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

All right. Great. Let's get started. My name is Nik Cremo. I help with the payments and fintech research team here at Credit Suisse, and I'm delighted to have Jack Henry management team here with me today. I have David Foss, Chairman and CEO; and Mimi Carsley, newly appointed CFO -- large client event last quarter, just in terms of how the outlook is looking for bank IT spending based upon those conversations?

Sure. So what Nik is alluding to is last -- in October, we had our big annual client conference. Thousands of people come to meet with us, just like any conference you can think about. During the conference, I also host a separate CEO track. So I had a little over 200 CEOs of Jack Henry customers and some prospects there with us. And so it's a great opportunity for us to talk to customers about not only potentially sales opportunities, but also what are they seeing and what are they thinking about, what are they planning as far as spending is concerned. We don't do -- I can't give you objective results. The Customers, X number of customers said they plan to increase their budget by Y. Don't have any of that kind of information as a result of that, all anecdotal. But the really good thing, as far as I was concerned, coming out of that was banks and credit unions, and we had a combined event, and most of these are community and regional banks and then credit unions. The bankers are not wringing their hands right now. This isn't 2007. What we're going through right now as far as the economy is concerned is not being driven by banks like it was back in the Great Recession. And so most of them, they have a net interest margin spread now for the first time in years. They actually are -- have the opportunity to make some money as far as net interest margin is concerned. And they're looking at new technology solutions to modernize their infrastructure, whether it's digital banking for serving their consumers better or digital lending for commercial customers. So lots of generally positive feel, I would say, out of our customers. When you look at the banking side, they're pretty well capitalized today. They don't feel like they have a lot of risky credits on the balance sheet. Their lending processes are pretty solid. They revamped a lot of that after the Great Recession. And so I think most banks and credit unions today are feeling okay. They're dealing with all the stuff that the rest of us are dealing with as far as the general economy. But I didn't hear anybody saying, we plan to cut back or we're not going to spend at the same rate that we've been spending at -- here in the recent past. So I think all of that is anecdotal, but all pretty positive within the last month.

Great. Next, it would be good just to hear about the top investment priorities that you're hearing from your customers and if there's any change that you've seen over the last like 1 or 2 years that you would call out.

Yes. So there's -- one of the things that the pandemic did was it accelerated demand for digital banking technology. That was already happening before the pandemic, but the pandemic certainly has accelerated that. And so one of the things I talk about a lot with investors and people that are trying to understand our industry, think about whatever -- however you -- everybody in the audience here, just think about whoever you bank with. I don't care who it is, I don't know who it is, but think about your experience with whoever you bank with today. Chances are what -- the experience you have on your phone is different from the experience you have when you sit down at your PC, right? You can do things probably on the online version that you can't do on the mobile version. And that's true for almost any bank or credit union in the United States today. Well, the Banno solution that we have today is -- it eliminates that problem. It's a single platform. Regardless of form factor, you get the same experiences. You can do all the same things. And so most banks and credit unions in the United States are looking to modernize their digital banking experience to get to that, to get to the point where the experience is consistent regardless of form factor. So that creates a lot of demand for us with our Banno solution. Certainly, it's true for anybody who has a modern digital banking platform. There is interest in demand out there. But because of the really wonderful industry response for our Banno solution, it's created a lot of demand for that technology. And then we can expand that to almost anything that we're doing as far as a digital presentation, commercial lending and fraud solutions, lots of demand for those types of technologies today as well.

So just following up on Banno. I mean the growth has been very incredible over the last 2 years, adding like a steady 50 or 60 customers per quarter. I mean, how far are we along in that growth journey for Banno? Like how penetrated is it in the core base? And can those -- can that keep up or...

So it's -- we probably have 25% to 30% of our core base today that's on Banno, but there is -- the runway is very long. Not only do we have the rest of the core base that we can sell that solution to and upgrade to that platform. But then as we start to sell it outside the core base, as I just mentioned, almost any bank or credit union needs to upgrade their digital banking technology to move away from mobile banking and Internet banking being 2 separate things and move toward a real digital banking experience. So the runway is very long. I get asked once in a while, what inning are we in as far as this is concerned? I would say overall or maybe the end of the first inning coming into the second inning. I mean there's just a lot -- I almost think of it as a greenfield opportunity these days because almost every institution needs to go through an upgrade to a true digital banking experience. So lots of opportunity for the future for the Banno platform.

That's great. And you guys are expected to roll out Banno for business here in a few months in early 2023. Can you talk about the demand you're seeing for that? I know you have, I think, like 150 or 160 customers already signed up.

Yes, we do. Yes. So to clarify, for those of you who maybe don't know the story, so Banno, when we originally rolled it out as a digital banking platform, it was only a retail platform, meaning only for consumers. We didn't develop the commercial banking side until just recently. And so we're rolling that out now in calendar Q1 of '23. But to the point Nik's making, we already have, at least on the earnings call, I think there have been more signs since the earnings call. But as of the earnings call, we had 160 customers, existing Banno customers who had signed for the Banno business component when we rolled that out in the quarter. And so what this does is it creates for our customers the opportunity to serve their retail customers and business customers with the same digital banking solution that accomplishes retail functions, but then also cash management functions. So think about the business side as a solution that would serve small, medium businesses as opposed to a large commercial enterprise. We have a treasury management solution that is also digital that's also on that platform that serves large commercial businesses that our bankers bank. But for this Banno business component is for SMBs, so they have the same experience that they have on the retail side. And as I said on the call, we expect demand there to be tremendous because we've already signed 160 customers, and we don't even have the product in market yet. So we think once we get it rolled out and people can actually see it in production, that's going to drive a lot of additional demand.

Can you just discuss how Banno for business stacks up to what your customers are currently using to serve their SMB clients?

Yes. It depends on -- there's a wide variety of things that they may be using today. So a lot of our core customers are using what's called NetTeller cash management. So NetTeller is our legacy Internet banking solution. It's a really nice, robust cash management platform. So a lot of our core customers are using that outside of our core base. And even inside of our core base, they may be using a variety of other solutions or nothing as a digital banking solution focused on SMBs. There are a lot of small, medium businesses out there who use the retail digital banking platform because it provides most of what they need without true cash management functionality. So it's a real mix of different things that customers might be using to serve their small business customers. But this, like I said before, allows them to bring everybody to a single experience, a single platform and really serve the needs of those small businesses more effectively than they can using a retail platform.

Understood. Very helpful. Mimi, maybe one for you. Is there any way for us to think about just how the monetization of Banno business compares to the consumer product and if there's any way for us to think about a potential revenue uplift that Jack Henry could see over time?

Yes. So I think as Dave spoke about, we have a robust pipeline in the works of customers sort of looking to sign as well as opportunity to go outside the base. And so I think there's a lot of greenfield there. We don't publish the numbers for the Banno contribution within the segment. But I think if you go to other competitors and we publish the number of users, you can kind of get an estimate of what that size magnitude is.

Interesting thing to keep in mind on the business side is, so when you think about the consumers, you sign -- consumers sign up one at a time, right? So each user -- registered user, I share those numbers on the call. When you get to the business side, when a business signs up, there's one business, but they will sign up multiple users within the business. We will get paid on the users, not a business. So you can really correlate the number of users that a business would bring with the number of users that we've already published when it comes to the retail side of the bank as you're kind of trying to think through how might this business grow and what will the revenue impacts be on Jack Henry.

Understood. Mimi, maybe another one for you. I know margins is always a focus for all of our companies and especially Jack Henry as of late. First, I mean, can we just review the underlying drivers for flattish non-GAAP operating margins this year and then also, like what your confidence is for getting back to margin expansion for next year?

Sure. So I think a lot of the headwinds we were seeing in FY '23 are really unique to this year, and none are really unique to Jack Henry. It's really what most companies out there are facing. So there's a couple of things. One, we've returned to travel. We started resuming travel as an organization. So that was coming out of the pandemic, obviously, not in the prior year numbers. The second is the return to travel is at elevated costs, as anyone who flew here today could experience. And so that certainly from a run rate going forward going to be an easier comp perspective. The other is wage inflation pressures that we've been seeing have been across the board. I think particularly in the areas of R&D talent, it was incredibly a competitive marketplace out there. The others, there's a lot of third-party costs that we were faced with, the other companies are faced with, costs like insurance, other providers, things like job also not being free that we're seeing that creates a 1-year kind of headwind. And then there was this year, as Dave mentioned, our user conference, the first time back in person, which we're quite excited about regathering, was in the first quarter. And so previously, we had 2 user events. Both were virtual last year, so less cost to run those. And so going forward, it will be in Q2 going forward next year. But Jack Henry remains committed to margin expansion. It's part of our core strategy. And so there's nothing that is structural that I see that would prevent us from returning back to a margin expansion story.

Great. I know another part of the 2024 margin picture relates to the Payrailz acquisition and that becoming accretive. Can you just kind of walk us through like kind of like the high-level pieces of that? Like how we get to being kind of like breakeven or accretive next year in terms of revenue synergies, cost synergies and how we should think about that?

I'll take that one.

Sure.

So first, Jack Henry has been a very successful serial acquirer. We have a very robust diligence process, a strong playbook on integration. I think we'll touch probably upon the M&A landscape. I'm sure people are curious to hear. But we're quite excited about the Payrailz acquisition. It was a dilutive acquisition out of the gate. We feel comfortable that in FY '24, it will return back to accretion. There's a couple of things that are unique in this acquisition. Jack Henry doesn't typically do a lot of acquisitions that rely on cost synergy takeouts. But there was some cost synergies in this acquisition, some that were early right out the gate, others that will be a little bit longer in comparing contracts and comparing some of the underlying costs for the payment railz, Jack Henry has more favorable terms than Payrailz did. And so that's one of the paths that we get to. There's also -- both companies were -- had significant development organizations to modernize the platforms. And so looking at a combined organization, there are some synergies there as well.

Okay. Great. All that makes sense to me. Just on the topic of Payrailz, I mean, can you just provide a little context into how that fits into Jack Henry's broader payment strategy?

Yes. So this is an interesting company. We started following them probably 3 years ago. We thought they were doing some pretty innovative things. And so the idea that we were able to complete the acquisition is pretty exciting for us. The reason that they attracted our attention in the first place, well, several reasons. Number one, this is a public cloud-native payment solution. So the platform is built on the public cloud. It's totally consistent with the strategy that I articulated to investors in February of this year. So that was attractive to us. Beyond that, the platform really contains 4 primary payment functions. So there's a bill pay component. So if you know anything about Jack Henry, you know we have a very widely installed bill pay platform today called iPay, but it's running on technology that's now getting older. And so we were facing the idea of having to rewrite that platform to bring it forward to the public cloud. With Payrailz, we have a public cloud-native bill-pay platform. So that's attractive to us. Second piece is Payrailz includes a P2P payments function, and so person-to-person payments that is -- that can stand as an independent platform or an independent function, and the participants don't have to be in network. So for example, you could send money to me, Nik, and we don't have to bank at the same bank. Whereas like with Zelle, for example, both you and I, if we don't bank at the same bank, we have to both be in the Zelle network. With our platform now, that isn't true. You can stand this up and you can be independent of -- or don't have to be both in network in order to facilitate transactions. This platform has an account-to-account transfer function. So if I have accounts at 2 different institutions and I want to move money back and forth, it's an intuitive public cloud-native web design-type experience for me to move money back and forth between accounts. And then the last piece is a business-to-business payments -- electronic payments component. And so any of you who have followed us for a while and have asked me about what does Jack Henry want to be in long term, one of the answers I've given is B2B payments because I believe that as that industry matures and more commercial businesses can accept electronic payments. A lot of them today can't. But as that industry matures, that's a business that we want to be in, working through our customers to serve their commercial customers with B2B payments technology. So if you roll all those things together, that's what really made this appealing to us, all public cloud-native, all taking advantage of all the design tools that you have on the public cloud, the security infrastructure that you have in the public cloud. That's why this was particularly appealing to us. And so it will either augment things we have today or with the bill pay platform, it will end up supplanting over the long term the solution that we have today.

Very helpful color there. Just while we're on the payments business, your largest segment, I think it would just be helpful to review like the 3 main subsegments of payments. And what are the kind of growth drivers for each?

Yes. So as Nik alluded to, 3 primary components in our payments business, our payments segment. So the first is the bill pay business. And as I've said for on many calls and in many settings like this over the past 2, 3 years, bill pay is growing slowly. It continues to grow, but it's the slowest grower in the payments bucket for Jack Henry. The second piece is our card platform. So we offer both debit and credit. Historically, Jack Henry was only in the debit processing business, so debit issuing. Today, because of the new platform that we put in place now, I guess, 3 years ago or so we finalized that, we can offer both debit and credit. So we're in that business. That business is growing nicely, growing faster than the bill pay business certainly. And then the fastest grower is what we call Enterprise Payment Solutions. So EPS is our mode post capture and ACH origination business. And you might say, "Okay, wait a minute, ACH origination." That's been around forever. How can that be the fastest-growing?" But it's really interesting. There's a lot of movement in the industry of people who originate ACH transactions looking for a really quality provider, and Jack Henry has that reputation. So we're grabbing new share in that space for ACH origination because there are just a lot of businesses out there who depend on ACH. And we're known as a real quality top-tier provider when it comes to that line of business.

Got it. Very helpful. So just in terms of your tech modernization strategy that you announced earlier this year, can you just give us an update on how that's progressing and maybe just like a brief overview of like the key parts of that?

Yes. So what Nik's alluding to there is back in February, on the earnings call in February, I talked about our tech modernization strategy. And this was a strategy announcement, not a product announcement. And the reason I did it in February was to make sure that customers and prospects and investors know where we're going as far as public cloud is concerned. And so this is a long-term strategy. But on the core side of our business, what I articulated is we are in the process of rewriting our core platforms at Jack Henry to live on the public cloud. This is not a lift-and-shift. So we're not taking what we have today and making it work on the public cloud. We're literally rewriting our solutions to take advantage of all the positives of being public cloud-native. And what we decided to do -- and we've been working on this strategy for years. We've had developers now for 3 years that have been writing code, but we just announced it in February just because we were real. We had products in beta by that time. And so we wanted to make sure people knew where we were going. So what we've decided to do is to unbundle the core. So if you think about a core system today, a banker or credit union buys a core. There are a number of functions in this solution, and we're unbundling all those components and making them stand-alone components on the public cloud so that customers can consume them either in a menu approach. I can buy these 5 things from Jack Henry, and I can buy these 10 things from fintechs and put them all together on the public cloud. So that's one option. Or they can bundle things together from Jack Henry and buy them as a bundle but all public cloud-native, all supported by a very robust API layer. And so our plan is over the next 10, 20 years, we'll be moving customers and signing new customers on this public cloud deliverable. So we're continuing -- to your question about how it's progressing, we're continuing at the pace that we had originally laid out. We have wires in production today. We have 2 other modules that are in beta today. We published last month for our customers, we published the road map so they can see where we're going as far as delivery of modules and make sure that we're kind of keeping up with our commitment as far as time frame. I had originally intended and hoped to publish that road map publicly, but we're learning now that there are other players out there that are hoping to emulate what Jack Henry is doing. And so we decided maybe that much transparency wasn't a great idea. So we're not publishing that publicly, but we do have it available to our customers now so they can follow along with what Jack Henry is doing and line their strategies up to our time frames.

Understood. Very helpful. Mimi, maybe one for you just on capital allocation. Private fintech valuations are still pretty high. So just kind of curious as to how -- like what are Jack Henry's priorities today? And in terms of M&A, are there any like particular areas where you think Jack Henry could beef up some of your current solutions there?

Sure. Happy to. So I think we're in the fortunate position that we have high free cash flow generation and conversion and relatively modest debt, certainly relative to peers, extremely low debt levels. And so as we think about capital allocation, we have a long-standing dividend policy over 33 years of increasing our dividend. We remain committed to that. And we like acquisitions. As I said previously, Jack Henry has been a very successful serial acquirer, over 50 deals. We feel it's a good part of our growth strategy, a way to be additive and accelerate some of our tech road map. So we're hopeful. At the moment, there's not much happening. We thought there'd be more. Dave is quite disappointed. I think he thought there would be more at this stage. But valuations -- public market valuations have come down. Private companies haven't necessarily conceded to the reality. We're hopeful that more opportunities come up for us to evaluate. But in the absence of that, we will continue to look at ways to continue to invest internally and look to return capital to shareholders as well.

Let me tag on to the point about the types of things we're looking for. So if you look back at the history of Jack Henry, where we've had a lot of success in M&A and I view us as a very successful acquirer because we're very good at sourcing deals and integrating those deals in. But where we've had lot of success is where we find those solutions that are complementary to something we already have. So we have a good solution in market already. We find somebody who has got a complementary solution. We put those 2 things together, create a whole new story for our customers. That's where we really had great success over the years. The one example I would give is we -- several years ago, now 5, 6, 7 years ago, we ended up acquiring 4 little companies. All -- none of them were needle movers in the grand scheme of things, but all with really great technology. And they -- none of them could quite find their niche as far as how to sell what they had. But we put those 4 groups together, a lot of investment to pull those together. But what we created is this end-to-end online digital commercial lending solution so we can manage the experience for commercial loans. These aren't consumer loans. These are complex commercial loans. We can manage the process from beginning to end, including managing the life of the loan after it's booked all digitally, so including all the financial refresh year-on-year after the credit is booked. And so by doing those little acquisitions and really understanding the demands of our customers and understanding the industry, we created this very robust commercial lending solution. And so we've done those types of things over and over and over again. That's where we really tend to be successful when we find those opportunities.

Got it. So one thing that's distinguishing Jack Henry as of late is just the trends that you're seeing remain robust, where some of your competitors are seeing some sales cycles extending and maybe tapering off a little bit. But can you just walk through kind of like what you're seeing today?

Yes. So it's very encouraging as far as I'm concerned. So what I reported on the last earnings call, we set an all-time sales record in our fourth quarter, which is the June quarter. So we had set an all-time sales record, blew the numbers out of the water in June. Normally, after you have a really successful quarter like that, the next quarter, our fiscal Q1, normally, that's a down quarter. And we've seen that for many years, down quarter. The interesting this year was, was it down as compared to Q4? Yes. But it was significantly up as compared to Q1 the prior year. So that was interesting. And the more interesting thing beyond that for me is that the pipeline, as I sit here today, is by far larger than it's ever been. So pipeline being those opportunities that are being worked by sales executives to turn into signed deals. And so when you add all those things together, the demand today for Jack Henry solutions is very robust. And I can't speak for any other company. I don't know if they're seeing similar demand. But at Jack Henry, the demand today is really remarkable. And so that generally is pretty predictable. I've run sales organizations for much of my career, and you can normally take the pipeline and you can assume that X percent of whatever is in the pipeline will close over a particular quarter. And so mapping that out, it looks like sales should continue to be reasonably robust. The thing to keep in mind with regard to the Jack Henry model is almost everything we sell today is a SaaS model. So you don't see a pop in the quarter. What you see us do is layer revenue on. Once we sign a deal, it layers on, normally long-term contracts, SaaS contracts. So we're just continuing to build that revenue contribution over the long term by signing those contracts.

Understood. So in terms of the M&A environment for your customer base, I know you mentioned over the -- on the last earnings call that things had slowed down compared to the prior year. Was just curious if you've seen any update over the last month or 2.

So that is holding true. In fact, I was in New York last week, I think it was -- no, week before last, and met with the CEO of the largest bank M&A firm in the country. They do more bank M&A than any other investment bank. And he confirmed that, that has not changed. M&A has slowed. Bank stocks have taken a hit. And so most bankers are kind of waiting and watching to see what happens here. His prediction was that probably next summer, if things kind of continue the way they are, things might start to loosen up. But -- and we're definitely seeing that at Jack Henry. We've seen less M&A activity at Jack Henry than we were seeing prior to this summer, let's say.

Understood. It looks like we have about 3 minutes left. We can take questions from the audience.

Yes. Okay. So just a 2-part question on bill pay as well as -- I think you said a number of times that you're looking to becoming cloud-native. So on the bill pay side, your platform of cloud-native is going to be the company that you acquired. Is that correct? And then for the other 2 segments that you highlighted, would that be more organic with substantiation from acquisitions that you've done in the past, maybe that's on public cloud? As well as on the M&A side, it does seem that, obviously, on the bill pay side, there is some context to being around scale. So the bigger that you are, you can control your costs better. But I think you mentioned that you don't do a lot of cost takeout, M&A stuff like that. So on the bill pay side, specifically on M&A because you have the platform for cloud-native, would there be more of a strategy of acquiring scale on the bill pay side? And then for everybody else, it would be more of the modernization of the platform?

So the thing to keep in mind on our bill pay business, we are definitely at scale today. We serve more than 3,000 financial institutions today with our bill pay platform. So we're one of the largest providers already when it comes to bill pay. So this move with Payrailz -- and again, I highlighted the 4 different components of Payrailz. But as far as the bill pay component of Payrailz, that allows us essentially to move our bill pay business to the public cloud without having to rewrite this huge platform that we already have. So that's where the opportunity is. Now there is -- I certainly see the opportunity for continued organic growth with a very modern platform that's cloud-native. And so our hope is that we can uptick the bill pay growth some. But again, we're one of the largest providers already in bill pay. So you're not going to see a 40% growth or something like that on a very large number, but we think there is opportunity to grow bill pay. The greater opportunity as far as I'm concerned is all those other things that I highlighted that we're not doing today that will all exist on the same public cloud-native platform for us to leverage going forward.

Looks like we have time for one more quick question. Is there any more from the audience? All right. Well, David, Mimi, thank you so much for coming here. Is there any final thoughts you want to leave the audience with or just leave it there?

No. I think we've kind of touched on a few things today. The industry that we're in today is exciting. It's dynamic. There is a lot of change happening. I've told several people, I'm a technologist at heart. My degree -- I'm not a finance guy. My degree is computer science. It's never been more exciting as far as I'm concerned than it is right now to be in this industry, to be in this business because of all the innovation that's happening. And we are reaping the benefits of Jack Henry because we have this reputation now for being a real leader when it comes to innovative technology. So we're looking forward to continuing that.

Yes. And I think from my perspective, I think just reiterating the stability, the resiliency of our model, the high quality of earnings and high reoccurring revenue, especially in these kind of volatile times.

And 90%-plus recurring revenue is not a bad thing to have right now.

It's a great thing to have right now and great customer service.

Well, thanks so much, guys. Appreciate you coming.

Thank you.

Thank you, Nik.