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

I'm part of the payments processing and IT services research team here at RBC, and I am pleased to be joined with Mimi Carsley, who is the CFO of Jack Henry & Associates. Welcome.

Thanks, Matt. Thank you.

I guess as my first question, can you provide just a very brief overview as to what Jack Henry does? Looking around the room, I know some people know the company really, really well, but I also see some new faces. So just quick...

Sure. So Jack Henry is a well-rounded financial technology firm. So we've been in business for over 48 years. We are very focused on serving credit unions and banks in the U.S. with technology that helps them compete with and stay -- and help their end customers and members. So we have a diverse product portfolio and -- but are very laser-focused from a strategy perspective.

You've had great demand and sales performance the last couple of quarters. What do you think is driving that?

Yes. I mean, we're actually on a multiyear journey here where you've seen IT demand in the high single digits, low double digits. We just did adjusted our strategic benchmark survey, and the most common response was people expecting IT demand from a spending perspective in the 6% to 10% range. So the reality is, we like to say, no matter the challenge that a bank or credit union is going through these days, the solution is technology or the heart of the solution is technology. And when you have over 250 solutions, you have the technology to meet whatever the demand is.

And where are those areas of demand, thinking about your product mix? Is it core? Is it lending?

Yes. So we just went through, as I mentioned, our strategic benchmark survey. It's out on the Jack Henry website. We interview and survey all of our bank and credit union CEOs and CIOs. And the top three priorities have been pretty much consistent over the last 3 to 5 years. But this year, they talked about trying to gather deposits. As we know, post the stimulus period, it's much harder to gather deposits. Growing loans is another priority. And then operating efficiency, which isn't surprising given the interest rate environment we're in. So our core product, if you think about core is the ERP system for a bank or credit union, kind of that part of the organization. And then we do payments. We do a lot in the payment space. I'd like to say we're not a payments company, but we do a lot in payments, whether that be card processing or that the enterprise payment services. And then we have a whole suite of complementary products. So that could be your fraud products, your lending products, your digital banking products. So coming out of the pandemic -- well, through the pandemic, there was a huge massive interest in digital because people couldn't get into branches. And so as people invested in digital -- and when I say digital, I mean anything you would need to do without walking into a branch. So it could be an account opening, it could be a loan process, it could be just checking your balance, making a payment. A full end-to-end digital presentation layer. So there was a massive need for banks and credit unions to invest in their digital experiences. But now that investment journey is still continuing. You have fraud. You have exciting things with faster payments, but we like to say, with faster payments comes faster fraud. So there's a lot of investment and interest in fraud tools. There's a lot of investments in lending tools, treasury tools. Pretty much anything that banks and credit unions need to stay competitive. Because as we know, like banking is not a geography-based business anymore. You can bank here in New York City, but I could also live in Missouri or San Diego, and I could bank in New York City. And if I'm at a credit union, yield and membership has been expansive over the last several years as well. So our banks and credit unions know that, first and foremost, it's around what is my growth strategy? And then from there, it's what products will I need, and what technology can Jack Henry help me with to serve that need?

A two-part question. I mean, you generally deal with smaller banks. And the number of banks have been going down in the U.S. by, call it, mid-single digits annually for a long time now. So is your market shrinking? And why does that number drop? Is it banks failing or merging?

Yes. So the industry has been consolidating for the past 4 decades at about 4% a year. But if you look at the number of assets, it's certainly been growing. And the way our business model works is it's not on an FI count. I mean, if we get to a situation where we're Canada or Sweden and we have a handful of banks, like that's a different situation. But we have over 9,000 today. So I don't think we're at any risk of also going to that. And the -- so our business model today is not based on the number of FIs. It's based on the number of account holders they have, the number of members, the number of transactions, the number of active users they have using digital products and the number of assets. So I wouldn't say we're indifferent to the number of institutions, but a declining number is not concerning from us. The one thing I'd like to correct you on, Matt, is just the misperception that we only deal with small banks. Today, our average bank size is $1.3 billion. Our average credit union size is $1.2 billion. And so we intentionally from a strategic perspective don't want to compete in the Tier 1. So talk about the top 20 to 30 banks in the U.S., we have no interest. We don't think it's economically interesting to serve those customers. And the teeniest, smallest institutions in the U.S., there's a lot of very small credit unions in America, very small banks. There, they just don't have the manpower. They're very price-sensitive, not compelling as well. But pretty much anything in between. And so when we think about market share, let's say, the $500 million and up to $10 billion market share of banks, we have 23%. Of credit unions $500 million to $10 billion, we have over 40 -- like almost 50%. So we really play more upmarket than people perceive. I think particularly when SVB and other issues were happening, there was a lot of writing in the newspaper, small banks. And they would say a $100 billion bank as a small bank in America. That's really not a small bank if you know the banking space.

Exactly. So it scares a little bit. And I guess about a year ago, you all announced a new technology strategy. I think at various times, you've called it unbundling the core, modularization. It's tough work for me to say it. Could you kind of, first of all, go through what it is, what it's designed to do? And whether it does help you move up in terms of competing for maybe some of that top 30 banks?

So our tech modernization project has been underway for a couple of years now. If you think about that core, we talked about that lifeblood of the operating system on a bank or credit union, it has roughly around like 30 pieces of functionality. How to account -- open an account in terms of the member information, how to post interest to a loan, how to take a deposit, et cetera. Like the core bits of the functionality. So part of the strategy around that core, our tech modernization is around moving to a public cloud, so digitally cloud native, API-first, a single platform. And so it's beyond just our core. It's how we think about some of the complementary products as well. But on that core, we're thinking about how to uncouple or how to unbundle into individual modules some of those key components. And the reason why that's super important is, one, it allows us to get some of those modules out sooner, like we have the domestic wires module out today. But it also derisks a migration for our customers. So we win 50 to 55 new banks and credit unions a year. And when we say new, like completely new logo to a core. Not they were switching from another core of ours to this core. Like completely new to the firm. But that's a big deal to move a bank or credit union. We like to joke that bank's CEO say, "I'd rather die or retire than move my core system." Which is a pretty strong language if you think about it. But it is a big deal. So it used to be you shut down on a Friday, you hold your breath all weekend, and you open on Monday. And the core system touches every employee, every system within a bank or credit union. Is integrated within the core. So it's a huge deal. That's a big amount of risk. So if you can unbundle that core, then you can potentially migrate pieces over time, not just do a one big bang approach, which has been really compelling. And we've gotten great external validation. And what's really interesting as we've been talking, and we didn't talk about this to talk about it with you guys, sorry, but we did not. We talked about it because we wanted our clients to know where we were going. As Jack Henry, we're very much into the transparency, the clarity. We publish every 6 months, road maps for our clients, so they know where we're going. And so what's been happening is we've been getting a tremendous positive response, particularly from large and I'd say really large institutions. So our largest institution today is a $50 billion institution on core. We serve up to $200 billion institutions on our complementary and payments products. But in core, our largest is $50 billion. We have roughly 20 customers that are over $15 million (sic) [ $15 billion ], several in the $30 billion size, several with the aspiration to grow to $100 billion. But it's rare that someone wants to come in and be your largest client. So we're getting -- today in our prospect funnel, we have over three $20 billion institutions who are interested in talking to us. And they're interested in our SilverLake product today, but they really love where we're going from a tech modernization and that public cloud. And so one of the questions we get, Matt is, well, why not do it sooner, right? Why not get there today? And the reality is we're building at the pace we think people will be ready for the technology. And that's not only clients, that's the regulators. And so while we have a lot of products that are public cloud today, our Banno Digital banking app, our Financial Crimes Defender. Basically everything we've built in the last 3 years has been public cloud native. But the regulators aren't ready for PII, personally identifiable information, in the public cloud yet. They don't know how to regulate, how do they do the superveillance, how do you do the compliance. And so we're working and partnering with them and our customers to get ready for that public cloud.

So it's still pressure. You're still not getting the full conversions to cloud.

We're getting conversions to our private cloud. So we're about 72% of our customers are on our private cloud. That's been about 40 to 50 clients a year have been migrating. You might ask like who wants to run a data center these days? Well, people are still in the process of migrating. And that's a nice healthy tailwind from a revenue perspective for us. We sell that at about 2x the revenue. And you might ask like, well, why does someone pay you 2x the revenue? Well, from a bank perspective, they were -- they have all the same costs. But now they don't need their own data center. They don't need to buy the million-dollar equipment. They don't need to have the backup and data recovery or the cyber insurance or the CTO staff to manage their own data center. And a lot of banks and credit unions, as they think about what are their core capabilities, where do they want to spend their time, it's on serving their account holders and members. It's not running a data center in this current environment. So that's a nice tailwind. So people are in our private cloud today. They're in the public cloud today with a lot of our products and services, but they're just not in it yet with the core system.

As you unbundle the core, how are you thinking about pricing or possible self-cannibalization?

Yes. So it's a lot of -- it's a big investment. It's been a big journey. So it's obviously a premium product for us. We also think there's a lot of value-add from a customer perspective. The public cloud has great positive attributes. If you think about 99.99% of uptime availability, if you think about the resiliency of a zero trust environment. We deal with all three cloud providers. We have a large partnership with Google. And while we invest a ton in our security infrastructure and fortifying our infrastructure, Google spends even more in terms of the security. So you have security, you have resilience, you have burst processing. Credit unions are real time, but banks are still batched. And you may say, like, "It's not really. I go to an ATM, and I see it right there in my statement." But it's memo posting, it's not really real time for most banks. So it allows -- at the end of the night, they still have to do a massive amount of workloads or end of month or end of year. Well, when you run a data center, you have to have enough capacity for those burst moments. In the public cloud, like capacity is limitless and it's certainly more affordable to buy it when you need it. So we think there's a lot of really great positive attributes that will help us from a margin perspective, from a pricing perspective, when we're in the public cloud. I think that most people will take a bundle of services. They're not going to just take one module. So I think, for the most part, it will look like the core today, that 30 pieces of data at the end of the day, but we're just thinking through the go-to-market for that.

Okay. You mentioned earlier your Banno digital product. Can you first of all provide a little overview of that, and then get into your recently launched Banno for business? Where do we stand there?

So Banno has been in the market since about 2018. It's our digital banking platform. We have over 11 million users. It's the #1 app in the App Store. It's your full banking experience. So it used to be like if you used a laptop or you used a phone or you used a tablet, you would know that you could do different functionality in your digital banking, and it wasn't the same experience. With Banno, it's ubiquitous. It is the same functionality. It's the same look and feel, the same UX and UI. So it is a full host of products. We started on the retail or consumer side of the house. We have 800 of our 1,700 core customers on Banno. We released this past year Banno for business, which is an add-on module. So it is an active user-based product. But it really allows a lot of integration. We have great third parties, like our team at Autobooks here, that can plug into Banno from an offering perspective. So it's really a gateway for the full digital experience of our products and services. Banno Business. And now we think as we have -- we used to say Banno retail, but it's really Banno the platform because everything else is an add-on. So Banno for Spanish, electronic statements, they're just uptick extra add-on modules. But now we have a full comprehensive product suite. We think we are on parity from a feature set with the leading providers historically in the market. So we've been converting and migrating a lot of our old NetTeller clients. We now are competitive with every digital platform that's out there. We think we're surpassing them from a superior product. But it really allows the banks and credit unions that wanted to do both commercial and retail to have something in one product. And there's some really great things. If you haven't heard of Banno Conversations, for example, it allows you to have an authenticated chat. Let's say I'm on my phone and I see a check that doesn't look like I wrote it or something. I just don't remember what it's for. I can pull up Banno, circle that. And in the branch, the representative can have a conversation with me, see the document I'm looking at and serve me right there. And that's an area where we're embedding AI as well because we can serve up to that bank representative what might be the next solution answer to give a customer, right? Still a human in the loop, the teller or the bank back-office customer service agent can change it. But it can help from an efficiency to say, what might it be? You can also say, we like to talk to our clients in these manners, or here's the language of our bank, or we want to talk to them in Spanish, or we want to talk to them like Snoop Dog. Like you can do anything you want. It's a pretty compelling and fun tool that's really taking off with our customer base.

Now are you selling Banno to non-Jack Henry core banks?

We aren't today. It's something by the end of this year, we've talked about. We've been ready technologically to do it. Frankly, the competitor set from other core providers were hoping we would bring Banno to their cores. But what we found was Banno was a great entry conversation point to help the core sale. And when people do a core, they don't buy core in a vacuum. They tend to buy core with 30 to 50 other of our ancillary products. So we want to make sure we continue that strong pipeline of core wins and Banno wins, but we're also now going to go outside the base to different vendors.

I see. Why do you think there's this pressure for digital banking on the commercial side or the business side?

I think it's on both sides, to be honest with you, Matt. Because let's be honest, the younger generation doesn't want to walk into a branch. I mean, my kids don't want to write a check, let alone like talk to someone in the branch for a deposit. So people want to be able to be served in a manner of which they want. So -- and the expectations for service changes with every new iPhone app, every new customer experience that you have with another fintech or another software provider. And so it allows us, because it is in the public cloud, we can put out 80 new releases or updates to Banno without you even knowing. It's like your iPhone, that continuous expansion of functionality. That's much different than monolithic code that gets updated maybe once, maybe twice a year. So just the pace of innovation in Banno, the ability to keep having functionality to serve small businesses, large businesses and consumers.

Let me switch gears a little bit. You're relatively new as CFO. Jack Henry just appointed a new CEO who was the COO. Should we expect any changes?

Yes. So Greg is going to be taking over on July 1. Greg has worked for Dave Foss, our current CEO, for 13 years while at Jack Henry. He has a strong payments background, but he also was instrumental in the strategy and the strategic partnerships, tech modernization. As President and COO, he's had a very strong influence on our strategy. So I am expecting a very seamless transition. We also have another round of like Shanon McLachlan's taking over as COO. So it's going to have some changes, but people with long tenures at Jack Henry, long tenures in the space from a banking experience perspective. So I think more will stay the same than will change, to be honest, Matt.

Putting your CFO hat on, how should the investors in this room sort of think about Jack Henry over the medium term?

Yes. Jack Henry is a premium franchise with strong execution, experience and predictability. So 90% reoccurring revenue, 7% to 8% growth with margin expansion story, strong cash flows and a disciplined capital allocator. I mean, that's pretty much it. As a CFO, it's like it's pretty clean. We are not an adjusted EBITDA smoke-and-mirror type of company. We are a clean balance sheet, almost no leverage, historically no leverage. A good acquirer. But the nice thing is we also have tremendous capabilities to build. So we're going to look at M&A more opportunistically, but just a strong runway, a large marketplace that we serve with a high reoccurring revenue rate.

With the tech modernization program going on, how should we think about CapEx?

So the tech modernization project has still been within the 14% to 15% of our revenue that we spend on R&D a year. That 14% to 15% has been our benchmark. We think that's probably 2x the amount that our competitors spend on R&D. But we've been able to do all of our innovation, we're just disciplined on prioritization. So we -- in that same time that we've been working on tech modernization, we've done a complete new rewrite of Financial Crimes Defender and treasury management and a lot of other products at the same time.

And what about margin performance this year and then into next year?

Yes. Well, when I came on as CFO, it was really important to me, of integrity. Jack Henry, our investors know that we're dependable, we're resilient, and we deliver as we say we're going to. And so when I looked at the margin capability of the firm, I wanted to make sure and put a guide out there that I knew would be the floor. It's not the ceiling. It's the floor from a dependability perspective. But the nature of our SaaS model, the nature of write once, use often type of software code, the tailwinds from the shift from on-premise to private cloud, the shift to public cloud. Like there's a lot of great tailwinds, so it will continue to expand upon the margin expansion capabilities of our model. But we know that margin expansion is a key part of the investment thesis. So we're committed to it.

Okay. I have more questions, but I'll ask the room if anyone -- please?

[indiscernible] [ talk about ] core players? Is it the [indiscernible] startups [indiscernible].

Sure. The question, just for those on the webcast, is on the digital banking, who are competitors in this space and who we kind of face up against? I would say it's a bit of both. I think the larger names, like the Q2, the Alchemys of the world are certainly formidable from a digital banking perspective. There's other core providers that have some products. But I would say Jack Henry is on parity with a Q2 from a feature functionality perspective. Other questions?

Okay. I'll keep going if you really want to hear my voice asking questions. Okay. Let's talk about the payment side a little bit. I guess 18 months ago, it was sort of the area of focus. Now it seems a little settled down. What's going on with payments, especially the Payrailz acquisition, the integration of it? And I know it's going to be a lot. And credit issuing and processing for your banks.

I'll try and remember all three components, but remind me, Matt. So payments is about 1/3 of our revenue if you think about 1/3 being kind of the core. In our three segments, we have core, about 1/3; payments is about 1/3; complementary's about 1/3. So within that 1/3 that represents payments, you have our payment processing. So that's about 60% of our business. So that is your debit, as I talked about, the 1,000 debit customers we have. We stepped back into being a credit issuer, processor a couple of years ago. We've always said that's a slow grower, but the benefit is banks and credit unions tend to want the same provider to do credit and debit. So it's as much defense as it is offense. So that's really tied to the resiliency of the U.S. consumer. We don't participate in interchange. So we like to say you can be buying a bottle of water or a laptop, we're somewhat indifferent. But our numbers will follow a Visa or a Mastercard type of numbers for the U.S. domestic transactional volume, or tends to be slightly higher because we're always winning new logos. So we have also that pipeline that fuels growth as well. But those numbers tend to be tied to the U.S. sentiment. Now the U.S. consumer has been extremely resilient. Debit tends to be more conservative than credit. So it tends to be what you use for gas and dry cleaning and supermarket groceries. What we saw in the last quarter was dollar volumes were actually up a little bit, but the number of transactions were lower, which is we don't think a long-term trend. We think that, that tends to ease out a bit. So overall, it's been a healthy grower, but it is tied a little bit to the U.S. consumer. And then we have the enterprise payment business. We're one of the largest on remote deposit capture. We do ACH. That's where business is. There's still a lot of U.S. check writing that happens. And so we help businesses with gathering those checks and doing remote deposit capture for it. And then we have our bill payment. And I say bill payment versus like just a bill pay system, that's where the Payrailz acquisition and iPay is. Is because that -- it used to be every bank, you have a website and you could pay a bill on. Well, that area is really seeing a lot of new stuff with pay a loan or least-cost routing because you now have new rails coming into that pay center and that pay hub. You have FedNow, you have RTP and Zelle. So there's a rejuvenation that's been happening there. We also now have within our financial crimes, we have modules that help fight the faster fraud and the faster payments. And so there's a lot of excitement within there that I think will also fuel growth.

Okay. Questions from the room? Okay.

[indiscernible]?

Yes. So the question is around R&D spend trends. The 14% to 15% has been our benchmark for a number of years, and I think that's, say, for the foreseeable future. The reality is we're not constrained from a resources perspective. What we're trying to do is deliver the technology in the bandwidth that people have to consume it to -- that we have from a demand perspective, from a regulator perspective. So we've been able to do all of the tech modernization road map as well as modernize the core, continue to support SilverLake and Symitar, our big flagship cores, and we have two other banking cores as well. So we're going to continue to do enhancements on our existing cores even while we are building the new tech modernization core and then the other flagship of payments and complementary products. So I think 14% to 15% is adequate to be able to do all of that innovation.

On the complementary products, what's the average? Where you have a core customer, what's number of additional products that they usually take?

So when a core customer is new, they tend to take somewhere between 30 and 50 of our other products. So usually, Banno is always with it, but there's treasury products. There's a lot of workflow products, account opening products, connectivity products. So they tend to take a whole roster of our products. And then as they grow every year as we talk to them and find out their growth strategies and needs, they tend to add on products. So some of our more mature customers who have been with us over 20 years, they may have upwards to 70 to 100 of our products over time. And then in our complementary noncore customers, so not the 1,700, but the other customers that -- they, on average, take 3, but it's a little bit of a misnomer because as people tend to get towards 12 or 15 or 20 then we tend to -- at the next renewal, we win the core. So that is kind of a capped number. But we tend to touch most banks and credit unions in the U.S. with some products. So that's the beauty of it, is that most people are experiencing the Jack Henry service and our company in general. So when they come up for renewal or a core win, they have some touch point with us.

Okay. Well, thank you for [ that great time. ]

Thank you, Matt. Thanks for having us.

Absolutely.

Yes.