller best-of-breed point solutions to connect into the Jack Henry core?

So that's an interesting question, David, because we have always been open. I mean you go back to how Jack Henry is found, Jack Henry and Jerry Hall started this company in 1976 as a core -- in-house core provider to community banks. So we didn't have any of the surrounding products or third-party solutions. So we have always been open and we've become even more open. And as Dave said on the last call, we currently have APIs connecting over 850 fintechs into our core solutions, which I'm pretty sure is more than anybody out there. So we are more than open to let any of our core customers use any fintech. Now having said that, that fintech does have to go through a certification process, which we've actually got a certification group. Because, obviously, if a fintech is going to go into our core, we want to make sure they don't tear something else up or break something. So they do have to go through a certificate process. It is a small onetime initial upfront fee. And again, it's a onetime fee unless they change something. So we have been very open to this idea since for 46 years, and I don't see that changing because we actually use our own APIs for our complemented products into our cores.

Understood. Very clear. How do you see consumer and business demand developing for new faster payment networks like Zelle and the Clearing House? And do the banks and credit unions you serve have a plan to add a social feed or other important new product features to Zelle to make it more competitive with Venmo over time?

Yes. The demand is growing, David. I mean it's not -- it hasn't taken off like we kind of thought it would. But there's a growing number of banks that are on either Zelle or the Clearing House for real-time payments. FedNow will be out sometime in early '23. They haven't given a specific date. But those are probably going to be the 3 primary channels that goes on out there. And I'm sure that either a bank or a fintech will come up with a some sort of a social engine to tie into Zelle and the Clearing House to absolutely compete with Venmo. But I don't know that any one bank will do that. But I think there will be that service added at some point to effectively compete with Venmo.

Since Jack Henry is a launch partner for the FedNow faster payments network, what is the go-live date for FedNow? And what will the per transaction pricing look like?

Yes. So like I said, it's supposedly sometime in early '23. They have not specified a true date or a hard date at this time. I think they'll probably announce in that later this summer or early fall. As far as pricing, I think the FedNow is going to be a little higher than Zelle or The Clearing House. If you think about wires are pretty expensive and ACH is virtually almost free. I mean the real-time payments are all going to be somewhere between those 2. They're going to be higher in ACH, but they're going to be a heck a lot cheaper than a wire. So I think FedNow is probably going to be comparable to The Clearing House, which are both a little more expensive than Zelle.

Understood. Given Jack Henry's debt-free balance sheet, what are your capital allocation priorities among dividends, share repurchase and acquisitions? You did buy back $194 million of stock in the first half of FY '22 and paid $68 million of dividends. Do you see acquisition opportunities developing given the pullbacks in valuation since you did sit out kind of the big round in 2019?

Yes. So we've actually bought back 4.1 million shares in the last 18 months. So we have been a little more aggressive buying back our shares. And part of that is because up until last quarter, there was really no true M&A targets out there, we would love to find the right potential candidate to acquire. It's not that we're not looking. I would tell you that we've looked all the way through the run-up in valuations. But -- and I'll date myself a little bit here, David. When I first took this chair, I mean our largest competitor for acquisitions was typically Fiserv. And the valuation of acquisitions was 7 to 9x EBITDA. And then when our other larger competitor, Fidelity got in the industry, they were willing to write a bigger check for the acquisitions and the typical average valuation went up to 12 to 15x EBITDA. Well, As of 3 or 4 months ago, valuations were 25x revenue. I mean it's almost impossible for a strategic to pay 25x revenue and look to shareholders in the eye and say, "Trust me, it will be good. It will be accretive in 8 or 10 years". So that's typically why we've been on sideline. One, the lack of good assets or quality assets that have been on the market, but two, the valuations have just been crazy. Now there has been a pullback in valuations. I think personally. I think some of the SPACs are going to have -- continue to have more problems. I think there's going to be some funds that realized they overpay for underperforming assets. And if the interest rates do increase, I think that there will be an acceleration of assets coming on the market, whether those are quality assets or better yet. If it's something that actually fits our customers' needs, we'll dictate whether we even look at it. But if the valuations are even close to reasonable, we don't mind paying up for a good acquisition that is strategic, that will give us a solution that we can cross-sell against all 3 brands or make our product -- our existing products that much stronger.

Hypothetically, if the valuations were attractive to you, what areas would you be looking in terms of technology or geography or specific product sets?

Yes. That's a very interesting question. Because obviously, we've been in a business for 46 years, we don't have a lot of gaping holes in our product mix. So it's not like we have customers screaming or clamoring for any products. But I would say that if you think back to some of the acquisitions we've done, David. I mean back in 2009, 2010, we did Goldleaf, PEMCo Technologies and iPay, all on a 12-month period, we didn't go out looking for any of those. But when we looked at them, it made sense because of either brought technology that we could sell to our customers or as an upgrade in technology like to -- from our online bill pay to iPay. So each candidate comes forward has a little different twist that we can look at and figure out whether it fits into our long-term strategy or not. The nice thing is when you're a company our size growing top line at high single digits with some margin expansion and a very clean balance sheet, it's not like we have to do anything. We don't have to go out and do a transformational acquisition just to grow and try to make the market happy. I mean I've been on investor calls for the last 3 days, I can tell you, most of our investors and holders are very happy with what we're doing. So I don't know that we need to really change anything on our course of strategies from what we've done for the last 20 years.

Understood. What do you see as Jack Henry's greatest underappreciated strengths?

Probably our reputation in the market, which is why we win so many new core competitive takeaways and our approach to the market and our focus because we are laser-like focused on just the financial institution industry in the United States. And we're not trying to do anything else. We don't want to be anything else that is our focus, and it is working extremely well for us.

And then the flip side of that question, what are the main business risks you're focused on in this environment for Jack Henry?

Well, there's -- as far as I'm concerned, really, David, there's really only one risk and that's cyber. And you can always do more. So I'm not going to say we're doing everything we can, but we're doing close to everything we can. We're devoting a lot of resources and a lot of money to that, to make sure that our customers' information and data is safe and that our employees are safe.

Understood. Kevin, well, thanks so much for being with us here today. Greatly appreciate your time and insights, and look forward to staying in touch while you're still in the chair. And hopefully, this time next year, we'll be able to host you in a live Payments & Fintech Conference.

Look forward to appreciate the invite, David.

Thanks, Kevin.

Bye-bye.