Welcome, everybody. We're a little bit past time to get started, so I'll try to keep us as best on schedule as I can. Thank you very much for, for joining us. I'm James Faucette of Morgan Stanley, Senior Analyst here, at the company, covering in fintech and, and among them, Jack Henry. So very pleased to have, Mr. David Foss, CEO of, of Jack Henry, with us this afternoon. You know, look, I've got prepared questions. We've got 28.5 minutes. I have about 2.5 hours of questions, literally.
Sure.
I'm not kidding. I got four pages printed. But if anybody from the audience has questions as we're going along, please just wave your hand at me. I'll get you a microphone, and we can kinda address your questions, 'cause this is really for the benefit of you here. But maybe with that as a preamble, Dave, can we just start, for those maybe that don't know Jack Henry very well, describe very quickly the role Jack Henry plays in the financial landscape and for banks, et cetera?
Sure. So, the way I describe our company is a pretty simple phrase I repeat regularly: We are a well-rounded financial technology company, meaning we provide-
Mm-hmm
A broad suite of technology to financial institutions in the United States, and that in the United States part is by strategy. We choose to be domestic US-focused. We could do things internationally. We used to have an international division, but we sold that a few years ago to focus on the opportunities in the domestic US market, so we're US-focused. We serve primarily middle-market banks and credit unions, so we don't serve the little, tiny banks and credit unions. And again, by strategy, we choose not to sell to B of A and Chase and Wells, for example. We don't serve the top-tier banks. We serve all those middle-market banks and credit unions in the US with a very broad suite of solutions, so everything from core technology.
So if you listen to or read things about Jack Henry, you'll often hear see references to the concept of core technology. Core, for a bank or credit union, is that solution that processes loans, deposits, and general ledger. It's the back-office, heavy-lifting engine that processes loans, deposits, and general ledger. We have four different core solutions at Jack Henry. Then, we have a complementary solutions division at Jack Henry, where we have a broad suite of solutions that surround the core, so digital banking and check processing and teller systems and voice response and all kinds of different things that wrap around the core. And then, the third area of focus for us is in payments. So we are an issuer for debit and credit, a processor for debit and credit.
We have a large bill pay presence in the United States, so a bill pay platform. And then we have an ACH origination or remote deposit capture platform as well in our payment segment. So those are the primary areas of focus for us as we serve financial institutions in the United States. A notable exception for us is we, by strategy, choose not to have a merchant acquiring business, so we're not in the business of serving merchants with point-of-sale capture technology. That's a choice. That's by strategy. We focus on serving financial institutions directly with this broad suite of solutions. We are known in our space as being the number one premier provider of customer service.
So if you read things about us or hear things about us from people who are knowledgeable in our space, they'll often talk about Jack Henry for the service that we offer. We're regularly recognized as the best service provider in our space. We are regularly recognized as the best place to work, so you'll see lots of press releases about surveys that people have done of different companies in the U.S. Jack Henry is very often recognized as the best place to work around the company, around the country. That's important to us. We really try to position ourselves with an outstanding culture, try to put our employees first, and try to make sure that it's a great, great place to work. And then the third thing, of course, is outstanding technology.
So leading-edge technology at Jack Henry is the other thing that we're known for among customers who do business with us and around the analysts who follow us. That's usually the message that you'll hear about our company.
So, just to give a little more context, how many companies or banks are core customers versus the overall reach of Jack Henry?
Yeah, so there are about a little under 10,000 banks and credit unions in the United States. Jack Henry has a little under 1,700 core customers. And then in total, we serve somewhere around 7,000 banks and credit unions in total. So what that means is we have a number of customers who are not running a Jack Henry core system but who have other solutions from Jack Henry. It may be bill pay. It may be remote deposit capture, whatever. But essentially, the majority of the banks and credit unions in the United States do something with Jack Henry. They may only have one or two solutions, or they may have 60 or 70 solutions where they've wrapped around the core, but we touch most financial institutions in our target target market in the U.S.
So let's talk about, like, how this year has evolved. Especially if we go back to March, we had the few handful of bank failures, three of them. And at the time, I know that there was a lot of concern about potential contagion or what that could mean in terms of industry structure. So can you just talk about, you know, once again, for the benefit of background, kind of how the thinking evolved over time and, more importantly, how your customers have reacted during that period?
Yeah, so that was a challenging time, and then I'll just tell you a quick aside from me personally. So I was i, s o Silicon Valley happened on that, Thursday or Friday.
Thursday, Friday
T he 12th or something like that, eleventh of March. The following Monday, I was in New York, so I was at a, speaking at a conference, an investor conference in New York. Tuesday, I was on CNBC. That was all, of course, pre-scheduled. Little did I know that over the weekend, the whole world was gonna change, and there I was. All the questions I got were about, you know, the potential meltdown of the banking industry in the United States. So Monday, Tuesday of that week after Silicon Valley was pretty interesting. The sad thing was, of course, for several weeks after that, there was a lot of speculation about the entire banking system in the U.S., melting down, and there was a lot of confusion around capitalization versus liquidity.
A lot of people who didn't understand that, a lot of consumer investors really were confused about, you know, what was really happening in the banking space. And so it was a challenging time for bankers, and a lot of them, of course, had investments in treasuries that were underwater, essentially, at the time because of what was happening with the rising rates. We commented at the time that the move that the White House and the Treasury did to make sure that they provided a backstop was a really smart thing. I think that really went a long way toward nipping that situation in the bud. Interestingly, there was a lot of speculation that deposits were just gonna flow out of all the banks in the U.S. into the eight largest banks.
You know, the only banks in the U.S. that were needed were gonna be B of A and Chase and Wells and so on, and that just didn't happen. So what we saw with our customers was there were certainly some that saw some outflows of deposits, but a lot of them saw inflows of deposits as people were kind of paying more attention to diversifying where they had their deposits. And so a lot of our customers saw an inflow of deposits. There was a lot of interest in longer-term investment CDs, so a lot of CD new CDs that were written during that period.
But there was a total disconnect between what people thought was happening in the banking industry and what we were actually seeing in the banking industry during that time. But because of what people thought was gonna happen, bank stocks took a significant hit. You know, most regional banks, the Republic, they saw their stock drop pretty significantly.
Yep.
They've been slowly, you know, kinda climbing out of that ever since. We, oddly enough, ended up being tied to the KRE, so the regional bank index, and so our stock started to kind of flow with the KRE, which didn't make any sense at all. We're not a bank. We were not being impacted as far as revenue flow or anything like that, but our stock was impacted, and so it was a, it was a frustrating and confusing, confusing time for a lot of people. Now, you know, in retrospect, things have really returned to normal. Our banks, I think, are seeing people understanding now that they're not under the pressure that people thought they were. Certainly, there was pressure in banking, but they weren't under the pressure that people thought they were.
We, of course, were never under any type of real pressure or threat through that process. So I think there's some sanity that's returned to the space as far as that's concerned. And our banks, by and large, are healthy and performing well. And again, it's a challenging time, no question about it, but, you know, they're bankers. They deal with challenges, and I think they're by and large doing pretty well.
What do you hear from yourn s o if, if we kinda got past that initial shock, if you will, of the bank failures, you know, you kinda characterized it. I think a lot of people in that, you know, mid-end of March or middle of March, felt like, "Oh, there's gonna be massive consolidation that's gonna be forced by regulators and other market factors besides," and that was gonna leave Jack Henry reduced, essentially, that position potential that you have. Then, you know, as we got past that, and we got into April and May, I think everybody had the assumption, well, even if we don't see that, there will be a natural hesitation or freeze on spending-
Yeah
B ehavior, and we didn't really see that. It seemed like a lot of the bank managers decided, like: Look, we're gonna act like we're gonna be around, and if we're gonna be around, we're gonna- we've got to invest, and we've got to spend the money. And so, you know, that continued to move pretty, pretty well in your favor. What's the outlook sitting here today? What are you hearing from bank information officers and CEOs that you talk to in terms of what their spending intention is going into next year and how they plan to invest?
Yeah, so I'll give you three touch points for comparison here. And I if you listen to the earnings calls, as often as I can, I try on our quarterly calls to share with you all what we're seeing as far as survey data and customer feedback, whether they're Jack Henry customers or just industry, about expectations for the future. So in January, we got the first survey for the calendar year that indicated that spending expectations for the year were, should be up around 10%, so that was back in January. In May, we, Jack Henry, published our survey. So we do a survey every year around various topics of what's going on in the banking space. As far as spending is concerned, same result in May, was around a 10% average increase, for the year.
And then, just in August, now, Bank Director published their survey, which I shared on the most recent earnings call. Same result there. The average expected increase over the course of the next year was 10%. And so throughout the year now, with all the volatility and all the things that have been going on, from a spending point of view, the expectation has not changed. People are expecting to continue to increase their technology budgets in the range of an average of around 10%. Why would that be?
You know, people will ask me, "Well, given the challenges in the economy, how can these bankers possibly think that increasing their tech budget is a good idea?" My response to that is, if you're running a bank or credit union today, almost any problem you have, any, any problem or challenge you face, the answer is technology today, right? If you're trying to gain deposits, you don't create statement stuffers or mailers to send to people to try and get people to bring money to your bank. You go online, and you create some kind of online promotion, and you have an online account origination solution set up and some type of an online experience for those customers to bring money to your bank.
If you're trying to attract commercial borrowers, you're not gonna just drive around to different companies and say: "Hey, I'm a friendly commercial loan officer. Do you wanna do business with me?" You attract them using technology, using online commercial loan origination technology, and Jack Henry provides those types of things. And so the, i t's maybe counterintuitive to some people, but the answer to almost any question today for bankers is to deploy technology. There's efficiency, there's customer attraction gains, and all that kind of thing. So, so I think that helps explain why what would justify their budgets continuing to increase when it comes to tech spending, given what's going on in the overall economy. And so we're certainly seeing that. You know, I shared on the last earnings call.
Coming into our fiscal Q1, and we're a June 30 year-end, by the way, so we're in Q2 right now. Coming into our fiscal Q1, our sales pipeline was larger than it had ever been coming into a first fiscal quarter. So think about, you know, you end your fourth quarter, what always happens is salespeople are cleaning out everything they can possibly sign because bonuses and quota attainment, and all that is tied to that. Customers know you're at the year-end, so customers will try and get deals done 'cause they think they're getting the best deal. So invariably, Q4 is a very strong quarter for us, and so normally the pipeline is pretty depleted coming into Q1. This year it was not.
We had a record fourth quarter, and yet the pipeline was larger coming into Q1 than it's ever been by far, and so we know there is a lot of interest out there in spending on technology. Now, I don't know that everybody else in our space was seeing that, so I think part of that is unique to Jack Henry because of all the new technology we've been rolling out and the things that we're doing to really show prospects that we're focused in the space, but there certainly is a lot of interest in Jack Henry and Jack Henry technology today.
And it's an interesting point, right? Because I think, you know, the steadiness of that expected growth for the next 12 months as you've hit each of those surveys is interesting because when we came into this year, I don't think that 10% was terribly surprising, given the increase in net interest income that most banks were experiencing, right?
Yep.
And then, when you published your survey in May, there was a little bit of a question like, well, maybe just the timing around the banking stress, but that persisted. But then, to see that, you know, that same level sustained and be validated by somebody else, even as NIIs have compressed, is should be reassuring.
It is, yeah. And by the way, before you go to the next question, so you also brought up M&A in your last question, and I forgot to address that. So one thing, you know, there was a lot of speculation during the regional bank crisis-
Sure
A nd I always put quotes around the word crisis, 'cause it wasn't really a crisis.
It's pretty contained.
There were three, four banks that were in trouble, but it wasn't a crisis, so. But during that period, there was all this speculation about that there was gonna be massive consolidation-
Right
B anks were gonna fail, and they were all gonna be rolled up together. The thing that's interesting in that discussion is M&A has essentially stopped since. I mean, there's been some deals that are being done, the, and I'm talking about banks acquiring other banks. There have been some deals getting done since the regional bank crisis, but it's really almost come to a stop. My expectation is, coming into Q1 of next year, Q2 of next year, I think that is going to pick up. I think there is so much interest out there among bankers to get deals done. There are sellers that are looking to sell. There are buyers that are looking to buy.
You know, the challenge is the buyers, their stock was hit so hard they didn't feel like they had a concern, currency to get a deal done, and the sellers didn't feel like, you know, they didn't want to sell their, their franchise for less than they thought it was worth. So I think that is starting to normalize again, so I think you'll see M&A pick up next year. But that's just the normal, the normal response. Whenever we have kind of a, a dip in M&A, what you see normally is kind of a, a spike in M&A afterwards. But what's been happening in the U.S. for 30 years now, the average consolidation is 4% per year, and that's been a number that's held true for 30 years. Yeah, we have little upticks and little down, little troughs.
We're in a trough right now, so you're gonna see an uptick in January, February, March, somewhere in that timeframe. And I guarantee you, I'm gonna have investors come to me and say, "Oh, my God, you know, here we go. All the consolidation is going through the roof." No, it's not. What's gonna happen is there's gonna be a natural reaction to the trough that we're in. You're gonna see a spike come early next year, I think, and then I think we'll normalize back to that 4% range that we've seen historically for many years. And so, I think there is going to be a rebound in bank M&A next early next year.
Yeah, and I think that's an important point, is like, I know we-- last night we were talking about, we were having a conversation just about how I think for some investors, particularly that just look at the software side without really appreciating the banking side, is that bank regulators in the U.S., et cetera, really like having a large number of financial institutions. They have a real desire for things like relationship-based underwriting, et cetera. They don't want kind of everybody to end up just going through a machine for underwriting.
Well, and Congress, too, you know?
Congress.
The only thing that Congress in the U.S. agrees on is this idea that having a broad banking system in the U.S. is a good thing.
Right.
They feel strongly about the fact that, community regional banks, the banks that we serve, do a better job of serving small, medium business customers than the, the major banks in the U.S. As an example, I was just meeting last week in Washington with the leadership from the ICBA, the Independent Community Bankers of America, and 84% of small, medium business loans in the U.S. are written by community and regional banks, not by the big banks, right? So the big banks are not focused on serving small, medium business. They're focused on serving the largest commercial customers. So the lifeblood of Main Street America, it really is those community financial institutions who write those loans for small, medium businesses and take care of those customers. So your point about regulators wanting that system to remain strong is true.
It's ironic to me that Congress also agrees-
Right
A nd they wanna keep that system strong in the U.S.
Got it. So let's talk specifically about some of the key components of Jack Henry. First, core segment. I think one of the thing that's most surprising to investors is how well you do in competitive core takeaways. You know, there's big names that people may know, like FIS or Fiserv, but there are lots of other players as well, and seems like you're pretty consistent in achieving about one competitive takeaway a week or 50-55 a year. Like, how much visibility do you have in that, and what are the key points that allow you to win at that frequency?
Yeah, so that's an important point for us. So core is an important part of our business. It's certainly not all we do. We do all kinds of other things, but core is an important part of the business. And as James points out, we're on that run rate of winning about one new core deal a week, one new logo, and that's well ahead of anybody else in our space. So why would people make a decision to come to Jack Henry?
Well, before I even address that, let me mention how hard that decision is for them to make. When they make a core decision, when they decide to change their core and move to Jack Henry, the way I always describe it is, it's the most difficult decision around technology that a CEO will ever make is to displace their core. Why?
Because when you displace your core, it affects every single process in the bank, every single employee in the bank, and it affects your customers. Because processes are changing, the technology is changing, and the user experience changes. So it's a really disruptive decision when they decide they're gonna change out their core. The other thing that most CEOs will tell me is, when they decide to change out their core, every other strategic project that they have, they put on the back burner for about a year and a half. They can't do those other things while they're going through a core change. So it's an incredibly difficult decision for somebody to say, "Yeah, we wanna take our business from one player and bring it over to Jack Henry," in this example.
And yet we're winning 50-55 per year, which way much exceeds what anybody else is doing. So when it's the hardest decision you can make, and it's incredibly painful to go through that, why in the world would you choose to go to Jack Henry? So there are several things. Number one, we are recognized as being the most focused provider in our space. We serve banks and credit unions in the United States in that middle market. That's who we are. It's what we do. Everybody in our space knows that we are experts in that particular area. As compared to anybody else that we compete with, we have a very focused approach. Number two, the breadth of the solutions that we offer.
So if you do business with Jack Henry, you know that you have options to do almost all of your technology stack, you can get from Jack Henry. Anything from processing checks, to digital banking, to commercial loan origination, to core, and everything in between, and we'll even outsource your network if you want us to host it for you. We do all of that if you wanna do that with Jack Henry, so a very broad suite of solutions.
We're recognized in our space as the best provider of customer service, and that's a big deal to bankers. If you're the best provider of customer service, 'cause they depend on us every day to make sure that they get answers to questions and keep their systems running effectively, that's a significant piece of the equation. And then, this idea of relationships.
So Jack Henry is also recognized as having really solid relationships with our customers. We have many customers who will do reference selling for us, meaning they will tell their friends, "You should do business with these guys," and they'll act as references for us. And so when you roll all those things together, and we have this great innovative technology that we're delivering, we tend to get recognized as the vendor of choice when it comes to going through that core transformation.
So we have about seven. Question here. Can I just ask on the, on the flip side, the one that you don't win.
Yeah.
Do you get any feedback or reasons as to why, where the competitors are competing out there?
Sure. Yeah, so
Let me just restate. Yeah, let me just restate the question. So the question is, on the deals that, that Jack Henry doesn't win, what's the feedback as to why not?
Yeah. So usually it's no decision. So back to the point of this being the hardest decision you'll ever make, oftentimes the banker will say, "We just decided we can't do this right now." So Jack Henry doesn't win in that case. The second reason is price. So we are never the low-price leader, and I say that right up front with anybody who wants to talk to us, and, and it's pretty well known in our space. So if you're really going for price, if you're looking for the cheapest solution, that's not Jack Henry. So we will lose on, on price once in a while. And then sometimes, the situation is, so we'll, we'll see a CIO or the CEO has come from a bank that was running, you know, one competitor.
They're just comfortable with that solution, and so they come into the bank, and they end up choosing that solution because it's something they've known, it they know. It was a known quantity. Those are the normal reasons why we lose a deal. It's not on the technology, it's not on the, you know, that they think our service isn't gonna be great or something like that. And today, price is becoming more of a topic than it used to be, and, you know, where people will really cut price, and we just don't do that. You know, that's not our model.
We have about six minutes left, and there are a few financial-related questions I wanted to make sure to get to. Let's start with margins. I think for some investors, we get a lot of questions about, you know, what's happening with margins? Can you give us a brief overview of how margins have historically evolved, as there are several moving pieces as to why margins may or may not be as consistent as you would like? How have you set the bar, and how are you thinking about the, Like, can you get back to a consistent level of margin expansion?
Yeah, so it's an important question. It's interesting because I've been doing this for a long time. I met with investors for a long time. Just really in the past two, three years, revenue growth and margin expansion have become the hot topics for Jack Henry. So they almost never came up in conversations with investors before. Certainly, they cared about, you know, are you growing the company and that kind of thing, but this really intense focus on revenue growth and achieving margin expansion targets has become really important. And so I went to our compensation committee a couple of years ago and said, "Okay, I'm CEO of this company.
Because this is such an important thing to our investors, I wanna make sure that my compensation program, our president's compensation program, and our CEO and CFO's compensation program are tied to those two things: revenue growth and margin expansion." So the comp committee put those changes in place to help ensure that we're focused on that. Not that I wouldn't have been focused on it anyway, but I wanted to make sure that we're reflecting what you all as investors think are highly important. The other thing that. So revenue growth has not been a, you know, question for a long time. We're growing top line at around 8% per year and have been successful there.
But as far as margin expansion, we tended to communicate to you all around margin expansion, more in terms of aspiration as opposed to what we can actually do and make sure we hit. And it's really it's the only topic that I can think of where that's the way we were communicating previously. We've always been very focused on being transparent with shareholders and with customers, making sure that we're telling you the straight scoop. So one example that I use regularly is we don't sell vaporware. You know, we don't go to customers and say, "Hey, we're thinking about developing this. We want you to sign a contract." We wait until we actually have a product, and we can actually show it to them before we, before we sign contracts.
And so we've made this change in the way we message around margin expansion to be consistent with what we do with everything else. And so some people perceive that, "Oh, you guys are dropping your margin expansion from 50 bps per year to something less than that." We weren't achieving 50 bps per year. That was aspirational, but we weren't actually doing that.
And so with our new CFO in place, one of the things that I asked of her was, "As we make this change, I wanna make sure that we're communicating what we can actually achieve per year and something that is sustainable for us as we go forward." And so that's the messaging that we've delivered with the guidance that we've provided most recently, and I feel very confident in our ability to now really deliver on the margin expansion expectation that our customers have of us-
Great-
- or our investors have.
So then, moving down in the, in the financial statements, talking about free cash flow, you know, usually and historically, your conversion has been 100% or, or even better most years. But this year, we're looking at something more like 50%, or in fiscal year 2023, it's more like 50%, and then you're looking for it to come back. Can you just kinda walk us through, the step down and then, more importantly, like, what, what we should be looking for for a recovery back to, and to what levels?
Yeah. So a few anomalies in the cash flow projection for this year. The biggest one for us is the tax law change that happened, where we have to expense R&D expense immediately, as opposed to being able to take that out over time. So this year, we had to make an $85 million cash payment above and beyond what we had to do last year, so that was a significant impact to free cash, and it's because of a change in the tax law. We believe, we hope, and believe that that will kind of revert, hopefully, within the next couple of years. But for now, there is no plan for that to revert. Congress hasn't agreed on a change, and so, we're living with that.
The other impact this year that was an anomaly was we rolled out an essentially an early retirement program. We call it Voluntary Early Departure Program, but it was this idea that employees who've been with us for a long time, who wanted the opportunity to retire, we incented them to retire. Well, of course, that was a cash impact as well, and there were some other nuances to that. So, our expectation right now is that within the next. Again, if the tax law changes, then we gotta have this conversation all over again because that'll have a pretty significant impact on us, a positive impact on us.
But absent a tax law change in the near term, it'll probably be, you know, within the next year, we'll be in the 80% range, 60-70 to 80% range, and hopefully, over the next four or five years, as we kinda work through the tax implications, we'll get back into that range that we were at prior to this tax issue.
Got it. And last question in the last minute and change, capital allocation. Historically, you guys have been great acquirers of other companies and, and seen a lot of success and added a lot of value and created a lot of value through that. At the same time, your stock is, is a little bit lower than it had been in previous years. How are you thinking about capital allocation, and, and what are you seeing, if anything, in terms of the opportunity to do acquisitions?
Yeah. So James knows well, M&A is always at the top of my list. We are a very competent acquirer. We acquired 34 companies between 2004 and 2015. We've done a lot of M&A. We're good at integrating them in. We're good at sourcing deals. We don't do deals where cost takeout is the driver. We're really good at doing additive deals. So we'd love to be doing M&A. The problem is, there aren't good deals to be had right now. Valuation expectations are just totally out of line, and I don't wanna do a deal and then have to come and face all of you and try and explain why we overpaid by 2x what we should have paid for an acquisition. So we're still looking for deals, but we're committed to our dividend policy.
We do share buybacks opportunistically, so our goal is to do buybacks to offset dilution when we do grants. That's not a requirement, it's not a stated commitment, but it's our goal. And then, opportunistic with other share buybacks as we see the opportunity to do that.
Well, that's great. Well, that's all the time we have with you today. David, thank you very much for joining us.
You bet. Thank you, everybody.