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

All right. Good afternoon, everybody. Why don't we get started here? All right, there it is. Why don't we get started. My name is Dave Koning. I'm a senior research analyst at Baird. I cover payments, fintech and services. I'm very pleased to announce Jack Henry. I feel like you've probably been at these for 25 years or over or so long time.

Long time. Yes.

And you guys have had just tremendous performance over the last many years. You'll have to tell the story in just a minute, I think what did you say the third best stock in the last 30 years or so?

Well, #1. So in November of 2019, Jack Henry was recognized in the Wall Street Journal as the best performing stock of all public stocks over the last 30 years. Now that changed a little bit in the pandemic. Apple and Amazon really benefited during the pandemic. Jack Henry did not. So I think we're #4 or something like that. But over the last 30 years, best performing public stock. Yes.

Yes. It's an incredible run, and it's a company that does bank software and as banks have shifted away from people and branches, et cetera, more and more technology that you guys have crushed. And so CEO, Dave Foss, is with us today. And, yes, with that, maybe I'll just turn it over and we can kind of talk through any recessionary type impacts, anything you've seen in the last couple of months?

Yes. So it's interesting because I'm getting that question a lot right now. The reality is, and we all are aware of what's going on in the economy, and I'm certainly sensitive to Jamie Dimon's reference to hurricane last week. But among our customers, they're really a pretty positive bunch right now. And so if you look at where community and regional banks and credit unions are today, they're well capitalized. They have been committed to spending more money on technology. Because especially through the pandemic, they recognize the need for new technology solutions to serve their customers digitally. So spend is up. They're seeing -- as a result of rising interest rates, they're seeing net interest margin improvement. They are not seeing a slowdown on their -- on the fees that they're charging. They've gotten really good during this lengthy period of no net interest margin. They've gotten good and creative when it comes to charging fees, so they're not seeing that slow down. So they're a pretty optimistic group. And of course, a lot of that for me is anecdotal. I talk to a lot of CEOs of a lot of institutions on a regular basis. But we did about 2 weeks ago host what we refer to as our Strategic Initiatives Symposium in Dallas. We invited about 150 of our largest customers, bank and credit union customers. Almost all of them showed up for that conference a couple of weeks ago, and they were a very positive group, a very optimistic group. So we'll see what continues to happen with the economy. But overall, right now, the feeling is pretty good among our customers, and they're willing to spend money as evidenced by what's happening in the sales channels for us today.

And one thing that's been interesting to me is, for as long as you've covered the stock, I think the slide has been up that you'll either grow 6% or 7% or something like the revenue build. And a few weeks ago, you put up the slide, it's now 8.5%. So it almost seems like there's something sustainable. It's not just that the demand right now is good, but there's a sustainable better demand. Maybe why might it be sustainable?

Yes. So it's a couple of key components to that. One is, we've really made the transition over the past several years to being -- we're not exclusively a SaaS company, but we're getting close to being exclusively a SaaS company. So every contract we sign today, we're signing long-term agreements with a SaaS model as opposed to selling license software. And so when you think about that, a customer signing of 5- or 10-year agreement and that revenue just gets layered in, we're adding more and more customers, and all that revenue is layering in. They're long-term contracts, long-term commitments. So that gives us a lot of visibility into the forward-looking position as far as top line revenue and top line growth. And then on top of that, we've been creating -- innovating over the last several years, a number of new solutions that we brought to market. And we're having great success with many of those. You and I have talked many times about our digital banking solution, and you may come back to that. But digital banking is hot right now, digital online, digital lending, things like that. So the combination of those things, this layering on of revenue that's very predictable for us and is continuing to go up. So if you're not losing revenue on the bottom end and you keep layering on revenue on the top end, that produces that growth. And then on top of that, this influx of new technology solutions that we've been innovating in the past few years has really helped create that environment for us. And by the way, on that topic of innovation, off your question, but I'll just mention it here anyway, so Jack Henry, again, last Friday, maybe some of you saw the press release we put out last Friday, American Banker every year now, which is pretty much any banker in the U.S. subscribers to American Banker. They recognize on an annual basis, the top 50 fintechs, so the top 50 fintechs to work for and Jack Henry again this year was named to that list. They only recognize 50 companies, 49 of the companies on that list would fit the profile you would think of when you think of the word FinTech. So less than $100 million in revenue, fewer than 500 employees, that kind of company. So 49 companies fit that profile. And then there's Jack Henry, $2 billion revenue, S&P 500, 46-year-old company. But we're again on what I refer to as the CoolKids list because of all this innovative technology that we're delivering. And the key thing for us is none of our major competitors have ever made that list. And Jack Henry continues to make the list because of all the innovative things that we're delivering and we're being recognized for that in the market that we serve primarily.

And maybe one other just high-level question, just margins like you're growing fast, but is this nice profitable revenue growth, do you expect margins to go up?

It is, yes. So what we've telegraphed to the Street consistently now is that we're -- we believe that it's sustainable for us to achieve about 50 bps per year in margin expansion. So as we're growing top line, we're also continuing to look for opportunities to improve margins. And I think 50 bps is a good expectation for us going forward.

Yes. In the core segment, what is that 30% of revenues or so, why have you taken share? Over time, we have, I think, about 15% of the U.S. banks and credit unions, something like that, but why have you taken share over time?

So today, we have about 26% of U.S.-based banks and credit unions, but we're continuing to add. And the thing that's important for people to understand is on the core side of the business, pretty much any bank or credit union today, there are maybe 5 exceptions, but pretty much any bank or credit union is using a third party to provide their core processing solutions. So whenever we win a new core, and I talk about that regularly on the earnings calls, we are taking share from somebody else. We're taking away from one of our major competitors. It's almost nonexistent for customers to write their own core solution anymore. And by the way, when I refer to core, in a bank or credit union, that's the primary accounting system that processes loans, deposits and GL. That's what the core system is. So think about it as that major accounting system. Everything else ties into the core. So mobile banking and check capture and voice response and all the other things they do, but the core is that heart and soul accounting system that the banker credit union depends on. And as you point out, Dave, we're continuing to take share at a rate of about one per week -- one new logo per week. So that annualizes out to 50 or 55 per year. And it's lumpy. There are some weeks where we'll sign 3, some weeks that we sign none. But over time, it's about 50 to 55 new logos that we're winning per year and we are well ahead of anybody else in the space. That was a run rate we were on for about 3 years leading up to the pandemic. Pandemic kind of threw all the sticks in the air, everything, all the rules changed there for a little while. Nobody was signing core deals. But now we're back to that rate again for the past 3, 4 quarters where we're signing one new core customer a week. And it absolutely feels sustainable for us right now because of the demand. We have a lot of visibility in the sales pipeline. They're long decision cycles. And so right now, that feels very sustainable for us going forward.

Great. Great. And you've had the shift of taking your core software where it's been a license maintenance deal for years. You had the shift where a lot of your clients are starting to use more of the full-service outsourcing model. What kind of -- how far along the journey are we and what's left?

Yes. So if you look back at the history of our company, we started out as a software license sale company, and this is a long time ago before I got to Jack Henry, selling only licenses. About 25 years ago, we moved those solutions into an outsourcing environment and then started on the process of working with our existing license customers to move them into the private cloud environment. And today, pretty much any new customer we sell, they take the private cloud option. They don't buy license anymore. And to the point you're making, so for the customers that had the license version, we convert about 50 of them per year. We still have around, I think, it's 600 or 700 of those customers. So about 50 a year, we have several years of that runway to go for us to get everybody over the public cloud. But we're -- almost anybody knew that we sign -- well, really anybody knew we sign -- signs up for the private cloud environment. So today, we're around 65% private cloud, 35% licensed. But again, that license number is going to continue to decline. The private cloud number is going to continue to increase. And when you look at the financial model, that's a very good thing for Jack Henry because we use the same customer service folks, the same install teams, all the infrastructure that we have other than hardware, everything else is the same whether you're on the license model or on the hosted model. So when we convert somebody from license over to the hosted private cloud version, we might have to buy a little bit of hardware, might not, because the infrastructure is there. We don't have to hire people because they're already supporting these customers. They just support them in a different model and yet the customer pays significantly more because they don't have to buy hardware anymore. They don't have to refresh that hardware. They don't have to have all the talent in-house to manage everything. So they can see a significant cost reduction, so they will pay us significantly more when they come to the hosted model and yet our costs go up minimally when that happens. So we have many years of runway. It's a very predictable transition that's happening among our customer base.

Yes. And you're paid on a number of accounts in the core systems?

For our hosted version. So if you license the software, you pay a license maintenance fee annually. But for our hosted solution, for the core, we're paid on a number of accounts. And there's -- for many of the things we do, there's an asset component, too. So as your assets grow, you pay Jack Henry a little bit more. But then for many of our other solutions, we're paid either on registered users, we're paid down per transaction as we get into the discussion on payments and those kinds of things. But for the core side of the business, it's primarily a number of accounts that were processing. Yes.

And so if we're in a higher rate environment and consumers go back to buying CDs, that would seem to be a catalyst for accounts. And then similarly, if we start having crypto accounts, could -- those it seems like you'd have to have their own bank accounts. Like could you have this big catalyst coming?

You are correct. Yes, that's absolutely right. It's because we're not paid on what are the balances in those accounts. We're paid on the number of accounts. So as they expand the number of accounts, CDs as a great example, I think that's a real thing that might be on the horizon. Crypto is an interesting discussion because the only state that allows you to -- allows the bank to take custody your crypto balance today is Texas. So if you're a state charter bank in Texas, you can take custody of crypto balances, which would imply a new account. No other state today is allowing that. And there's lots of talk and New York DFS has said that they're going to not allow that. And so we'll see what the evolution is there. But for states that allow custody of crypto balances, if the bank is going to take that on to their balance sheet, there is an implied new account required for that customer. Yes.

Is that why you live in Dallas because of your big crypto account?

I'll tell you -- I don't yet, but we actually have a customer. So Jack Henry customer today, who is mining crypto, they've created their own stable coin. They announced it at our client conference a couple of weeks ago that they were doing this, but they haven't done the big splash public announcement. So as soon as they go public, Jack Henry is very deeply ingrained in that project. We're also partnered with the USDF team in -- that's active in community regional banks. They're running on our platform as well. So we're very involved in that space, but there's a lot of evolution that still needs to happen there to figure out winners and losers and what are the rules going to be and all that kind of stuff so...

Yes. While we're on core platforms, if we might as well talk about the transformation, like the new open kind of model, our open architecture. Can you talk maybe a little about how the system is going to change over the years?

Sure. Yes. So traditionally, Jack Henry, we support 4 different core solutions. So we're the most focused of all the providers out there. We've limited our number of cores to 4. But all of them are delivered just like everybody else in the industry, delivered through a traditional model with kind of legacy development concepts, hosting in a private cloud, not a public cloud. And so all of us are kind of in the same boat, those of us who provide core solutions. What we -- part of our job at Jack Henry is to try and see around corners and figure out what does the future hold for our banks and credit unions and what are they going to want to be doing in the future? And so a few years ago, we started strategizing about what does the future look like, particularly related to public cloud? We know that at some point or we believe that at some point, customers are going to want to be on the public cloud. There's a lot of benefit, a lot of advantage to being fully deployed on the public cloud. Today, really nobody doing it because the regulatory environment is undefined, and there's no bank CEOs that want to get crossways with the regulators. And so -- and most CEOs are kind of real hesitant to put kind of the crown jewels on a public cloud platform, but we see it coming. There will be demand in the future. And so a few years ago, we started strategizing about that and trying to figure out how do we get to the public cloud? And there's a few ways that you can do that. You can take your current private cloud platform and say, okay, we're going to rewrite it. So do a lift and shift. We're going to rewrite it, so it will operate on the public cloud. That is not a public cloud native delivery, but it's an option. It's something that would work. So we looked at that option. And -- but what we settled on was that we wanted to be truly cloud native. So we're rewriting kind of the best functionality of all of our cores, rewriting that functionality to put it on this public cloud platform. But at the same time, we started rethinking what does core mean. Because we see a demand in the future for customers who are going to want to kind of pick and choose fintech solutions that they tie directly into the things you traditionally think of as core. And they want to do it more easily than what you've been able to do in the past. And so what we ended up doing was we're redefining the core. We're breaking out the pieces of core into discrete components, I think in terms of roughly 30. That's not a hard number, but kind of think in terms of 30 major functions that the core does regardless of who, what core you're talking about. And we're rewriting those as components and putting them as cloud-native components sitting on a public cloud platform that our customers can consume a la carte, if they want to. And I'll come back to that in a moment. But we already have the platform. It's already up and running on the public cloud. We're -- our goal is to be cloud agnostic. We're live in Azure and AWS right now, working with Google. So our goal is to be cloud agnostic. But we already have a platform up and running in the public cloud. It supports our digital banking solution today, which has been in market for 6 years. So we have a lot of experience doing public cloud native development and delivery and DevOps and all that kind of stuff. So we know how to do all that. We already have our complete API layer on the public cloud. We're supporting about 650 different fintechs today using that API layer through that public cloud delivery. But what we're in the process of doing is completing all of these components and putting them on the public cloud. So now we can have a complete core stack with all of these complementary solutions and fintech connectivity. So we talked about this. I announced it in February in the earnings call. And that was not a product announcement. It was not a message to investors to say, "Hey, you're going to see a great big revenue influx in the next quarter or even year." This was about strategy. This is about where is our company going for the long term, and it was really designed to telegraph to our customers and prospects. If you're trying to figure out how to get to public cloud, here's how Jack Henry is going to do it. Here's where we're going and here's how you can partner with us to get to that platform. So this will be a long-term delivery. There's a lot of development work to be done. But it's something that we're committed to because we believe the long-term best position for our customers will be to be on a public cloud native platform. And the real value there is when you're full on public cloud, you have all the advantages when it comes to the design tools. So think about any app that you have on your phone that you're running today, right, all that stuff, that's all supported on public cloud, all the design tools that you can take advantage of in that environment. The security infrastructure is very robust in that environment. You can take advantage of bursting for processing, so particularly for banks and credit unions. At the end of the month or periodically, they have these real requirements for excess processing. When you're in a private cloud environment, you only have as much processing capacity as you have. In a public cloud environment, there's so much opportunity to do burst processing and then just scale back down again. So it's a very efficient model for our customers to take advantage of. And then for us, we can take advantage of what's called a DevOps environment where -- and we do this today with Banno. So you think about a traditional software company, they're delivering new releases of software, new feature function maybe 1 or 2x a year. And all of us in the core business, that's the model we live under, 1 or 2x a year, our customers get new releases. In DevOps, where we have our Banno application, for example, we're doing 20, 25 releases a month because of that opportunity to do rapid deployment. And so we're going to really change the dynamic of what core is by putting these components on the public cloud platform and then taking advantage of all those efficiencies and tools that are available to you only if you're truly a public cloud provider. So it's a major move for our company. But again, it's -- this will take years to roll out. This isn't 1 year and we're done kind of a thing.

Yes. Yes. And maybe if we can move to payments. So about 35% to 40% of revenue is payments. Debit processing, the biggest part of it. That's a little bit challenged right now just because it was -- it grew so fast, right? Debit volumes of [ Visa, Mastercard ] grew so faster in the pandemic as all the stimulus, now they're hitting tougher comps. Is that -- how close are we to like reaccelerating back to high single digits?

Yes. It's a good question. So -- and we are -- best indicator for us on our debit business is if you follow the Visa, Mastercard debit numbers, we track pretty closely with them. The big difference with our business is we get paid on transactions, not on the dollar amount for those transactions. We don't participate in the interchange. And so even as there's challenges in the economy, people are still spending money. They may not be -- the ticket price may not be as high. It doesn't matter to Jack Henry. We get paid per transaction. And so I don't have a crystal ball on that. We believe that, that opportunity is going to reemerge here soon as far as the volume of transactions. Essentially, we'll anniversary the real spike in volumes that you saw because of stimulus. We'll anniversary that and we'll then get back to kind of more normal growth rates. But the good news, I think, for your investors to know is when the economy is in trouble, Jack Henry, our model isn't really impacted because we get paid on a number of transactions, not on the dollar amount. Now the flip side of that is when the economy is on fire, we don't benefit either. But for us, that just produces a really predictable nice revenue stream when it comes to payments. And of course, you were talking on debit, we now also have the credit opportunity that we didn't have before. So we've started that sales engine. I guess I'll put it that way to start selling credit. You'll see us more involved in credit deals going forward as well.

Sounds good. And then the enterprise and ACH part of payments. So when we think of just payments and total is about a little over 1/3 of revenue. But when you take that segment itself, it's, I think, 60% debit, 20% enterprise ACH.

Something -- yes, little more than 20%. Yes. So its -- Enterprise Payment Solutions is the other piece that you're referencing and that's ACH origination in remote [indiscernible] capture growing amazingly well. So that business -- ACH has been around forever, why would a business like that be growing? It's because we have a number of customers that have become really active with their commercial customers to originate payroll and other types of transactions that they weren't doing before because we have such a robust platform available to them. The good news for us is we're a leader now in real-time payments. So 67% of all FIs in the U.S., that are doing real-time payments, are doing it through Jack Henry. So we are right there at the forefront of real-time payments. So the good news as far as I'm concerned is, as we're signing all these customers on ACH, when the day comes that they want to transition to real time, we're already the leader in real time, and so we have a great platform to just move them over from ACH to real time. And you might say, well, why doesn't every do real-time already today? Well, number one, it's more expensive. And number two, most back-end systems, commercial, not banking but commercial businesses aren't equipped to handle real-time payments yet. And so they have to go through that transition. There's not that much demand of their bankers to do real-time payments because they can't handle those electronic transactions on the back end yet, but it will come. And when that day comes, we're wonderfully positioned to move customers over from ACH to real-time payments.

Yes. Okay. And then Bill Pay is the last -- probably the smallest of the 3 now. That's been kind of flattish, growing low single digits maybe. Maybe is there a catalyst at some point for that to get better? Could you get into Builder Direct, for example?

Yes. So Biller Direct is an area that we have explored in the past. We have a small Biller Direct offering. But there are other things that, hopefully, next time we're talking to each other, I can talk about some of the other things that we see as real opportunities there. We're working on a few things right now that we think will present the opportunity to spark some growth when it comes to Bill Pay and kind of that platform, but nothing that I'm ready to talk about today. But Biller Direct is an opportunity. The challenge with Biller Direct is you sell directly to commercial customers. What we like to do is sell through our bankers, sell through the bank or credit union as opposed to trying to call on Verizon directly and get them to adopt our Biller Direct solution. And it's a very efficient model that we have selling through the bank or credit union as opposed to trying to attract all these commercial businesses directly. And so that's been the challenge for us in Biller Direct. It's a little -- it's a little contrary to what our normal model is as far as how we sell solutions.

Yes. Yes. Now what about R&D spend? Your R&D spend is a little higher than some of your competitors, it's about 14% of revenue. But is that maybe part of why you've been growing faster? And how do you think of that over time?

Yes, absolutely. So I think that's definitely been a contributor to our growth. It's the reason we got American Banker, top 50 fintech. It's all that recognition we're getting is because we're -- I don't -- I hesitate to say overspending because I don't feel like we're overspending. But compared to our competitors, it looks like we're overspending on R&D. But we're a technology company. Our value is in the solution that we offer and the service that accompanies that. And so you're never done when you're a technology company, at least if you hope to be in business for another 10, 20 years, you could sit back and milk the cow for some period of time. But our commitment is long term, we think long term about everything we do. And so we're always looking to innovate technology that will create sales opportunities for years to come. And to do that, you have to continue to spend on R&D. Particularly in this environment as the technology expectations of customers and the opportunity back to the public cloud discussion, the opportunity is tremendous, and the demands of customers have never been greater, I don't think, than they are today because our customers want to present a different experience to their customers and they depend on us to make sure that they're positioned to do that.

Yes. And after you bought Banno and you kept investing, isn't the growth there? I remember you had a slide that basically showed how it is faster, faster than almost any FinTech type growth that product like...

Yes. So Banno is referencing to as our digital banking application. So we bought this little tiny company 7 years ago now, probably. They were producing a little bit of revenue and certainly no EBITDA. But when we looked at them, we saw they had a unique vision as compared to anybody else in the industry, the vision that they had, the strategy that they had for delivering digital banking and this idea of regardless of form factor, you end up with the same experience. Whether you're on your PC or your phone or your tablet, it all looks and feels and functions the same. They were well ahead of anybody else in the industry. And by the way, I would challenge any of you, think about whoever you all bank with, pick up your phone, what's your experience when you're checking your balance on your phone and does it look and feel the same as when you're on your PC? Chances are not. But we have solved that problem with the Banno platform. So we saw what they were doing, saw that they were well ahead of the rest of the industry, required a lot of investment, required time and patience to get it all pulled together. But now we're in a great position with that Banno platform and signing customers, adding registered users. Very, very successful acquisition for us.

Yes. That's great. And speaking of M&A, what's your thought now? It seems like a lot of these faster growth companies that were trading at sky high, valuations have come down now. Are there opportunities now?

Yes. It's -- I think it's a pretty exciting time right now. So those of you who followed us for a while know that historically, we were known as a serial acquirer. We would do a lot of deals every year. We did 32 acquisitions between 2004 and 2015. And I'm very confident we are a good acquirer. We're a disciplined acquirer. We know how to source deals. We know how to price deals. We don't chase the shiny object. We're disciplined in how we do these deals. And we're really good at integrating acquired companies in, including the sales, getting the sales engine going in. So it's been frustrating in the last couple of years. Valuations have been crazy. IPOs were happening, companies that several of them who never should have IPO-ed, but they did because all anybody seemed to care about is revenue growth and the IPOs that happens. SPACs were happening. PE seem to be willing to pay anything for anything and for a strategic like us, it was tough to get a deal done because we just don't operate that way. Now a friend of mine a couple of weeks ago described what's happening with some of these smaller public companies that IPO-ed in the last couple of years, described it as they're going through the grieving process right now, trying to figure out where do we end up? Are we going to be able to get back to IPO price or not? And what if the shareholders pushing? And so I'm hopeful that there will be 1 or 2 or more of those opportunities that will present themselves. It's -- we're not there yet. There's a lot of people think we're going to return to the glory days and everything is going to be fine. The better opportunity is the private companies who are planning to IPO. There's a bunch of them out there. Now IPO is off the table. SPAC is off the table. PE maybe not as ready to talk to them because they're looking at rising interest rates and trying to figure out what are they going to spend, how are they going to spend. Now strategic like us, looks a lot more appealing to some of those guys who are facing a capital raise or what is their exit. And so I'm very hopeful that between now and the end of this calendar year, there will be some really nice opportunities and maybe something that we can take advantage of.

Yes. That sounds good. And just maybe a minute left. Just one other macro thing, inflation. How does that impact? Did you get CPI escalators in your core business and any other impacts?

Yes. We have CPI escalators in pretty much any contract that we have at Jack Henry. So all of those have been put into place with the exception of our license, our maintenance fees. So maintenance billing happen now for most of the things we have as license. They happened in May. Payments are due in June and July. That's when you normally see the big influx of cash at Jack Henry. So those payments are coming in now. Those -- that will be the last piece that was impacted by CPI for FY '22. And then for FY '23, those will kind of roll out during the course of the year, any other CPI increases. The thing I'll stress is at Jack Henry, when there is -- historically, when there's been not a real valid reason to do CPI increases, we haven't done CPI increases. We have them in the contract. But we don't take advantage of that just to juice revenue. That is in our model. It's not how we work our partnerships with our customers. And then when we do put CPI increases in, we put them in really to maintain margins. So it's not that we're going to try and drive a bunch of revenue growth. It's a pretty nominal increase just to make sure that we're covering cost and maintaining our margins. And that's what we've done with our customers. We've had 0 pushback. All of our customers are bankers. I mean they understand how the economy works. They understand how CPI works. And so as long as you're being reasonable about what you do, bankers don't push back, and we have had no issue with that so far.

Yes, customers first and you guys treat them well.

For sure. And that's what we're known for in our space as being a great partner to our customers, and we don't want to mess that up. It's not worth it so...

Yes. Well, good. Well, that's all the time we have. Please join me in thanking Dave and Jack Henry.

All right. Thanks.