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

Yes. So the initial strategy came out of about 4 years ago through a strategy meeting we had and actually one of our former Chief Technology Officer, had said, "Hey, we need to start thinking about these things differently and where the public cloud was going." That strategy is morphed many times into what it is today. But we publicly announced it 2 years ago, we've been working on it for 3.5 years. And it's really, as I described, is really just kind of building this flexible set of components that will allow us to decouple the core and products. But it also allows our customers to work off of a single platform. So eventually, when we're completed with this, we'll have one platform that we will be able to service both banks and credit unions. That platform will have all of our key products integrated to it. All of the key third parties that we integrate and allow to integrate, back to the product rationalization we are a believer that there's fintechs out there that are going to build that particular feature that Jack Henry has today and build an entire company out of it. So it's hard to compete with some of those. So we will let the fintech come into our platform, make sure that the customer is happy. That's the one reason why we win a lot too, which I probably should have mentioned that we are the easiest to work with and the most flexible, we have over 1,000 integrations into the Jack Henry ecosystem today from third-party fintechs. But that tech modernization strategy, again, will open up the doors to a lot more of these opportunities in both at large institutions and small institutions based on their level of innovation and willingness to see what the value is and realize the value of being in the public cloud.

Yes. And I guess on the new platform, the new tech strategy, that's all public cloud basically going forward?

That's correct. So everything we're building will be in the public cloud. We've already actually moved like our wire platforms in the public cloud now. We move Banno, Banno was in the public cloud, but we moved them into Google. Google, by the way, is our primary public cloud provider, but we do have relationship with Azure and AWS, and we'll continue to do that. But yes, everything is in the public cloud. So if we have customers today that are on-prem, and we still have about 28% of our customer base that's on-prem, 72% in our private cloud, which is still a data center kind of environment. So we'll see people move from private cloud to public cloud. We'll see people move from on-prem to public cloud. We'll see that evolution continue over time.

Yes. I'm sure that transition is going to take a long time.

It will. And I don't think I'll be sitting on the stage by the time all that takes place.

Yes. And I guess when we look at the industry and the core processing business, I think I mean, what we find -- what makes it a good business is that there's high switching costs, and you combine that with economies of scale in R&D, right? So you're spending X amount on R&D, you're spreading that out over thousands of customers. So it creates this nice business with high margins, high returns on capital. As you think about this shift to this more open architecture, componentized offering, does that lower the switching costs at all in the industry? Or do you think it's about the same as it was before?

No. I mean I think it depends on if you're only buying a single module at a time, maybe it does lower that, but we believe that they're going to be buying the bundle, right? They want to -- they don't want to just operate a single feature of their core in the public cloud. And then -- I'll just use this example. So let's just say one of our largest competitors has a core customer, but that core customer isn't happy with their general ledger. So they try the Jack Henry general ledger. Well, that switching for them is minimal. But the point is, is that they're actually kind of trying before they buy, as I mentioned earlier, and there's some opportunities for that to happen. But I think for Jack Henry, the opportunity really isn't just from a customer standpoint and the revenue growth, but it's also from operational efficiency. We were able to build things one time and share them across kind of what we call the shared services mindset. So authentication is a perfect example where you have to build authentication and the ability for the credit union's employees or the bank's employees to get into whatever set system it is, whether it's core digital, fraud whatever. And we've built authentication now one time. So all new products are absorbing that one API, and we're using it across the entire organization. Where in the past, we used to build that individually in every single product, whenever we needed to make a change, we had to do that individually in every single product. So one of the big benefits of how we're building out this tech modernization is the ability to share the experiences and do it one time. Perfect example, ISO 20022 is something that everybody is working towards right now. Well, we have to fix that in 6 different wires platforms. We got ACH solutions. We got the cores itself. I mean we are doing that in a multitude of places. Well, over time, if something like that comes down the road, we would only have to do it in one place.

Yes. Does that change the contribution margin or the margin profile of the business at all...

Over time, that's obviously the goal. It will take some time to your point, to see all that happen. And there's some duplication that happens as you move from just call it the private cloud to the public cloud, you still got data center costs. One of the things that we're focused on is actually getting out of the true data center businesses and either moving into a colo type application or the public cloud and not necessarily running our own data centers to the level we do today. It's not a moneymaking business, right? And there's people that can do it at much less cost. So as that happens, as things move either from the private cloud to the public cloud or over to the colo, those costs start to decline.

Yes. And where do you guys expect to see them the greatest demand? Is it prospects, existing clients? Is it banks, credit unions, small, large? How do you guys think about where that demand might come from?

All of those, honestly, that's what we've seen. We've had some small credit unions that I've been really surprised about their level of interest. We've seen some large opportunities. We're talking to banks now that are over $100 billion in assets that are interested in what we're doing and either the complementary side of what we're doing, plus the core component side as well. So there's been interest at all levels. And candidly, it's about what I said earlier about building that level of credibility. We need a few of those larger institutions to say yes. And when they do and we prove it out, then that's when everything starts. But our credit unions, we have some small credit unions and some small banks that the reason why they renewed with Jack Henry is because of that strategy.

And I mean, there's a few different sort of modern platforms out there, modern offerings in the market, right? You have your strategy think FIS talks about modern banking platform, Fiserv bought Finxact. I mean how do you think about some of the differences or similarities between some of those? Just because that's one question I get a lot and it's hard to know exactly when you're an outsider looking -- trying to look in.

It's hard to know exactly the period. So I think the biggest validation I can give you to the level of differences understanding and execution and reality is what customers and prospects tell us. So when we're in a -- either a competitive bid for a new opportunity or in a renewal. We're just hearing from our customers that our level -- our strategy itself and our level of execution exceeds where our competitors are. The level of nuances there. So without FIS's modern core has taken several different twists and turns over time. I think Stephanie is definitely focused on making some changes there with some of the things they're trying to do now. And then Finxact, when they bought Finxact, it really was more tiered or more geared towards the Tier 1. That's kind of where they've been so far. They're adding a lot of complementary services to that. Because if you think about it, core itself is just a processing engine unless you're able to -- most of the new entrants, too, the Nimbuses and the Temenoses and the Thought Machines and things like that. A lot of the things that they're missing are the complementary components of that. So some of them can't even process a payment on any U.S. payment rails. So you got those components. So the short answer to your question is that what we have seen and what we've heard from our customers is that there's a level of differentiation in not only what we have as a strategy, but our level of execution.

Okay. I think you launched a Banno and you guys are seeing great results. I think this last quarter, you had 70 new signings. I think 40 of those were Banno for business. What's driving such high demand for the offering? And how should we think about the potential going forward? Because we always get a question -- we get the question of how big is this within complementary seems to be growing faster than the overall segment?

Yes. Well, it is growing faster than the overall segment. So we've been in kind of the 25% range. We've talked about that. For those of you that don't know Banno, so it is our digital offering. So it is unique in this aspect. So one, it's the newest solution that's been built. It was built in 2018. We started to roll it out. It's built on completely new technology, as I mentioned, all public cloud. You don't see that with our largest competitors in their offering or even any of the complementary solutions like a Q2 or Alchemy or others. And so newest technology, 11.6 million users in 5 years and growing on an average of about 200,000 a month. I think what's really unique is that in all of you probably experienced this today with your own institutions is that when you use a Banno application, it doesn't matter whether you're on your phone, your laptop, your iPad or whatever, you get the same experience regardless. And that is very unique, same features, same experience, everything else. So again, we don't know of anybody else that can say that. So that is a big differentiator. We have a lot of key solution sets like Banno Conversations, which is an authenticated chat that allows the customer or member to speak to a customer service representative at the bank or credit union in an authenticated way to where they can actually share data, they can share files, they can share everything to talk about, hey, this wasn't my transaction. Okay, we'll send it to me, those kind of things. That's very unique in the space. Nobody else has that. We've built some AI, generative AI components into that as well. The biggest thing for us is that if you go to the App Store, we're one of the highest, if not the highest, depending on the day. And so you just have this level of comfort. The one thing that's kept us from being even more penetrated is that we didn't have Banno Business. So we came out in 2018 is really a retail-based application. So we've been highly focused on building the business application over the last couple of years. So as you mentioned, we had a successful quarter. We have about 124 implementations live today of Banno Business. We have 850 Banno clients. So we still have an opportunity to sell within the 850 retail base selling Banno Business into that base. Will everybody take that? No, not everybody is focused on the commercial side. So I referenced on the last earnings call that I think we'll be somewhere in the 60% to 70% penetration. I think that's a reasonable conservative approach to that. But -- so that still gives us a lot. We're probably about 8% penetrated as I speak today. But the applications, the features, all those have really been the big driver. Going outside the Jack Henry base is going to create that whole another level of opportunity. So if we don't win a core deal, so there's roughly 200 core deals a year, 100 of them don't make a decision, 100 do make decision, Jack Henry wins 50 to 55 of those. Well, of those 100 that didn't make a decision, well, in the past, we couldn't even sell them Banno because we didn't go outside the Jack Henry core base. Well, now we have a chance to sell them Banno, sell them card, sell them Financial Crimes, all of those things, which is why that's a key part of the strategy.

Maybe talk about that because I think that was a learning point for Jack Henry as well in terms of going outside the base, I think you had to changed your strategy there a little bit. Maybe touch on how you came to that decision and why you made that and how it's progressing because it is a big opportunity.

Yes. It's a big opportunity. Part of it was that we just didn't want to make -- for the reasons I mentioned earlier, and again, I don't want to get being too critical of any of our competition, their digital offerings weren't at the same level as Banno or Q2 or Alchemy. So there was some level of excitement that was, hey, now that we can sell this product, that we had heard in the space. So we wanted to be a little more surgical and tactical on how we approach this. And so that part of the reason why we pulled back on the strategy to just make it open to all cores where we're really going after just a few, and we're not mentioning those names at this point in time. How it's going is some of it is reliant on the core itself cooperation. And so in some cases, that's better than others. And so we're working through that. We have some ways to get around that through either integration we already have on other products as well as some of the coopetition we do in the space with some of our other providers. So we're working through those -- that dynamic, but there is a level of excitement for us because we think the card product, coupled with the digital products and the fraud product, make a really strong offering. So we'll wait to see. Our plan is to be able to start selling this later this calendar year, start implementing it right around the end of this next fiscal year for us, which will be June of '25 will be the end of that fiscal year and into '26, fiscal year '26. So that's kind of where you won't see much until fiscal year '26 from that. But we're executing on the strategy and holding people accountable for doing that.

Yes. Great. Maybe we could touch on card processing. I think Jack Henry has been known for debit card processing. You guys have added capability on the credit side. So what does that bring to your customer base? And I guess, how do we think about that opportunity in terms of sizing it? How meaningful can that be for the overall company?

Yes. It's a great question. So when I was leading the payments group, we were going through a lot of the strategy part of this. And so I think if you think about our debit business today, I may have referenced this earlier, but it's roughly 98% of our transactions from our card business are debit and about 90 -- roughly 90% of our revenue is debit. So it's still -- credit is still a very small piece of that. What we decided to do back when we were actually making the decision to add credit. We wanted it to be on a single platform. We wanted debit and credit to be on a single platform. There wasn't a lot of players out there that could do that. And candidly, we couldn't do it in our own solution. We looked at a couple of acquisitions. It didn't make sense. So that's why we ended up partnering with First Data, which now is part of Fiserv. So they are our card provider. It's been a very successful partnership in spite of our competing on other things that we do. The partnership has been great and the people we work with have been great. That business has grown significantly since we did that partnership. Credit itself has not grown to the level that maybe honestly that I had thought it would. A lot of the smaller institutions really just don't want to do full service credit. They don't have the staff. They don't have the knowledge. And so what we've rolled out about 1.5 years ago now is an agent program, which is a smaller opportunity, their card portfolio is held and managed by somebody else. And if it grows to a decent size and they want to buy it back, they can. So we're closing 3 to 5 credit deals or so a month -- I mean, a quarter, but it's never -- I say never, it will be a long time before it ever gets to the same points where we are on the debit side. But what it has done is because it is on the same platform, it's created the opportunity for us to keep a lot of debit deals in competitive situations because we have the ability to add credit if they want and we've been very successful with that.

So it helps to retention a bit.

For sure.

Okay. Great. And then I guess another question we get is just around the margin profile of the business. I mean you mentioned some initiatives that might help that over time. But when we look at Jack Henry's margins versus competitors, they're relatively lower. So I guess, is there an opportunity -- I guess, what drives the delta in your opinion? And is there an opportunity to close that gap over time?

Well, I'm going to first start with your premise. I mean I don't know if truly viewed apples-for-apples that our margins are less. We have a very straightforward approach to non-GAAP items, maybe not so straightforward in some of the others. But to answer your question, I think we have been highly focused, Mimi and myself, in particular, but Dave was as well. But as we've kind of embarked on what we needed to do to scale the business on the things that we were adding, what we've added from a product standpoint, what we've added from a talent standpoint, we've been able to manage still through the margin opportunity, and we'll continue to stay focused on that. Part that you should know and any potential shareholders should know is that our entire management team is -- a lot of their compensation is based on revenue and margin growth. So everybody in the company has a high focus on this.

Yes. That makes sense. And you guys have some really high-quality financial statements. I think that is an area of focus, I think, for payment investors going forward. Greg, you called out productivity improvements driven by automation in the past. Can you talk about the progress the company has made on the AI front? And how much benefit that you're seeing from those capabilities?

Yes. So we started even back when I was leading the payments group, we started continuous improvement initiatives that have now morphed into enterprise-wide. So we see a lot of what we're able to do with headcount control and other things as we're a big believer in doing more with the same instead of doing more with less, that's the mindset, where we're not necessarily laying off people to achieve these, we're just not adding. And so that's a mindset and it's worked for us really, really, really well. About 30% or so of our company is -- are Green Belts. So that's something that's been very important for us to continue to drive from a continuous improvement. As it applies to AI, so we've been heavily involved in AI probably the last 9 months or so where we've gotten our Chief Risk Officer, our Chief Technology Officer and our incoming COO, who is running our credit union business, but he's been taking the lead on this over the last several months, is getting them involved and really developing our framework and our strategy and our guidelines. So we are now in the phase of what I would call rolling out opportunities in use cases. And we've decided that we're going to spend the bulk of our time initially internal. We want to make sure that we fully understand what the capabilities are, what the challenges are with AI and being very what we call responsibly holding balance. And that's an approach that we're taking to ensure that our customers don't get blindsided or surprise with things. We share everything. We're very transparent that way. But we believe that the efficiency and effectiveness that we can build within the company will end up teaching us the nuances of where we want to go. So I'll give you an example. We've now rolled out GitHub for developers -- to all of our developers. We're starting to see some ability to improve our code base, improve QA, be able to move code over from legacy code, things along that line that we're starting to play with. And then we've rolled out the Microsoft Copilot for all of our employees. So there's efficiency gains being done every single day just by our employees and how they build an e-mail or whatever else. But what we've also done is we've brought each one of our business units into a meeting. We've asked them to prioritize their top three initiatives for their business. HR or legal, operations, whatever. So all these groups have come in. And then as a committee, we will decide which ones we're going to prioritize which ones will have the biggest bang for the buck. So we are in the process of doing that. We're in the process of building out our budgets for fiscal year '25, which, for us, starts July 1. And we will be building a lot of those opportunities into our budget plan. So giving you the full background, but I don't have any specifics to understanding what that value will be yet, but we're going to take that type of approach.

Okay. Great. We have a few minutes left here, Greg. So I just want to hit on a couple of other topics. Maybe we could touch on the free cash flow of the business. I think you recently raised your guidance on free cash flow conversion for fiscal year '24, driven by changes in cash, tax payments. Does that continue into next year? And I'm curious what are some of the factors that could push you back at 90% to 100% free cash flow conversion range?

So the biggest and more immediate factor will be just what's going on with legislation, right? So Section 174 and really what happens with that with potentially a new Congress and what that looks like. We really had high hopes that, that was going to get done this year. It doesn't look like that will happen now. And so if that does happen with whether it's a change of the President or not, Congress in and itself, we believe that has a strong chance of making that happen. If it does, that will provide a more immediate opportunity for us to get to the 90% to 105%, it is what we're estimating back into those levels. If it doesn't, then part of what we've been doing is we'll have to build up kind of a reservoir of depreciation of development expenses that we can depreciate over that 5-year time frame. Fortunately for us is that most of our development is onshore. And so if it's done offshore, that's a 15-year horizon versus the 5. So we'll be able to play with that. But we are highly focused on that. Mimi is all over it. And so again, the short way to get there is if we can get some legislative help.

Okay, great. And maybe just last two, we have a couple of minutes left. It still feels like we're in this phase of maybe 7% to 8% top line growth that's certainly above peers, it's above average for the industry. I guess one of the questions that we get is just on the sustainability of that growth, right? How durable is that? And are we going to be sitting here in 3 to 4 years talking about another 7% to 8% growth type of year?

Well, short answer is that my goal is to break that barrier, I don't know whether we were able to do that near term, we're still focused on. I can tell you that in the near term, 7% to 8% is absolutely reasonable. There are some things that I mentioned from a strategy standpoint that we think that potentially can move us forward. I don't know the answer to that. I'm not signing up for that today. But I will tell you that we, as I mentioned earlier, from a revenue and margin standpoint, we're highly focused on moving the needle. And so I think when you look at where we are unless there's some macro conditions ,7% for the foreseeable future is definitely a low bar and getting closer to that 8% and above would be definitely the goal.

Okay. Great. And real quick 30 seconds what excites you the most over the next 5 years?

Yes. I mean next -- I'll just start with, a, just the opportunity to lead this company. This is a great company. I'm very honored to have that. We have a great team and excited. But it really is what I described as a strategy. Our SMB strategy, I think, is going to be very unique to what we're doing. It's not just what I described as kind of the existing assets is where we're going with that outside the base and creating those opportunities in tech monetization is definitely. Those three are at the top.

All right. Well, thanks Greg. Really appreciate you joining us. Thanks for doing this, learn a lot, as always. So thank you. And Thanks, everyone for attending.

Yes. Thank you.