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

We'll go ahead and get started here. Thank you very much for -- to all of you for joining us here at the NASDAQ event. Great to be back in person after a few-year hiatus. And at the same time, very pleased to have Jack Henry back with us again at this event. Mr. David Foss, CEO and Board Chair of Jack Henry, is joining us. Also here in the room today with us is recently named CFO for Jack Henry, Mimi Carsley. I think she was saying she's only the third or fourth CFO in Jack Henry's history.

46-year history, yes.

46-year history. So good, if you have an opportunity to get to know her, obviously, that will be great; as well as Vance Sherard, who's VP of IR.

So I guess maybe I wanted to just start really quickly. And we were talking last night at dinner, Dave, that one of the funny things about Jack Henry is that you retain your customers and you hold on to them for such long periods of time, but you have this very high-margin line item called deconversion fees. And deconversion fees, a lot of times, can move around and it can move both top and especially bottom line, around in ways that maybe investors aren't prepared for. So maybe can you help inoculate us against like what happens with that? What those are? And how we should be thinking about those? Especially because they can be a little volatile.

Sure. So just to kind of set the stage for this, if you look at Jack Henry, we are a full suite technology provider to banks and credit unions in the United States. So by strategy, we serve the U.S. domestic market. We could be international, we choose not to be international. We choose banks and credit unions in the U.S. And in that market that we serve, and again, it's a very full suite of solutions. So pretty much any technology you need to run a bank or credit union, you can get from Jack Henry. We run a SaaS model primarily, so they're signing long-term contracts with recurring revenue, so it's a very stable revenue model. The exception to that is what James is referring to, we call it deconversion revenue. So M&A happens in our space where banks are acquiring other banks. It doesn't happen much on the credit union side. But on the banking side, banks acquire other banks once in a while. And so if one of our customers is acquired by another institution, they have to buy their way out of the contract, right? They've signed a long-term agreement with us. It's a recurring revenue agreement. So if they get acquired by somebody, they have to buy their way out of the contract. That's what we refer to as deconversion revenue. So it's a onetime shot to Jack Henry. It's high margin because they're essentially buying their way out of the contract. It's a challenging thing for us because we have no idea when we're going to get this revenue or if we're going to get any revenue, right? So when somebody announces they're being acquired, we had no hand in that. There's not a reflection on our operation when that happens. It's just that somebody got acquired. Now the really good news for us is it doesn't happen very often at Jack Henry. But when it does happen, oftentimes, the buyout is a large number because they're -- let's say, they're 2 years into a 10-year agreement, they got to buy out the remaining 8 years of that contract. So you can sometimes get a big pop in revenue. But what I -- the phrase I use all the time is it's revenue that you, as an investor, don't want to see. You don't want deconversion revenue because that means we're losing a customer. And yet so many people are focused on it because it's a high margin. You get a big pop of revenue and it's high margin, and it can impact the quarter. But trust me, you don't want to see us with a lot of deconversion revenue because that's not a good sign for the company as far as retaining customers. And so it's difficult for us to predict. It's not a reflection of the operation of the company, and it's not revenue that is helpful overall to the business. So we always -- we'll call out deconversion revenue, specifically make sure that our investors know how much revenue is coming from deconversions and how much we expect, even though where it's a little bit of a crystal ball thing for us. We try to project, based on what's happening, as far as M&A, what you could think of a reasonable number for deconversion revenue, but it's really -- it's that revenue that none of us want.

That's right. Yes. And to your point is it's interesting, like I'm always looking at a guess for market inefficiencies, even if short lived. But it is interesting how like if you've got a forecast right now of $30-ish million, $35 million in deconversion revenue, and if you miss that number, like, is it going to put downward pressure on my EPS estimate? A little bit. But to your point like, but that raises long-term revenue and earnings in a meaningful way.

For sure. Yes, it's much better for the company if we don't see deconversion revenue because then, those contracts stay in place. And again, they're long-term contracts. Good, solid, predictable revenue for us. And so we normally -- if we "miss" on deconversion revenue, even though it's a total guess, it's not based on any operation of the company. If we miss on deconversion revenue, we're penalized sometimes, and yet, it's that revenue that you don't want. And so I think that's the key point.

Good. All right. So now we've done the inoculation for everybody that's new to the name. So let's talk about like probably the best place to kick off is maybe at least for right now is just the macro environment, right? And some of the local -- or some of the European-based comparables have talked about struggles with their own business in Europe, et cetera. You on the other hand have said, "Hey, at least most recently, things stand pretty good." What are you seeing right now from banks and your credit union customers? And how are they treating and planning for the current environment? Are you -- and I guess it would be easy for me to imagine at least some lengthening sales cycles or more sign-offs, but that's what I would imagine. What's actually happening with the customers?

Yes. So it's interesting. We've heard a lot of folks in our space talk about lengthening sales cycles or their challenges in selling. Jack Henry is not seeing that at all. So I reported on the last earnings call, our sales pipeline right now, larger than it's ever been in the history of the company and significantly larger than it's ever been in the history of the company. Our deal pace is consistent with what it's been for the last several years. And we saw a slowdown when the pandemic really took off, so early 2020, but that was about a quarter's worth of slowdown in sales, then we got right back to it again. So if you look back over the last 5 years or so, we're running at that same pace generally that we've seen in the past 5 years as far as the time it takes to close the deal. So we're not seeing a slowdown in sales. We've seen a big increase in the pipeline to the point that we're at a record pace right now in the pipeline. A lot of interest in Jack Henry technology solutions these days, and I think it's because we've been rolling out a lot of new solutions in the past couple of years. Have received really good response in the market that we serve. And so if you put all those things together, our business has continued to function really well. Now your question about our customers and where they're at today. So again, we serve community regional banks and credit unions in the United States. So by strategy, I mentioned earlier, we choose not to have an international business. We also choose not to serve the top 10 banks in the country. So we are not trying to sell to BofA, Wells and Chase. That's not our market. We've been in that business before. We don't want to be in that business, so we're not selling in that market. And then by strategy, we also don't serve the really tiny banks and credit unions in the country, in the United States, and there are many of them. We choose to really serve that middle market as our primary customer base. And I can't cite a survey or any specifics that -- where customers have said, "Here's the state of our business." But I have a lot of -- I do a lot of conversations with CEOs. I meet regularly with CEOs. I hosted a CEO conference about 1.5 months ago with some of our 200 bank and credit union CEOs were there. So all of this is anecdotal, but what I'm hearing from all these folks is: number one, they're not wringing their hands right now. They understand what's going on in the overall economy, but I think they feel like they're well capitalized today. They don't feel like they have a lot of risky credits on the balance sheet, so they're not facing a whole bunch of defaults. And I'm comparing a lot of this to 2007, 2008, the Great Recession, right? Things were very different then. That recession was caused by the banking market. What we're going through today is not caused by the banking market. You don't have very many banks on the FDIC watch list. There's not a lot of concern about banks being shut down. I think most bankers would tell you that they feel like their lending practices are solid today, so they're not writing risky credits. They're making money now. They have a net interest margin spread now for the first time in a long time where loan rates are here and deposit rates are still down here, as compared to what they've been dealing with for the past several years, where their net interest margin spread was infinitesimal. And so most of the bankers I talk to say, "We're making money now on the net interest margin spread. We don't have risky credits on the balance sheet. We're well capitalized. Our operations are running well. We're continuing to use technology to introduce efficiencies into the bank. Life is pretty reasonably good." Knowing that there's a lot of angst out there around the general economy and are we in a recession already? Or is there a recession coming? What are the impacts going to be? I think most bankers that I talk to really aren't worried right now. They're very conscious, but they're not worried.

And so let's dissect a little bit your customer base. So you say you don't target the top 8 or 10 banks in the U.S. I know historically, you've also said you don't go for the very small communities that are typically, what, less than $250 million in assets or something like that. But in that big middle, like how -- roughly how many customers do you have? And how do you split that up between banks and credit unions?

Yes. So we have -- there are about 11,000 banks and credit unions total in the United States. We serve about 8,000 of them today with various solutions that we sell. About 1,700 of those 8,000 are running a Jack Henry core solution.

Got it.

And the core, for those of you who maybe don't know our business, the core is that heart and soul accounting system at a bank or credit union. So it's processing loans, deposits and general ledger. It's accruing interest, it's doing payment posting and that kind of thing. We surround the core with a whole bunch of complementary solutions. So digital banking and check capture and voice response and risk management solutions, all of those things. So we have about 300 other solutions that surround the core. That core system is the primary processing system for the bank and credit union. And where was I going with that? What was your...

Well, just in terms of the market. And then -- so if we have 20%, 25% of the share of that group, the core, then what about the credit union? And where are you with credit unions? And I think it's maybe important for people that aren't as familiar with the U.S. system to understand like difference how credit unions behave from banks.

So on the credit union side of the house, we're the dominant player in credit unions, over $1 billion in assets. So larger credit unions, Jack Henry, about 49% of that market. Their core processing is done with Jack Henry. On the banking side, as James just mentioned, about 25% of the banks do their core processing with Jack Henry. But again, we touch most banks and credit unions. The key difference between banks and credit unions in the U.S., and they are about the same number, so about 5,500 or 6,000 of each, banks and credit unions. Banks traditionally have been focused on commercial markets. Certainly, they have a retail presence, they serve individual customers, but they focus on commercial customers. So a lot of their effort is around serving commercial customers, commercial lending, handling commercial deposits, cash management, treasury management, those types of things. That's what most banks in the U.S. are focused on. The credit union side of the industry, very little focus on serving commercial customers. They're primarily focused on their retail customer base. And so their customers are referred to as members, they're members of the credit union. Credit unions are not-for-profit. So any profits they make at the end of the year, they return back to their membership in the form of a dividend or some kind of reduced fee or something like that. And because of the difference in serving commercial and consumers between those 2 markets, they process differently. So credit unions have always done real-time processing, where if you show up at a branch and make a deposit, that deposit is credited immediately, and it shows up in your account immediately because there's no reason to hold off on that. On the banking side, because they were serving primarily commercial businesses, if you think about the way a commercial business operates, they're doing business all day long. And then at the end of the day, they go to the bank to make a deposit and do whatever they have to do at the end of the day. So on the banking side of the industry, most banks wait until the end of the day to do all their processing. As opposed to credit unions that are processing live all day long, banks wait till the end of the day and do their processing at the end of the day. So the systems function differently. And the way they approach banking, the services they offer, is different just because of the customer bases that they tend to serve. Now I say all that, I still want to point out, banks serve retail customers. They got a lot of individuals as customers, but they just do their processing differently because of the historical nature of where their focus has always been on a commercial customer base.

Got it. Got it. And so when you look at kind of -- so you talked about the core processing. And we have a rough idea of 50-ish or just around half of the credit unions have Jack Henry's core processing, around 1/4 of banks have core processing. But you mentioned multiple times other capabilities that allow you to touch most of the banks and credit unions, even if they aren't core processing customers. A key growth driver or feature or product set that you have been investing in as Banno. So maybe you can talk about what Banno is, where it fits, just to help contextualize a little bit more the offering that Jack Henry is bringing right now.

Sure. Yes. So Banno is the brand-name for our digital banking solution. So we -- just to give you a little bit of the back story. We acquired Banno 8 years ago. It was a little company. They were doing mobile banking. But we, when we started to learn about them, we saw that they had a totally different approach and a different technology from anybody else in the market. So they had written this solution to be public cloud-native from day 1. So really nice public cloud-native solution, which took advantage of all the tools that you have when you're public cloud-native. They happened to originally develop their solution in Azure, so the Microsoft Cloud. They moved it to AWS. So today, we're processing in the AWS environment. But the really nice thing about this application, as we saw it, was the design, the usability of the -- for the customer and the concepts that they had built out as far as where they wanted to take this application, we thought would revolutionize the industry. So we acquired them 8 years ago. We've invested a lot of money. We continue to invest a lot in that platform. And we've built it out now, so it's a very robust digital banking platform. And I use the term digital banking as opposed to Internet banking or mobile banking because part of the whole value proposition with Banno is you can move away from having an Internet banking solution and a mobile banking solution that are different, which most banks and credit unions have today. An Internet banking solution is different from the mobile banking solution. It looks different. It feels different. The functionality is different. That's what most banks and credit unions in the U.S. are running today. With Banno, you get a single experience. It's one platform. So whether you're on your phone, your tablet, your PC, whatever the form factor is, you get the same experience. You get the same functionality. It looks like a public cloud-native platform. So it's garnered rave reviews in the United States, highest-rated application in the App Store and also the fastest application in our space. And we know that because analysts have done the analysis on usability of our application as compared to everybody else in the market. Most applications out there -- and the way they measure this is, once you enter your credentials, how long does it take from the time you finish entering your credentials until you can actually do something: look at a balance or do a transaction or whatever. Most applications that is measured in seconds, with Jack Henry's Banno applications, it's milliseconds, less than 1 second, from the time you finish entering your credentials to the time you can use the application. So not only are we differentiated on the usability and the beautiful screen design, but we're differentiated on the speed of this application. And so we continue to build it out now. So you can do a lot more than just look at your account and move money and all that kind of stuff. We have new account opening through this platform. We have personal financial management through the platform. We've already integrated our payroll solution into the platform. Our online commercial lending solution is integrated into the platform. And beyond that, we've created all these API connections. So we made it easy for people to integrate fintech solutions into that same user experience, into that same platform. So we're adding customers rapidly and then they are, in turn, adding customers on the platform. So we sell to a bank or create union, they go and enable it for their customers to the point that we're adding around 200,000 consumers a month now on the platform. The other thing to point out is we aren't in market with our business side of that platform yet. So next quarter, Banno Business will come live. So everything we've done so far is serving retail customers. But the Banno Business side comes live next quarter. So now we'll deliver that same functionality to small, medium business customers on the same platform with that same user experience. And I will say I've been asked, so if you think about baseball, what inning are you in now as far as selling this solution? And what I'd normally say is we're probably in the first inning out of 9 innings, right, we're probably in the first inning. Because most banks and credit unions, I'm not just talking about Jack Henry customers, I'm talking about most banks and credit unions, don't have a single digital solution today. They have an Internet banking solution and a mobile banking solution, and yet consumers want to have the same experience regardless of form factor. And so we see a lot of opportunity for us to continue to grow that base of customers. I almost view it as a greenfield opportunity. I mean it's not literally greenfield because there are solutions out there, but it's almost a greenfield opportunity because everybody needs to update to a single experience for their customers.

So you talk about that kind of, I think, financial services generally are very deliberate and slow to move, and everybody has to be comfortable with the moves they're making. But what's interesting to me is like we're starting to really hear the topic of cloud-based solutions ramp up in banking. And for most of the rest of enterprise, that was a conversation from 7, 10 years ago, but it's really becoming important now. So where are we now in terms of cloud-based solutions for Jack Henry and Jack Henry's customers? And how do you think -- how should we think about the potential there, not only for incremental revenue but relative profitability, et cetera?

Yes. So we have a number of noncore solutions live in the public cloud environment today. So I mentioned Banno was public cloud-native, Payrailz, our payment platform is public cloud-native. We have our financial management tools for bank budgeting and profitability. That's all public cloud-native. So we have many different solutions in the public cloud. The hesitance, in the U.S. market at least, regarding public cloud has been around the regulators. Regulators have not been ready to approve generally banks moving to the public cloud because they didn't know how to do proper exams, they didn't know how to manage the risk. And so they've allowed some solutions to move to the public cloud or customers to adopt solutions to the public cloud. But on the core side, it's been very limited. There have been a few experimental situations where banks have moved their core business to the public cloud, but the regulators have been really hesitant. One of the challenges was when we all -- and this is 10 years ago, when we first moved our first application to the public cloud, the examiners would say to Microsoft, for example, we first went into the Azure environment, the examiners would say to Microsoft, "Okay. We want to see your full SOC 1 and SOC 2. We want to make sure we understand the -- what you've done as far as security environment." Then Microsoft would say, "No, we're not providing that." And the regulators would go, "Well, wait a minute, that's what we're used to getting." But these large corporations would say, "We're not giving you the keys to the kingdom as far as our security infrastructure." And same has happened with AWS and I'm sure with Google. I haven't checked on Google, but I'm sure it's the same thing. So the regulators have kind of had to adopt and try to learn different ways to conduct exams to ensure the safety and soundness of those operations, but they conduct them without getting the full report from those large public entities because if they do provide the public report, then that opens them up to other scrutiny I'm sure that they don't want to put up with. And so the examiners in the U.S., the systems are adjusting and they're learning how to conduct exams, and they're evolving. And so that's what gives us confidence that, over time, as we move everything we do onto the public cloud, the examiners will be happy with that. We know customers are looking forward to it. And it will be good for us to make that move, but it's going to take time. And we're talking many years to move everything across to the cloud and make sure that customers are comfortable moving to the public cloud. But as we make that move, number one, that's a very -- you're very tech-forward as you're running in the public cloud.

Right, right.

So you're using a lot of tools that you can't use unless you're on the public cloud. So that creates opportunities for us to have a real modern look and feel for our customers, a real modern tech stack that they're looking for. When you move to the public cloud, we're allowed to or we're enabled to do what's called DevOps. So in a DevOps environment, you can do rapid release of software. In a traditional software development environment, and this is for all companies in our space, not just Jack Henry, you would do new releases of software maybe every 6 months, maybe every 12 months because it's such a complex process. Well, when you get to public cloud, and we've been doing this for years with our current offerings, you can do -- and we have -- and Banno sometimes we'll do 20 new releases a month because the technology allows you to do that. So you can do really rapid deployment of new features, which of course, customers love. So that makes you more appealing to them as a potential provider of technology. The security infrastructure in the public clouds is amazing. There's nobody who's doing a private cloud deliverable who can measure up to the security infrastructure that they have in the public cloud environments. And particularly now, we're centered on Google. Google has just got an amazing infrastructure. And so you put all those things together, not only does that create an opportunity to grow the company because we're delivering all this modern technology, there is the opportunity to save money, because then, we can eventually get out of the business of owning our own data centers. We're a large private cloud provider today, but that's very expensive to own our own data center. So as we're able to scale those things back and not have to invest as much there and consume based on capacity from the public cloud providers, that provides an opportunity for us to become more efficient and to cut out some costs over time as well.

So as we start to talk about costs and that kind of thing, how should we think about, as investors, kind of the current algorithm of growth and profitability that you guys are targeting, at least for the next couple of years?

Yes. So I think the best way to think about that is in this, if you look at the segments that we report on. So we report on 3 segments. The first is our core segment, the second is our payments segment and the third is what we refer to as complementary or complementary products. And so the core segment is continuing to grow mainly by us gaining share in that space. So we're gaining 50 to 55 new logos, new customers bringing their core business from a competitor to Jack Henry on an annual basis. Almost every one of those contracts -- well, this year, every one of those contracts, is signed as a SaaS agreement. So we're layering in revenue. You don't see big pops in a quarter. What you see is us signing a 7- to 10-year agreements with these customers and that revenue just keeps layering on, layering on, layering on. That's really the primary approach as far as the core segment of our business. We're taking share, and those contracts are long-term SaaS recurring revenue contracts. In the payments segment of our business, we have 3 different primary components. We have our card business, which is debit and credit; we have what we refer to as EPS, Enterprise Payment Solutions, which is remote deposit capture and ACH origination; and then the third piece of our business is our bill pay business. Bill pay, as I've said on earnings calls in the past, growing slowly, but still a nice, steady grower for us. EPS, the enterprise payments business growing more quickly, in fact, the fastest-growing area of our business. Believe it or not, still lots of people trying to find a really good quality provider for ACH origination, even though ACH have been around forever. Jack Henry is gaining share in that space. And then on the card side, we are a card issuer for both debit and credit, and those businesses are growing nicely as well. And then the third segment is what we call complementary. It's 200-and-some other products. So they're not -- if it's not payments and it's not core, it goes in the complementary bucket. So there's a whole bunch of products in there, including Banno, as we talked about a moment ago. And so some of those are growing very quickly like Banno, some of them are not. Some of them are older complementary solutions that we're not selling real actively, but that segment continues to be a nice, steady grower for us as well. But those are the kind of the drivers behind the growth in each of those segments.

Got it. And then in the last couple of minutes, you and the Jack Henry team historically have been really great acquirers, added a lot of and created a lot of value for investors. I don't think it's a stretch to say that in some ways, you guys have been better allocators of capital via acquisition than your investors themselves could be. And so you've been able to add value that -- there. You haven't done a lot of acquisitions as valuations have been high. I know we kind of -- you came into the year thinking maybe they'd come down. They hadn't really. What's your current thinking in terms of potential and when the right time and circumstances will be to get back in the acquisition?

Yes. So first off, I appreciate you pointing out the ROIC. So we hover some above 20% as an ROIC. We publish that regularly. We're very proud of our -- I think our skill in that area. We are -- we have historically been known as a serial acquirer. We've acquired a lot of companies in the past, well over 60 companies. Just in the time between 2004 and 2015, when I was in charge of that practice at Jack Henry, we acquired 32 companies or something like that. So we're a very good, disciplined acquirer. And we're proud of the accomplishments when it comes to acquisitions and really creating value for our investors. Now as James knows, early this year, February-ish, I was very bullish. I thought that this year, boy, by October, deals were going to be happening and valuations would kind of settle in and people would find religion as far as what they thought their company was really worth. And none of that has happened. Everybody still has their expectations sky-high as far as valuation. But I think one of the drivers for that is, throughout the summer, PE was still investing in a lot of these private companies, and we thought that spigot would have been turned off by the summer just because of what was happening in the economy. It didn't get turned off. But now talk to a lot of those private companies, they're having more trouble raising capital today. So we believe that probably early next calendar year, mid next calendar year, we think there will be some opportunities for us to pursue, and so we're anxious to try and find some deals. The good news is our top line revenue growth is hovering around 8.5% right now. We don't need acquisitions to fuel revenue growth. So we haven't done -- we did the little Payrailz deal a couple of months ago, but that added just a little tiny amount of revenue. We haven't done anything else in the last 3 years. So we've been growing at that rate organically. We don't require acquisitions to fuel growth, but it would be nice, I think, to find a deal or two.

Yes. I mean I thought the way that you've talked about it in the past is that from time to time, obviously, there's going to be strategic opportunities. Right now, you don't feel like there are, but that doesn't mean you're closed off to hey, this is an incremental opportunity, et cetera.

We're always looking. Yes. And every banker in our space knows us. They know us as an acquirer, and so they'll bring deals to us as soon as they have a good quality deal for us to look at.

Well, Dave, thank you very much for joining us. Thanks to all of you for sitting in. Any follow-up questions, I'm sure that Vance will be more than happy to entertain. So thank you very much.

Great. Thank you, James. Yes. Thank you, everybody.