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

All right. We'll go ahead and get started here. Thank you to all of us for joining us this morning here to chat with Mimi Carsley, CFO of Jack Henry. Before we get started with Mimi, I do have an important disclosure to read. Please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley rep.

So maybe just as a preamble, Mimi, for those that aren't familiar, can you just give us a brief overview of your business and what are the problems or the types of solutions Jack Henry is trying to bring to market? And where do you fit in the value chain for banks and credit unions?

Sure. Happy to. Thanks, James. So Jack Henry is a public company. We are a well-rounded financial technology company. We serve primarily domestic U.S. banks and credit unions. We offer a number of solutions. But if you think about our 3 segments, there is core, which is kind of the heart and soul of a credit union or a bank that allows them to kind of operate on a daily basis. There's the payments. We do a lot in payments. We say we're not a payments company, but we do a lot in payments. And that's our ACH, our bank payments business. There's a lot there. There's also a credit and debit business in that segment, and there's also the bill pay. And our latest acquisition, Payrailz, is in that segment. And then there's the complementary segment, and that's about 250 solutions. And in terms of value proposition, I'd like to think about it as we allow banks and credit unions to have access to the technology that allows them to stay competitive.

Right, right, right. So one of the things -- and I'm not asking you to opine on the market itself, but one of the key starting points of conversation around Jack Henry that we often get from investors is, hey, historically, Jack Henry is treated at a pretty big and material premium to names like FIS or Pfizer or Global Payments. And so the question we get is like what -- on paper or in the description, they look like similar businesses, but what really differentiates Jack Henry, from your perspective, compared to some of those comparables?

Yes. So I mean, first, I would say a couple of years ago, it probably would have been a more accurate comparison. As those businesses have diversified into the merchant acquiring business, there's more of a roughly kind of 30% overlap with Jack Henry. We chose by design, by its strategy, very intentionally not to enter the merchant acquiring business. We have done a number of years of study of what it took to be in that business and did not find it to be attractive. But I think to your question on differentiation of that multiple, there's a couple of things. One is Jack Henry's long-standing history of executional performance. There's also the service brand that we have for excellent customer service. I would also point to transparency, both in reporting the openness of which we engage. So things like our higher [ IRRC ], just the reoccurring revenue stream, strong performance overall.

Got it. Got it. So on this point of your position is, obviously, there's lots of questions about like if we're entering into a slowing macroeconomic environment and at least a more uncertain one, et cetera, what does that imply for technology spend of banks? And how willing are they going to be to engage with Jack Henry, et cetera? I think, David, the CEO, had mentioned on the last earnings call that most bank and credit union executives are looking at 5% to 10% year-over-year growth in their technology spend. But is that realistic? And has that changed at all? And have smaller banks and credit unions tend to spend more than their larger counterparts or less? Just kind of give us the landscape of your customers and their behavior.

Sure. So typically, we'd love to share third-party data. Unfortunately, the third-party data did not ask one of the most salient questions here, which was what was your expectations for IT spend. So unfortunately, I can't share that. So most of the feedback I'll share is anecdotal, but we did meet with over 250 bank CEOs fairly recently. And they quoted about 7% on average for this year's budget. So that's not necessarily like where they're thinking about that's actual planning for this year. So overall, I would say our customers are feeling quite healthy. They're continuing to spend. Now that's their total spend, not necessarily just planned spend with us. But those businesses have to continue to invest in order to stay competitive. They're also talking about long-term road map strategies that you can't really just kind of take your foot off the gas for. And you're talking about mission-critical or red generation or things that drive automation or things that drive deposit capture, things that they need in this day and age. So I think overall, where they're investing, the type of things they are investing, we're going to see resilience into that.

And what is their -- if we look back historically in their spend activity, how does that tend to relate to interest rates or particularly NII? I mean if we're in a period of better earnings, do they want to reinvest that? Or what's your sense of how to tie out that piece of the equation?

Yes. I mean they're certainly enjoying a healthy net interest spread today, but they know it's going to end. We're slowly seeing deposit rates tick up as they're attempting to go gather those deposits. They're still getting attractive lending rates. But they know how to operate on those compressed margins. They've been doing it for years in a zero interest rate environment. So they have found other ways to generate fees and revenue. But the reality is they really just can't put a pause to the type of investments they're making, and it's important for them to stay competitive. You asked a question in terms of the differentiation between the FIs that we serve and the larger FIs. And just so -- from a segmentation perspective, we choose by strategy not to serve those Tier 1, call it, the top 12 banks in the U.S. And we choose not to proactively go after the very teeniest of institutions. So that leaves a lot of area and institutions to kind of play in. Those guys have done a great job of modernizing their back end, if you think about the underlying architecture. So where they're investing is more in the digital presentation, the forward front-end customer engagement segment versus the Tier 1 guys are -- they have a lot of mainframes. They have a lot of cobalt, they have a lot of like duct tape and chewing gum, putting together their architecture, but they've invested in the front end. So while, it may look cool on a mobile app, they actually have problems from the underlying architecture. Those are things that, since they're not customer-facing, they could hit pause on more versus our customers. It's around how they stay competitive and how they engage with their end customers.

Got it. So they have a different need. So one of the things that's interesting or at least I find interesting about Jack Henry and the modernization strategy that Jack Henry is trying to enable is building more modularized solutions and making those available to the market. But the question that occurs to me a little bit at least is, does that have the potential to cannibalize some of your existing core revenue? And then also, how does that -- a modularized solution set change your go-to-market and engagement with customers?

Yes. So it was about a year ago today that we announced the tech modernization road map. I would say it's a strategy. It wasn't a product launch. It's not a product launch today. We have a couple of modules out there, domestic wires, international wires is coming, but we're publishing 6-month road maps for that strategy. But it's going to be a while until it's being sold and in the market. So it's much more around us wanting to communicate to prospects and existing customers where we were heading over the next 10 years. But part of that is taking the benefits of a digital cloud-native core, so that core, that lifeblood of the bank and credit union, their ERP system, if you will, and modernizing that. There's a lot of benefits, not just the componentization of that. I don't think that's a word, but the modularization of that. First, just being digital cloud-native itself has some benefits that we're going to see in terms of speed, bursting capability, security environment, the tools, the DevOps tools that come from a modern architecture. So -- and then there's the modules that you talked about. So one of the ways we're thinking about that is the core system today, if you think about core, it's about 30 key pieces of functionality that now will be in a la carte. We still expect, at the end of the day, people will choose a bundle that fairly resembles the bundle that core is today. So they will have the option to do it piecemeal. They will have the option to buy a bundle. Dave had a great analogy the other day, which was cable TV. Like it used to be you paid for cable TV and you've got your 100 channels. And now through streaming services, you probably have 3 or 4 individual subscriptions. On the whole, you're probably paying more than you did before with cable. That's our expectation around the tech modernization, that even though it will be in components, you'll probably end up with a fairly reasonable package that looks similar to the functionality you have today at a higher price point. To your point about the modules, we didn't build it for the intention of being able to go to larger institutions. Our largest institution today is roughly about $35 billion. Now we tend not to -- historically, we didn't attract a $35 billion customer. We -- they joined us and then have grown. That customer and other customers, we suspect, if I'm sitting here 3 years from today, hopefully with you, James, we'll say, "Oh, we have a $50 billion or $75 billion client," because they're going to continue to grow. But what -- one of the positive benefits we've seen out of this tech road map that we've been talking to customers about is large institutions, call it, a $20 billion, $30 billion financial institution, are proactively coming to Jack Henry because they love that strategy. One of the things -- it's funny, as you replace core, because it's so pervasive within the financial institutions, we hear from CEOs and CIOs that they would rather die or retire before changing out their core system. So it's pretty sticky and it's pretty pervasive within the institution. So this allows them -- and typically, a conversion happens over one weekend. So think about like every single employee of that bank and credit union learning a new process, new training, all the new account numbers, like every screen of the bank is different and new if you change providers. That's a lot of risk for an institution. And so by this modernization strategy, they could say, "Oh, let's just update our modern for deposits." or "Let's do account opening." So they could derisk the conversion by taking it piecemeal. And so it's brought a lot of people to Jack Henry, excited to have that conversation and some of them looking to switch to us today because they know, in the future, then they'll be able to use these modules.

So on that, though, how do you manage with the pricing? Like one of the benefits that -- or one of the characteristics of Jack Henry over the years has been that you have very good margins and very good ROI. But if you're taking a module like that or some part of the functionality into a larger organization, what do you need to do from a services perspective integration? Does that somehow impact the -- at least the initial profitability? How should we think about that as an opportunity and the puts and takes?

Yes. I think on the whole, our expectation is we want to be making the investment unless we thought it was an uplift. It's not a minor feat of our percentage for R&D., so there's that. I mean I think in terms of larger, like truly large, we've initiated something called the regional banking office, which supports our existing customers today and prospects who are in that upper tier space, not that Tier 1 space but just right after, who maybe want to grow. We've also done testing to say, on a transactional basis in our labs, we can support a $75 billion or $100 billion size institution today. And so it's not a technology question. To your point, it's a support question, it's a go-to-market question. And so we've developed this cross-functional team to say how -- what are the needs of those clientele and how do we support them in growth. But I'm not concerned in terms of margin or price impact. It's still early innings here on our tech road map. But I think what it's going to do is allow us to go into segments we wouldn't have gone into previously, which is additive.

And if you were communicating kind of a framework and a road map for customers and prospective customers, what's the realistic time frame that we should expect to see you being able to talk about customer wins and then initial revenue, et cetera, for some of these modules?

Yes. So I think it's still -- you're a couple years away. I mean today, we have just pieces of that on the periphery, like domestic wires, international wires coming. We're going to have more tools out there. We'll publish metrics around that adoption. But the reason why it's not -- today isn't necessarily -- like no customer is demanding it today. And it's mostly because the regulators aren't ready for it because they don't want core PII, or personal identifiable information in the public cloud. So we have public cloud-native apps today and function today. Like if you think about Payrailz and payments or fraud, that is digital cloud-native today. But that's not the core PII of a bank or credit union. And the regulators just aren't there yet. And so we anticipate, over the next 3 to 5 years, those who are at the most forefront tip of the spear will have interest, and we'll be ready for them at that point. So I think it will be a number of years before you see real adoption into the -- into that module.

Got it. I've been dominating the conversation here with Mimi. So if anybody has any questions or follow-ups that you want to raise, just give us an indication with the hand and we'll get you a microphone. So otherwise, I can keep going here. So let's turn to Banno and Banno Business. Maybe if you just give an outline of what Banno is, what the intended solution set is there. And let's start with that as a product.

So Banno is our digital banking platform. It's the #1 app in the App Store. It allows a credit union or bank to white label and have a digital banking offering. Today, either people have no digital strategy or they may have a laptop strategy, but it's not the same experience as the mobile phone strategy and this helps have a ubiquitous digital presence. And so when we talk about digital, it is everything you would want to do to engage and serve a client without having them walk into a branch. And so today, we have over 8 million active users. Only Banno retail product is out thus far. We're about to go GA this year on Banno Business. So quite excited about what -- that will also have some treasury light type functionality to help small- and medium-sized businesses. So it's been a great grower for us and really exciting.

So I think one of the things that I grapple with to conceptualize a little bit is that a lot of times, we think about banks and banks being for consumers, et cetera. But a lot of times, in the segments that you participate in, these are more commercial banks. And I was taken aback a couple of years ago when one of the other analysts at Morgan Stanley was talking about, no, like that group of customers that Jack Henry serves is actually growing deposit share because of their commercial banking relationships. So this Banno Business, it seems like it has the potential to be quite an important product for your customers if that's a fair assessment.

Yes. And because the pricing model is based on active users, we may each have Banno retail, and we're all active users. But let's say, we run a construction company. Well, 5 of us need to be on the system. Well, that's 5 active users at a higher price point. So not every bank or credit union does commercial business. So credit unions, for instance, are more retail-focused. But -- so it's not going to be a one-for-one take, but it is going to be a driver of active users and active revenue at a premium price point.

So as that goes GA then, is that when we should assume the initial revenue will start to flow? Or how does that -- how should we think about that ramp?

Yes. So we have over 300 customers today that have signed contracts for Banno Business. We also have some customers that were waiting for Banno Business to install Banno retail, so that's also going to drive some retail. And it will take a little bit of time to implement them all. One of the things that we should talk about because it was a little bit maybe vague on our last earnings call was our strategy outside the base. So today, we have over 1,700 banks and credit unions that use our core, that lifeblood kind of heart and soul of the bank or credit union. We have 6,000 FIs that use some other complementary product to Jack Henry. And on average, they take about 3 out of our 250 solutions. So today, Banno retail is only available to those inside the base users. So eventually -- originally, we had talked about Banno for business and opening the floodgates to go outside the base. But what we've been seeing is that Banno is such a differentiator, that it's helping us win core win takeaways, competitive takeaways. And when we get a new core win, people tend to sign up for about 30 to 40 new products in addition to Banno. So we certainly don't want to stop that train from going because it's been a huge boost to our sales pipeline. And so we're just going to be really thoughtful as to what outside the base products we go to. We actually heard some funny anecdotal evidence from competitor salespeople who said, "Please bring Banno to us." Because they thought it would shore up their own core and fill the gap of their own digital banking options. So we're certainly not in that market of helping support competitors. So we're just going to really be thoughtful and tactical as to when we go outside of our base.

So as you think about that, though, like what should be the evolution or what do you envision being the evolution of that strategy? And are there potential changes in the economics where you're like, okay, well, maybe we use Banno Business as a lead generation or something like that then tie it to something else? Just wondering how to think about that as it impacts the P&L.

Yes. So today, you're seeing the impact from just core sales. You're seeing the pull-through that it leads to new core and other complementary products. We do report the metrics of Banno users on a quarterly basis. We'll be transparent about the number of business users as well on a go forward. In terms of that go-to-market strategy, whether we price at a different price point or a different time to market, we're figuring out what that will be so as to ensure that we're doing all that we can from a core sales win.

Got it. And look -- turning now to actual revenue and pipeline, et cetera, inflation obviously has remained elevated, and it sounds like Jack Henry continues to implement some of the CPI escalators that are built into your contracts. For '23, fiscal year '23, non-GAAP revenue growth outlook was just over 7% at the midpoint. Can you give us a sense of how much of that is price contributing versus the relative mix? And like how much benefit incrementally are you getting this year?

Yes, it's a great question. So all of our contracts have -- predominantly, all of our contracts have CPI escalator language in them. It has for some time. Jack Henry has never utilized that. We did not see it as a mechanism to fuel growth. We think our customers are quite astute, and they know what's going on, especially in the economy. And so until we -- recently, when we did see inflationary pressures, we had not chosen to implement the CPI escalators. So this past year, we did because we saw some inflationary pressures. We did it modestly, not to the max allowable under the contract. I would say it was not material in terms of the revenue contract. As I said, it's not a crutch we're using to fuel growth. I suspect if the current environment stays the way it is, we'll probably adopt them for next year as well, but we look on a case-by-case basis. And I would say our customers have been quite understanding, and the reception has been really accepting because they know we're not being egregious on it.

Got it. So if I could play back and summarize for my own benefit, at least, is that, historically, whatever growth that you're putting up, you probably weren't getting much benefit from -- none from the CPI escalators that were built into the contracts, but you weren't exercising. Now you're doing it a little bit more, but it's -- it doesn't sound like it's anywhere near like what the contract would allow, like if CPI is 6, then you're not doing anywhere close to 6.

Correct. Right.

But it is on a case-by-case basis. And I think it would make sense, is you're saying is that the -- everybody realizes that costs have gone up and so like the appetite or willingness to accept that is probably okay. Let's talk about pipeline. Management has continued to reiterate that pipelines are the largest they've ever been. How should we think about the prospect of converting that pipeline in the difficult macro environment? Like what's leading to the big pipelines? And then what are you seeing in terms of conversion, et cetera?

Yes. So we were a little bit nervous, to be frank. We had a record year last year and, with that, kind of drained some of the pipeline. And so we were a little nervous. But not only have they restocked it, but it's been growing to our largest level. And so I would say to the point made earlier that these institutions have long road maps. A core is about a 12- to 18-month implementation not because of our timing but because of the training that needs to go on, the new process engineering that needs to go on, just the readiness of that financial institution. So people don't take those decisions lightly. And so when they make a decision, they're going to move forward with that. I would say the robustness of our portfolio of new products, we have Financial Crimes Defender, the treasury products, the new Payrailz product, Banno that we talked about, has been great for the salespeople to talk about new product generation. I would also say that just the demand that need to stay competitive from our financial institutions, they're feeling healthy at the moment. They're feeling healthy, and they're going to continue to invest.

Want to turn quickly to acquisitions. Historically, Jack Henry has been quite astute -- acquisitive but astute in doing so. What's the general appetite right now to do acquisitions? What are you seeing from a valuation perspective? Is that -- are you finding compelling opportunities, et cetera?

Yes. So Jack Henry has a long history of acquisitions. I would say we're an experienced but very disciplined buyer. We didn't do a lot in the last 3 years when -- we're not a chaser. And it has to be strategic. It has to be a really strong cultural fit, matters a lot to Jack Henry, not just the financials. So we did not do a lot of deals in the last 3 years when there was just like this run-up of valuation. So we were quite excited and thought, "Oh, the prospects are going to be like overflowing." But it has yet to truly materialize. I think the last 5 weeks, we would say we're seeing more inbound, public companies, a little bit easier to face the reality, maybe, of their valuation; private companies, if they have funding or kind of just holding tight. I suspect towards the latter half of the calendar year, we're going to start to see more pickup. It's been part of our growth history, but it's not a requirement. We have a really strong engineering team. We spend over 14% in R&D. And I would also say it's opportunistic. There aren't a lot of strategic gaps in our portfolio of complementary solutions. So it really needs to be additive. If you think about our Payrailz acquisition, we had something in that space, bill pay solution. It needed some modernization. But through Payrailz, we've been watching them for about 3 years, a smaller start-up company. We thought very highly of them. They were starting to get traction competitively in the marketplace. They were digitally cloud-native. So we got additive functionality, plus we got to accelerate and leapfrog the development we would have had to do on our platform. So those are the types of acquisitions that make the most sense, but we're going to continue to be a disciplined buyer.

On Payrailz, we've had some investors ask like, were there some misjudgments or issues with the integration, et cetera, just because it seems like the contribution maybe didn't ramp as fast as at least some of us in the market would have anticipated, especially given the newer technology and the trajectory they seem to have been on pre-acquisition.

Yes. No, it's early days. We closed the deal in September. I think from an investment thesis perspective, things are coming out better than we had anticipated. The quality of the product, the quality of the people, we've done that in an early integration of teams and product road maps. We have the sales team now focused on selling it. So the reality is, from a contribution, it's pretty de minimis. I mean call it, $12 million to $15 million of revenue size on a $2 billion revenue company. I think it's getting more attention because it's one of the first deals we've done in a couple of years, and it was a decent price point. So we will be -- we have every confidence in terms of driving that to accretion and the trajectory for it. So I wouldn't say that there's been stumbles. I would say it's going as planned.

Got it. And then just lastly to wrap up, I mean, last year, good year, but there was certainly a bit more wage pressure and cost pressure than maybe was anticipated at the beginning of the calendar year. What has been your perspective on the headlines we've seen around fintech and technology layoffs? Is this giving you the opportunity to hire a little bit better? Or what are you feeling in terms of like your own cost base?

Yes. We definitely saw, at the start of the year, we anticipated from a budget cycle perspective, headwinds on inflation, both the full year impact from hiring at higher wage levels. There was increases in third-party costs, including like insurance and cyber and Adobe. Like -- so there were some known things that we were guiding to a flat to down on a margin basis. We are very disciplined on thinking about expense management and especially given a little bit of softness of deconversion revenue, a little bit less overly optimistic in terms of the payments business and cards. We're managing expenses. And so we're being thoughtful. We zero base every new and replacement head that we have. We're cutting back a little bit on travel and the like, but we're continuing to hire. We're taking advantage of tech talent, especially in the marketplace. Jack Henry does not believe in layoffs. We'll do other mechanisms. During downturns, we've cut salaries, highest at management and below. We have a bonus pool that is tied to operating income. So we're very actively on managing the costs on that side of the house to ensure margin expansion in the long term.

Well, Mimi, that's all the time we have today. Thank you to everybody for joining us, and thanks for chatting with us about Jack Henry today. Thanks.

Thank you, guys.