Earnings Call Transcript - JKHY Q1 2022

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Jack Henry and Associates First Quarter FY 2022 earnings conference call. At this time, all participants are in listen-only mode. After the speakers' presentation, there will be a question-and-answer session. And please be advised today's conference is being recorded. I will now hand the conference over to your first speaker for today, Kevin Williams, CFO and Treasurer. You may begin, sir.

Kevin Williams, CFO

Thanks, Brian. Good morning. Thank you for joining us for Jack Henry & Associates first quarter of fiscal 2022 earnings call. I am Kevin Williams, CFO and Treasurer. On the call today is David Foss, Board Chair, President, and CEO of Jack Henry. I will turn the call over to Dave to provide some of his thoughts about the business, financial sales performance for the quarter, comments regarding the industry in general, and some other key initiatives that we have in place. After Dave concludes his comments, I will provide some additional comments regarding the press release we put out yesterday after market close, and also provide some comments regarding our updated guidance for our fiscal year 2022, provided in the release yesterday. I need to remind you that this call includes certain forward-looking statements, including remarks or responses to questions concerning future expectations, events, objectives, strategies, trends, or results. Like other forward-looking statements, these are subject to a number of factors that could cause actual results or events to differ materially from those which we anticipate due to a number of risks and uncertainties. The Company undertakes no obligation to update or revise these statements. For a summary of these risk factors and additional information, please refer to yesterday's press release and the sections in our 10-K entitled risk factors and forward-looking statements. We will also discuss certain non-GAAP financial measures, including non-GAAP revenue and non-GAAP operating income. The reconciliations for historical non-GAAP financial measures can be found in yesterday's press release. With that, I'll now turn the call over to Dave.

David Foss, CEO

Thank you, Kevin. Good morning, everyone. We're pleased to report another strong quarter of revenue and operating income growth. As always, I'd like to begin today by thanking our associates for all the hard work and commitment that went into producing those results for our first fiscal quarter, particularly in light of the challenges posed by the ongoing pandemic. We continue to operate with well over 90% of our employees working full-time remote and continue to evaluate options regarding an appropriate return to office target for all affected employees. With that, let's shift our focus to look at our performance for the quarter we completed in September. For the first quarter of fiscal 2022, total revenue increased 8% for the quarter and increased 9% on a non-GAAP basis. Deconversion fees were down more than $2 million compared to the prior year quarter. Turning to the segments, we had another solid quarter in the core segment of our business. Revenue increased by 8% for the quarter and increased by 9% on a non-GAAP basis. Our Payments segment again performed well and also posted an 8% increase in revenue this quarter and a 9% increase on a non-GAAP basis. We also had another strong quarter in our complementary solutions businesses with a 9% increase in revenue this quarter and a 9% increase on a non-GAAP basis. Traditionally, our first quarter has been our lightest sales bookings quarter because our fourth quarter tends to be extremely strong, and the sales pipeline is depleted as a result. As you may recall, the June quarter was the strongest sales quarter in the history of the Company, so we certainly expected this historical trend to hold. What we experienced, however, was just the opposite, the performance of the sales organization was again, very strong with a number of notable wins. In the quarter, we booked 6 competitive core takeaways and 10 deals to move existing in-house customers to our private cloud environment. Although our rate of 6 takeaways is light compared to our normal run rate, it is clear to me that a number of deals fell into the month of October because we booked 6 more core takeaways in October alone. As we've discussed on prior calls, our convert merge backlog is a good indicator for us of what to expect with coming mergers and acquisitions within our base of customers. We can now see that M&A in the banking space will be very active this year because almost all of our conversion slots for acquired banks are full for the year. We are working to evaluate whether or not we need to add more conversion teams to keep up with the activity. You should expect to see a corresponding increase in deconversion revenue, as some of our institutions are acquired by others in the space. Kevin will provide more detail on this line when he shares his comments. We continue to see good success with our new card processing solution, signing 6 new debit processing clients this quarter and one new credit client. We also continue to see great success in signing clients to our Banno digital suite with 35 new contracts in Q1. Speaking of our digital suite, we're continuing to implement new financial institution clients on the Banno platform at a similar pace to recent quarters. At the end of Q1, we surpassed 6 million registered users on the platform, and that number is growing at about 125,000 users per month. At the same time, our Banno platform continues to hold one of the highest consumer ratings in the App Store. The Banno digital suite is well on the path to becoming the industry-leading digital banking solution. The continued success we've seen with sales and adoption of our digital suite is consistent with the expectations coming out of the bank director technology survey published in August. This year’s survey showed an interesting shift, as more than 70% of the responding banks had moved efficiency of operation to the top of their priority list, with improved customer experience and an improved digital experience following closely behind. To further the point regarding an improved digital experience, this year, 54% of the respondents indicated that their customers prefer to interact with their bank using a digital channel rather than in-branch or over the phone. The survey also indicated that the median increase in expected technology spending for the coming year was 10% compared to the prior year. All of this bodes well for the future of our digital suite as well as the other solutions offered by Jack Henry, which help facilitate an improved customer experience and an opportunity to enhance efficiency in the financial institution. As many of you know, we normally conduct our two largest client conferences in the fall each year. This year, we combined those conferences into one event and again hosted the sessions virtually. We had hoped to be in person this year, but because of the size of the event, we decided that wasn't prudent. As we saw last year, attendance was much larger than our in-person conferences because nobody had to incur any travel expense and they were able to readily drop into virtual sessions. We were pleased to be able to successfully interact in a virtual setting with many of our existing clients and prospects. Last week, we announced two pending retirements from our leadership team. Our longtime CFO and Treasurer, Kevin Williams, and our CTO, Ted Bulky, have both announced their intent to retire next summer. As we shared in the press release, we already have a search in process to find Kevin's replacement and will be considering both internal and external candidates. Kevin will be with us until we identify the right person and have them fully prepared to take the reins. Ted will transition out of his role in January when Ben Mats, our current Head of Digital Solutions, will become our Chief Digital and Technology Officer. Ted will stay for several months after that to help Ben with the transition. Of course, we have many months before each of them actually retire, so I have lots of time to thank them for their many years of service to our associates, customers, and shareholders. I would be remiss if I didn't acknowledge how much I've enjoyed working with each of them and how much I appreciate the approach each has taken in executing these much-deserved retirements. Next week, we will conduct our annual shareholder meeting. We will be hosting this meeting in person, but we'll abide by strict COVID protocols to ensure a safe event for all attendees. We are excited to meet with our shareholders in person again, who are also very aware of the ongoing pandemic-related concerns that arise when you assemble a group of people. We will start an hour earlier than in past years, we'll require all our attendees to be masked, and we won't be serving lunch following the meeting. With these changes, I'm confident we will have a productive and safe meeting. In our ongoing attempt to communicate effectively regarding our ESG-related efforts, we recently published our ESG statement, which provides a centralized overview of Jack Henry's ESG commitments and material, environmental, and social topics. Additionally, it points readers towards other related policies, like our human rights policy. We've also published an environmental policy that highlights our commitment to sustainability and proper environmental management practices. Both documents can be found on our new corporate responsibility website via Investor Relations. We created this website to house our sustainability reports and provide a centralized location for Jack Henry's ESG information. Speaking of sustainability reports, our next sustainability report covering calendar year 2021 will be published in March. We have continued to make major advances across our environmental, social, and governance initiatives, and the board has established a quarterly cadence to discuss ESG matters. As we move forward, I'm very optimistic regarding our levels of sales activity and customer responses to the solutions we're delivering and the strategies we are executing. We will continue with our disciplined approach to running the Company and we expect that approach to continue to provide stability and solid performance for our employees, customers, and shareholders. With that, I will turn it over to Kevin for some detail on the numbers.

Kevin Williams, CFO

Thanks, Dave. Service and support revenue increased 6% in the first quarter of FY 22 compared to the same quarter a year ago. As Dave mentioned, our deconversion fees were actually down $2 million compared to last year, or 37% for the quarter. License revenue was down slightly compared to the prior year. Our hardware revenue was down $4 million or 39% compared to Q1 a year ago. This is due to our customers continuing to choose our private cloud delivery and therefore not purchasing hardware. Service support line revenue drivers were our software subscription revenue and our data processing hosting fees and our private and public cloud offerings, which combined, continued to show strong growth in the quarter compared to the previous year, growing combined by 10% for the quarter. However, the growth in this line was slowed significantly due to the product builder in services revenue, which includes the previously mentioned deconversion fees, license, and hardware along with other revenue, which combined were down by a total of 9% compared to the prior-year quarter. Therefore, total support and services net grew 6% for the quarter. Our processing revenue increased 12% in the first quarter FY 22 compared to the same quarter last fiscal year. This increase was primarily driven by higher card volumes with new customers we sold to last year and increased debit card usage from existing customers. Our Jack Henry digital revenue continues to show strong growth as demand for our Banno digital platform continues to be very strong. As Dave mentioned, total revenues grew 8% for the quarter compared to last year on a GAAP basis and 9% on a non-GAAP basis. Our cost of revenue was up 5% compared to last year's first quarter. The increase is primarily due to higher costs associated with customer maintenance, card and transaction processing, along with higher personnel costs compared to a year ago. Research and development expense increased 3% for the quarter FY22 compared to last year. This increase is primarily due to personnel costs. Our SG&A expense increased 13% in the first quarter compared to the same quarter in the previous year. This increase was due primarily to increased personnel costs and travel-related costs compared to last year, as travel increased significantly in Q1 compared to last year. Our reported consolidated operating margins increased from 26% last year to 27.4% in the current year, or 140 basis points increase. On a non-GAAP basis, operating margin expanded from 25.2% last year to 26.9% this year for a 170 basis points expansion. We had margin expansion in all three of our reporting operating segments on both a GAAP and non-GAAP basis. The effective tax rate for the first quarter of fiscal '22 increased to 23.4% compared to 22.4% in the same quarter a year ago, which is in line with guidance we provided on the previous call. Our net income grew 12% to 102.1 million for the first fiscal quarter compared to 91.2 million last year, with earnings per share of $1.38 for the quarter compared to $1.19 last year, a $0.19 or 16% increase year-over-year. For cash flow, our total amortization increased 2% in the quarter compared to last year due to capitalized software projects being placed into service. Included in total amortization is amortization of intangibles related to acquisitions which decreased to $4.3 million this year compared to $4.4 million last year's quarter. Our depreciation was down 2% compared to the prior fiscal year and during the quarter, we paid dividends of $34 million. Our operating cash flow was $106.5 million for the year, which is down from $114.5 million last year, with the decrease primarily due to the timing and changes of various operating assets of liabilities in the calculation of operating cash flow. We invested $46.5 million back into our companies capex and capitalized software. Our free cash flow, which is operating cash flow less capex and capitalized software and adding back net proceeds from disposed assets was $60.1 million for the quarter. Our cash position at September 30th was $44.3 million compared to $195.3 million a year ago, primarily due to the significant stock repurchases we did last year, with $65 million drawn on our revolver in the quarter and we had no other long-term debt on our balance sheet. Return on our average assets for the trailing 12 months is 13.7%. Return on invested capital for the trailing 12 months is 21.5% and return on equity for the trailing 12 months was 21.9%, which are all very strong. For FY22 guidance, we provided both GAAP and non-GAAP updated revenue guidance in the press release yesterday for fiscal '22. We also provided a reconciliation of GAAP to non-GAAP revenue in the release immediately following the segment information in the release yesterday. However, just to be clear, this guidance continues to assume that the country continues to open and the economy continues to improve, and if things were to change significantly, obviously this guidance will be revised. For GAAP revenue growth for fiscal '22 based on the amounts in the release yesterday, our revenue guidance has a range of 8.6% to 9.1% over the previous year. We now anticipate deconversion revenue to be approximately $42 million to $43 million for the entire fiscal year, with a significant percentage of that being in Q2 and Q3. For non-GAAP revenue growth, we continue to guide to a range of 7.5% to 8% growth for the fiscal year. Obviously, these will be updated during the year. We continue to anticipate GAAP and non-GAAP operating margins to improve in FY 22 compared to last year, as we should have very nice margin expansion in our payments segment and anticipated higher deconversion fees. However, I continue to be somewhat cautious about guiding too much towards operating margin expansion. As we will continue to have headwinds on license and hardware revenue as we continue to move core customers from on-premise to our private cloud, and also travel costs will continue to increase significantly compared to the prior year. Our effective tax rate for FY22 continues to be projected slightly higher at approximately 23% compared to the prior year. Obviously, significant changes in corporate tax structure could change this guidance. And our FY22 GAAP EPS guidance is a range of $4.064 to $4.073, which is an increase from the prior guidance of $4.053 to $4.060. This concludes our opening comments, we're now ready to take questions.

Operator, Operator

Our first questions come from Vasu Govil with KBW.

Vasu Govil, Analyst

Hi, thanks and I wanted to congratulate Kevin on the announcement of your retirement. We will be sad to see you go, but now we have a couple more quarters to talk with you. I guess my first question is on the merger comment that I think David you made that you're seeing strength there. I know last quarter you had said that you expect it to be better this year, but it didn't seem like we were really including much in the guide. I just want to get a sense of what you're including in the guide versus what could be upside based on what you're seeing.

David Foss, CEO

I said in my comments, the convert merge slots and just to make sure nobody is unclear when we reference convert merge; it happens when one of our institutions is acquiring another institution. They notify us well ahead of time, long before the conversion or the acquisition actually happens. They notify us that they will need our help to convert the acquired institution onto the Jack Henry platform, and so we hold those slots. In the past several weeks, that volume has increased significantly with customers contacting us to hold conversion slots and essentially signing contracts to lock those in. What I said in my comments was, every conversion slot now on the banking side of our business is filled for convert merge activity through the remainder of the fiscal year, and we're evaluating whether or not we need to add more teams. The reason for that evaluation is we have to keep an eye on whether a deal falls through. Since they notify us well ahead of time and ask us to hold a slot and contract with us, we have various indicators from our experience to predict what is going to actually happen. But everything that we have today that is known is worked into the guidance that Kevin provided to you, and there is more potential opportunity out there. We may stand up an additional conversion team or even two if demand justifies that, which we've done in the past. The key message there was just for you to know that convert merges or M&A is back in the banking space. Not only is that a real positive for us and that we have customers acquiring other customers, but we also expect deconversion revenue to go up because we know some of our customers will also be acquired away from us as M&A continues to grow.

Vasu Govil, Analyst

That's very helpful. Thank you. Just a follow-up I had was on the payments segment. It has been, to me coming into the quarter, that you would probably be the high watermark and then kind of level off from there. I didn't think the revenues in the quarter were at that light compared to what we were modeling. I just am curious to see where they came in relative to your internal expectations. I know debit volume rolled off a bit; is that probably impactful to your Payments segment? And then, if you could also comment on what's going on in the bill pay business. I know there are softer trends across the peer group. But if you could comment on if you have any insights on that. Is that just more competition from digital wallets or something else which is driving bill pay revenue to be flat?

David Foss, CEO

So there are a lot in the payments line of course, and you highlighted three primary components in the payments line for us. The Payments segment for us consists of bill pay revenue, card revenue, and what we refer to as EPS enterprise payments solutions. The bill pay business continues to be relatively flat. There's some growth, but as we've talked about on the call before, anybody who needs the bill pay solution already has it. Volumes aren't really fluctuating that much, so it's relatively flat in the bill pay business. The card business continues to grow. We're seeing nice growth not only because we're adding customers but also because as the pandemic numbers have dropped, transaction volumes have increased. That correlation is evident as infection rates drop. The enterprise payments business is also growing very nicely, albeit it's the smallest piece of that segment but it is the fastest-growing piece, driven by remodel by capture and its origination's. We have a number of customers who have signed with that platform recently, and some that we'll announce next year as they come live. So it's a combination of all these factors that I think are driving the payments revenue, and all of them are positioned well for continued growth in the coming year.

Kartik Mehta, Analyst

Hey, good morning, Dave and Kevin. Dave, I wanted to maybe get a little bit more on your sales pipeline question. I think when you spoke last earnings call, you talked about the FY2022 pipeline being up 3% to 5%, if I remembered my numbers right. And I'm wondering what your expectations are. It sounds like things are going well, but it would be interesting to know what your expectations are for the growth in the pipeline for this fiscal year.

David Foss, CEO

Yes, that's a good question. I have no hesitation in reaffirming the 3% to 5%. Can it be greater than 5%? It's a little early for me to commit to that. But I will say with no hesitation, 3% to 5%. In fact, at the high end, I would comfortably say 5% based on what we're seeing right now. Below the core, it has been interesting watching core deals as we've come out of the COVID trough. While the pandemic isn't over, we are seeing a tremendous amount of activity across our business. If you look at the rest of the suite of Jack Henry, the forecasts and pipelines are looking very strong right now, so I'm comfortable signing up for the high end of that guide, and it could be even higher, but I think we need a little more time under our belt here to make sure I'm not overextending.

Kartik Mehta, Analyst

Kevin, I know you talked about margins in your guidance, a little bit cautious, but you had an excellent quarter this quarter. It seems like margins were better than you thought. I'm wondering if your reluctance to think you will be better than the 50 basis points you talked about last fiscal year is just too early in your opinion or are there other things that might impact margins that we should be aware of?

Kevin Williams, CFO

Yes. I mean, Kartik, there are so many moving parts this year that are coming back that weren't there last year. I mean, deconversion fees will obviously be higher. As Dave mentioned, M&A activity drives several different moving parts within our financials. Obviously, travel is going to be a lot higher. There are other costs. Salespeople are getting out and traveling more, and so travel expense will be higher. Could it be possible that our total margins could be higher? Yes. But I can tell you that Q1 margins are the highest of the year because of all the software subscription revenue that we've recognized in Q1 for all the software delivered in previous years. This is the high watermark for margins for the year. That said, what I will say is license revenue was down almost 40% this quarter, which impacts our margins since hardware revenue being down makes it higher. If hardware revenue levels off, our margins might go back up a little as well. That said, I am still comfortable with the guidance of 50 basis points and it could be higher than that, but I'm just managing expectations.

Peter Heckmann, Analyst

This is John on for Peter. Just a quick question. You touched on this in the prepared remarks, but what’s the expectation for deconversion fees and how does that play out each quarter again?

Kevin Williams, CFO

So we expect deconversion fees to be around $42 to $43 million. This is somewhat of a prediction; we don't know for sure, but we believe about 80% of that will occur in Q2 and Q3 based on what we know right now. So deconversion fees in Q2 and Q3 could be $15 million or more in each of those quarters.

Peter Heckmann, Analyst

Got it. Thank you. And that non-GAAP payments segment growth was 9%. Were there segments that grew notably faster or slower than the segment average?

David Foss, CEO

I assume you're referencing my earlier comments about the three different pieces of the payments segment, is that correct? So, three pieces: bill pay, our card business, and then what we refer to as EPS enterprise payment solutions. The Enterprise Payment Solutions business is growing the fastest, but it's the smallest of those three components. The card business is the largest segment while the bill pay business is relatively flat, growing a little, but most people who need bill pay already have a solution, and volumes don't change that much in that piece of the segment. However, the card business is performing well with growth driven by new customers as well as transaction volumes increasing.

David Koning, Analyst

Yes. Hey, guys, thank you. As we look at the market, we hear a lot about super apps and how they're progressing. Is there much difference that a super app can do than what a Banno client that's on the Banno system can do? And do you do some work for a lot of the super apps to help them grow as well?

David Foss, CEO

Well, I am not exactly sure what you're including in the super app bucket. There are lots of things going on out there. We are working with a modern technology stack, which is open API based. You saw the press release we did in October where we announced the partnership and integration of Finicity, Akoya, and Plaid. All these relationships are designed to provide greater functionality on this digital platform, to connect FinTech solutions to other FinTech solutions. Our goal with the platform is to offer the best experience for the consumer and also provide the best platform in the industry for interconnectivity of applications. We're doing this diligently to eliminate the old practice known as screen scraping and we've been recognized in our industry for being on the cusp of this, ahead of traditional competitors.

David Koning, Analyst

Great. Thank you, guys. Good job.

Ken Suchoski, Analyst

Hi, good morning, David and Kevin. Thanks for taking the questions here. I just want to follow up on that last comment about the shift in core customers from on-prem to the private cloud. I mean, what's the revenue lift that you might get from that on a per customer, per unit basis?

Kevin Williams, CFO

On average, if you look at an on-prem customer, everything that they're paying us can be seen in several buckets related to in-house maintenance or disaster recovery, or hardware maintenance. But on average, when an on-prem customer moves to our private cloud, the revenue that we get out of that customer essentially doubles. There is very little cost increase because remember, it’s the same software, and it's the same support organization. We've got the infrastructure in place in our data centers. So there's very high margin from that additional revenue.

Ken Suchoski, Analyst

That's very helpful. And then maybe just a question on the payments segment. It looks like on a non-GAAP basis, the growth in this segment slowed from about 17% last quarter to 9% this quarter. What drove that slowdown and what are your expectations for that segment going forward?

David Foss, CEO

I don't recall us reporting 17%. That segment is growing very well, and we're very happy with what's happening in that segment. Last quarter was impacted by COVID and the depth of payments during that period, which made it an easy comp. So I think the 9% growth we showed this quarter is probably more of what you can expect for the entire fiscal year.

Ken Suchoski, Analyst

Okay. And then just last one from me just on the share repurchases. I don't think you guys bought back any stock in the quarter. I think in the prior quarter you had a larger buyback. I guess what are your thoughts on overall capital allocation at this point and what are your thoughts on repurchases at the current stock price?

Kevin Williams, CFO

We will continue to buy back stock. I will say that this quarter, one of the reasons we didn't buy stock back was related to trying to get tax planning in place based on the new administration's proposals. We were considering using significant cash to pay upfront taxes, but now with changes in the corporate tax structure, we can reevaluate our timing for stock buybacks moving forward.

Dominic Gabriel, Analyst

Okay, great. Thank you so much for taking the question. I appreciate the commentary on Banno and the partnerships with other fintechs. As you think about the net M&A activity affecting your partners, how do you think that could change the geography of your average asset size of your banking, credit union mix? And how do you typically win or lose customers?

David Foss, CEO

You've packed a lot into that question, and they are all things I love to talk about. First of all, yes, it does happen that customers are acquired away and then they come back to Jack Henry. Often, the acquiring institution realizes after the integration that their platform doesn't meet the expectations of those acquired, who then educate the acquirer on what it was like to do business with us. We also can sell the acquirer on converting to the Jack Henry platform when targeting an institution we serve. Therefore, our asset base among our customers is growing. Most of the M&A activity occurs at the lower end of the range of small institutions being acquired by large institutions, and we don't typically serve the smallest institutions. This means we tend to benefit when our institutions acquire smaller ones. Overall, our average asset size among customers is increasing. Again, we're pleased with the overall results of our ongoing operations. I want to thank all of our associates for the way they've handled these challenging times by taking care of sales and our customers and to continue working hard to improve our Company and to continue moving forward for the future. All of us at Jack Henry are focused on what is best for our customers and our shareholders. Again, I want to thank you for joining us today.

Operator, Operator

The call replay will be available two hours after the call is concluded. This concludes today's conference call. You may now disconnect.