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

Good morning, everyone. My name is Dave Koning. I'm a senior analyst at Baird covering payments and IT Services and very excited to have Jack Henry with us today. Feels like probably the 30th year in a row they've been at our conference. So it's exciting. And we have Greg Adelson with us President and COO. And in about a month, he's going to take over as CEO, that was announced several months ago now, that he's the incoming CEO. And so maybe with that, I mean, I think you guys all know Jack Henry is one of the leading core bank providers of software. They run, I don't know, 1,500, 1,600 banks in our country. So a very big market share there. But maybe, Greg, you could kind of kick us off a little bit with your philosophy about running Jack Henry and what might be the differences from Dave Foss' leadership?

Yes. So first of all, thanks for having me today. And -- we appreciate that. So I've been with the company 13 years, been fortunate to work my entire career for Dave. So for those of you that know Dave, we have a very similar philosophical approach to the business, both on how we treat our associates and making sure that we talk about our 3 pillars of taking care of our associates first, and they'll take care of our clients and ultimately, our shareholders. But the other part is that we're very much aligned on how strategically the things that we're working on. So I've been very integral into the strategy that we're embarking upon now in our tech modernization strategy. I think we can dive into a little bit, but it's basically us uncoupling the core and discrete components where we're actually taking the Top 30 or so core components building them in a public cloud native API-first structure, and we're actually already haven't been embarking on that. I know we're going to talk about that a little bit later. But then the other part is, just so you know, so from a strategy standpoint, we'll continue down that. We'll continue down the One Jack Henry stuff that we've been focused on, which is making ourselves an easier company to do business with. We're an amalgamation of about 48 acquisitions over a 48-year period. By the way, we just hit 48 years yesterday, which was Jack Henry and Jerry Hall, founder of our company. But -- from that standpoint, I have a few other things that I'll be adding an SMB strategy that we're focused on through the financial institutions and some product rationalization where we're looking at really some of our products that don't grow at the same level from a revenue standpoint or even from a margin standpoint and either looking at divesting of those particular products, cash counting them. Some of them will go away just through pure sunsets with what we're doing with our tech modernization, but really getting focused on what really moves the needle for us, for our customers, for our shareholders.

Yes. Great. Well, thanks for that. And -- maybe we can kick it off, what's changed over the last several years in terms of just how contracts are structured, right? I mean I remember years ago it was off on a 5-year contract. It seems like contracts are longer now. What are just the dynamics now of...

Yes. From a contract term, what I would say our average core term is either 6 or 7 years, typically is what we don't really go with 5-year core terms. But we've seen them as high as 12 and 15 years. And of course, there's several that fall in between that. But 6 and 7 is on average. The things that I would say that have -- and then for our complementary products or payment products, we typically see 3 to 5 years, depending on if they're sold as point-to-point solutions. If they're sold as part of the core deal, a lot of times they're coterminous with the core deal. So it really depends on how that particular product was added and when it was added. Just for context, though, we actually include about 50 to 60 complementary and payment products with a banking core deal, and we see about 35 complementary and payment products for a credit union deal. So that gives you some context on that. The only other thing I would say that really has potentially changed is there's been some focus from the ABA and their core committee and really looking at kind of how SLAs work and things along that line. So you see some movement in really the contract negotiations of that, but the terms themselves are basically, as I described.

And how many complementary products as a core client typically have? And maybe how has that changed from 5, 10 years ago?

So really, it hasn't changed significantly. Like I said, 50 to 60 on the banking 35 on the credit union. That number has really stayed pretty consistent the last 5, 6, 7 years. I would say the dynamic of what they're selecting just because we've changed what we're including in that with financial crimes, Defender, Banno obviously, is in most core our card. We had some challenges when we made our card changes several years ago that we've worked through and now that's a really growing business. So -- but that's really the dynamic. It really depends on what the mix is.

Got you. Okay. And what makes Jack Henry special. When we think of companies, there might be almost no companies in the country that have such low attrition, right? And -- what is it that has allowed a, your clients to just stick with you for just decades and b, you tend to win more than your competitors. Why?

Well, I think it starts with the very first thing I said earlier, it starts with our associates. So we have very low turnover at our company. So even with the contact center and over 7,000 employees, our turnover is 11%. And -- and it's been like that even through the great resignation, it rose a little bit. So back to taking care of your associates, they're going to continue to be motivated to take care of your clients, which is why we have exceptional customer service, industry best and have for many, many years, and that will continue under my watch for sure, both of those things. I think the other component is what I mentioned around the tech modernization strategy. So we have been validated by both -- by our customers, by prospects that we're talking to, by the consultants that serve our industry that the strategy that we are embarking upon is different than what they've seen from anybody else in the market. And that includes the European companies that are coming in, trying to kind of get into the U.S.-based market. So it's not only the strategy that's different but we're actually executing on the strategy. So we share 6-month road maps with our clients really on about 70 of our products. And we show how we execute. I think that's very different from what most people do. We hold ourselves accountable with our clients, and we do the exact same thing with the road map for our tech modernization strategy. So we are now 2 years into that strategy. And not only are we executing to the exact dates that we said we were, we're under budget. Those are 2 things that don't typically happen for a project of this size. And so again, we're gaining a lot of confidence and credibility in the marketplace because candidly, 5, 6 years ago, Jack Henry wasn't really known as a technology innovator. They were known as a great service company with good technology but not innovative technology. And I think now that people are viewing us differently, they wanted to make sure that we could actually execute and we're showing that we can.

Yes. Great. And then what about -- so for years, the shift to outsourcing has been a catalyst, we think maybe adding a percent or maybe a little more to revenue growth. So the shift from clients that took a license delivery where they would buy your software and then run it with a few of their own employees, move it to your servers and all of a sudden you double the contract value, right? So it's a really good shift. We're about 70% of the way there. We're getting close to fully penetrated. How many years left? And then what is the next driver kind of that comes after that?

Yes. That's a great question. So we've been focused on this for many years. We're actually 72% penetrated as we speak today. That's both on the credit union and the banking side. We're still moving on average about 40 to 50 of our clients into our private cloud a year. We're still on pace for that this year. We're expecting to be on pace for that for the next several years. So from a runway standpoint, we expect not to get to 100%, obviously, somewhere between 90% and 95%, we believe, to be the expectation. But what will happen over the next several years, and there's still 3, 4, 5 years of good runway for that to happen at the growth rates that I talked about, the 40% to 50%. But if you look at where we're going with our technician strategy, we see several of our clients that may actually skip from going from on-prem to our private cloud to going on-prem to the public cloud. And so though, to your point, we've mentioned that we're about 2x the revenue, when we move from on-prem to private cloud. We expect to be 2-plus moving from on-prem to public cloud. So not only from a revenue aspect, but then from a cost standpoint, the public cloud is cheaper to run for us in the long run. So you're going to get that aspect. And then when somebody moves from, say, the private cloud to the public cloud, which will start to happen as well over time, you're not going to get a 2x lift, but you might get 20%, 25% lift is what we're seeing right now. So that's kind of the trajectory of where we expect to go with that business and again, a lot of runway on both sides.

And is the shift from your private cloud to the public cloud, so 20%, 25% revenue lift, is there actually a cost reduction on ...

There should be, yes. So well, that should be, there will be. So what will end up happening is we end up moving more and more to the public cloud, we have less and less need for the servers and the infrastructure that we have. We're also moving from our own data centers to [ colos ] So we actually can -- we can build up and pull down when we need to, a lot easier than we can, when you own the data centers themselves. So over the next several years, you're going to see a migration from our own data centers to [ colos ] and to the public cloud as both -- both of them being cost-saving opportunities.

Got you. Good, good. Well and when we think of the business, I'm going to ask about Banno on a minute, we think 2/3 of it is just the bank technology to run kind of the software. The -- half of that is core and half of its complementary products. Banno is kind of the gold star of the complementary products. It's been growing like a little Fintech, right? And kind of exploit -- maybe describe a little bit about how penetrated you're at Banno? How much room for growth there is left, how fast maybe that's growing?

Yes. So great. So we actually built Banno, which is our digital banking platform around 2017, actually slow -- kind of slow launched it in 2018. So roughly since 2018 to today, have 850 clients and 0.6 million registered users. So it is the fastest-growing platform that's out there today based on those time frames. But when you look at what we built inside of that, we originally launched that product with a retail-only focus. And there was many reasons why I won't get into that today. But we've now since gone back and built a lot of the business functionality that our customers need. And so when you look at a competitive landscape from us to a Q2 or an alchemy, what Banno was missing in the space really was the business functionality. So we've been highly focused on delivering that and we slowly started to deliver features and functionality. So as a byproduct, we actually now have 124 clients that are live on that platform that are using the business functionality. So that's 124 of the 850 and I'll get back to that in a minute. And there's a little over 70 that are in the implementation queue and growing. What we end up doing is that we'll continue to add feature functionality throughout the rest of this calendar year. And our expectation is by the end of the calendar year that we will be on full feature parity with our competitors, which will allow us to take Banno outside of the Jack Henry base as well. And that's part of the strategy that we'll continue to embark upon, that we've announced recently. So lots of runway in that. From a penetration standpoint, we're more highly penetrated into our Banking business than we are our Credit Union business. So we still have a lot of runway in the Credit Union side and in the Banking side. But once we take it outside the base and add the business functionality, I expect -- I actually said this on the last earnings call that I expect us to be somewhere between 60% and 70% penetrated into the Banno base. And if you remember, Dave joked and said it would be 100% because he was leaving. But anyway, we're on track right now. We're only about 10% penetrated into that base and have a long runway for that too.

And are you getting the interest from kind of noncore clients that want it?

Very much. And in fact, that's one of the reasons why we changed our strategy initially. We were going to open it up to more cores. But candidly, the interest level got to be to a level of too much excitement that we're worried about a little bit about what would happen on the core side of our business because today, a lot of people make changes to come to Jack Henry so they can get Banno. But what we're actually focused on, if you think about the 200 or so core opportunities in the space every year, about 100 don't make a decision, 100 do make a decision and 50 to 55 come to Jack Henry. Those 100 that don't make a decision either haven't decided because of a core or their digital or whatever. We now have an opportunity to sell that -- the digital into the 100 we didn't win or didn't make a decision on the core side. And start to kind of put ourselves in play for core decisions. So if you think about the 3 hardest things to move if you're a client, moving your core, moving your digital, moving your card. And so we're going to go in with a bundled solution that has digital card and financial crimes, Defender as a bundled solution and sell into those opportunities into select cores.

Got you. Okay. Great. And One question we've probably asked every year people how in the world do you guys grow 6% to 8% so regularly in a consolidating market, right? Banks were -- over 30,000 banks and credit unions, I think in the early '90s today, they were maybe at 9,000?

9,000, Yes.

Like how does that happen?

Yes. So interestingly, the market has been going through this evolution for the last 40 years. So about a 4% decline. But most of them, if you look, are under the $500 million market, there are some exceptions for sure. But the most of them come in the $250 million to $500 million and even less in a lot of cases, especially early years, it was $100 million, $50 million on the credit union side, things like that. So that's not really a space that we really focus on. And that's number one. Number 2 is that we have a large number of our institutions that are acquiring institution. So -- and the way we actually -- we do our revenue model. Our revenue model isn't necessarily based on assets. It's more based on transactions for a number of accounts, active users, things along that side that really, really drives. So asset size is really immaterial. In fact, just to put this in perspective, probably our tenth or 11th largest credit Union Is our largest revenue producer on the Credit Union side of our business. So it really is more about how many complementary products and payment products do they buy? And which ones do they buy that have higher revenue potential and higher margin potential, much like the Banno, the payments and the financial crimes.

Got you. Okay. No, that's good. So if we move to payments and remember, so the core client base, we're running the deposit accounts, that's 1/3 of revenue, complementary products are 1/3. The last 1/3 is payments, right? So, this is where you're doing debit processing, keep track of every debit swipe for a bank, bill pay, et cetera. Debit processing is the biggest part of payments, right? It's like 60% of payments. How do you see the long run in that business with 2 kind of questions here. One is Master and Visa talk a little bit about decelerating volume growth and kind of towards retail. So that's a little bit of a factor. But then also, you have a processing relationship with Fiserv. So maybe talk about those 2 parts of that business.

Yes. So let me go to the second question first to lay the groundwork. So around 2,000 -- I ran our payments group, by the way, until 2019 when I became COO. So I was heavily involved in the creation of the strategy and the direct contract negotiations with FTC at the time and PSCU. And really, the message there was, it's a build by partner kind of mindset. We had some parts of our card business that was not performing to a level that any of us wanted and we were concerned about time. So building it really wasn't an option from a time standpoint, and we looked at a couple of acquisitions and they didn't materialize to what we wanted to. So we ended up on the partner route and it's turned out to be really -- a really good relationship, which is ironic for a lot of reasons, right, because we're staunch competitors on the core side. But from the business itself, where about 98% of our transactions. Well, let me back up one other thing that we wanted to do is that when we built this relationship, we wanted our Card customers to have a single platform to process debit and credit on a single platform. There wasn't really anybody else in the industry that could do that, except for at the time FDC. And so we wanted that single platform experience for them for a variety of reasons. So we added credit to our list of products in 2019, when after we moved all of our debit clients. And so that's been a slow growth. We only -- we have roughly 100 customers. We have roughly about 98% of our transactions are debit transactions today, 2% credit, but about 10% of our revenue, even on those 100 clients is coming from the credit side. So it's a much higher revenue stream. As compared to Visa, MasterCard and even PSCU because we get data from really all of them, our debit volume has really kind of mirrored what's happened in the Card network space. it has for the last several years. If you kind of look at debit transactions today, in some cases, the dollar amount may have increased but that doesn't affect Jack Henry. We don't really play in the interchange side of that model. So if it's $1 transaction or a $100 transaction, it doesn't matter really to Jack Henry, other than the transaction itself. So seeing that volume, it has stabilized a little bit, but we're still continue to be optimistic based on what's going on in the economy, that those things will continue to rise. But I don't see anything that is going to keep us from either underperforming what the market is doing. And there are some things that we're adding from a feature functionality and really kind of what we call adoption programs, that could help drive more and more transaction volume. But for right now, we'll probably stay right where the card associations are.

Got you. yes, I often think of you guys is growing a little faster in debit just because, a, you have some of the smaller, less penetrated banks than the big money center banks on the coast and stuff. So that might help a little bit. And then just you tend to take a little bit of share over time anyway, so those 2...

It's a great point because a lot of our smaller institutions don't want to do credit. So debit is their only transaction opportunity. But you also got to recognize that not everything in that bucket is tied to just transaction volume, right? So there's fraud transactions that go in there and other things. And as we've gotten better and better at fighting fraud, there's less and less of those transactions that come up or alerts to come up. So it's a byproduct of a lot of things that we've continued to improve, to make it a better experience for the consumer and for our institution.

Got you. I guess while we're on that topic quick, and this goes back to some of the complementary products. But fraud was even called out in -- it's been called out at some point in your filings as a driver of growth, both some of the Yellow Hammer product, I think, the debit processing front. Like is this growing well above normal growth?

I wouldn't say well above normal. I mean I think where the call out for the Card side was what I was referencing before. So when card fraud was rampant across the most of the industry, there was a huge uptick for that. So as we and others have built better mousetraps to be able to stop the fraudsters, then there's less of that uptick that's happening. Where you're going to see the uptick for Jack Henry is really in our financial crimes Defender product, which is a -- it's AI-based -- it is a single platform, Yellow Hammer was 2 separate platforms for fraud and BSA, but it's a single platform to fight fraud and BSA. Basically today has got wires, ACH check, anything that really from any of the payment rails that happen today that are in there. And we're getting a lot of fanfare for that. So we have only 10 clients live, but we have 174 in our implementation queue. And mainly because it's sold even faster than we expected it to do. So there's about 1/4 of those are Yellow Hammer migrations moving from our old product to our new one, but the rest of those are new takeaways from our competitors. And so we continue to see the other big dynamic of that product, especially in a world where real-time payments is creates more real-time fraud. We're the only platform that's out there today that has real-time capabilities. So that's a significant opportunity for the Zelle market, for the RTP market for the FedNow market because we've created a module that allows all of our clients to leverage those that module to fight fraud in real time for each of those. So we're hoping that based on what we're seeing in our POCs and some of the initial customers is that customers are going to have more of an affinity to drive Zelle and other transactions because today, they're a little bit of afraid of it, right? So Zelle for an institution creates no revenue stream, right, because I can't charge for it, and all it does is create fraud. So a lot of people have kind of backed away. You put it in if you have to, if you're a big institution, fruad is just part of your number. But for our small community and regional institutions, it's a big deal. So I think what we're starting to see is more of an appetite to test that.

Yes. Yes. That sounds good. Enterprise payments, about 20% of the Payments segment. What do you do there? I've covered the stock for about 20 years and as that's the one part of the business and I was like what exactly is going on? And maybe is this where you're talking about some of the SMB type payments? Is that here?

No, it won't be in there, but I can go back to that in a second. So EPS itself, which it stands for enterprise payment solutions. So it's one of -- today in our Payments segment. So we have the card, as we mentioned already, which is roughly 25% of the company and 60% of the Payment revenue. We also have EPS enterprise payments, which is ACH origination, which we are one of the largest ACH originators in the company -- or in the country. But what we are the largest is we're the largest remote deposit capture solution provider. We have over 3,000 institutions. We do both consumer and commercial capture. And a lot of that has come through the acquisitions that we've made through the years. The most recent one was when we acquired Ensenta about 5 or 6 years ago, that really kind of rounded out our offering and made us the largest provider. So that's the bulk of what's in there. We do a few other things, but that's really it. And then the other arm is our Bill Pay business, which is a which today really consists of iPay our Payrailz acquisition, which we're blending those 2 products together and taking the back end and the front end and creating more than a bill pay solution. We're creating a bill management solution. Because we believe the days of traditional bank bill pay are going away. We've seen what's happened with growth rates across the industry. But a bill management solution allows you to do other things that allows you to do consumer commercial payments. It allows you to do P2P, straight into the platform. It will allow you to leverage all the rails that are out there today. So we'll be able to use RTP. We'll be able to use ACH. We'll do a lease cost routing kind of mindset for a lot of that. So that's all part of that evolution. And then the last part is our PayCenter business, which is really our real-time payments hub that we created. So we have real-time connections into the Fed, RTP, Zelle. We have over 300 clients live on each of those platforms, and we actually are about 60% of all the RTP clients that are live today on the network are Jack Henry clients.

Got you. And why does that -- I know Bill Pay -- the Bill Pay part grows kind of low single digits, but that enterprise part with the ACH and some of the -- that grows like 15% plus. Why do you say...

Well, it slowed down, but it grew a lot through the pandemic because think about remote deposit capture. Nobody was going into the institution. So a lot like my mother who would never use remote deposit capture before, she started using a remote deposit capture. So there was an increase, and so we're kind of coming down off of that. So we have a leveling effect of people that are using it and not going into the institution. But a lot of that growth in EPS came from during the pandemic.

Okay. No, that's great. And then a couple of questions. We've got a few minutes. There's a couple of questions just on financials. As you're stepping to the CEO role, now you have to answer these financial questions -- do you like doing that?

Well, I have an accounting background.

That's perfect. Okay. This is good. So margins for the last 5 years or so have been pretty flat between wage inflation, right, that created a little bit of a headwind the original implementation of the first state of [ process ]. There were a lot of little headwinds what do you see the next 5 years? Like are those headwinds behind now and it's just leverage kicking in?

So there are some points of leverage kicking in. But you got to remember, as a company that's taking care of literally 1,700 core clients and almost 8,000 total clients, we have to make sure that our cybersecurity and our compliance and everything else. So we have made significant investments in both of those from a tools, technology, people, we've added a lot of staff in all of those areas. Unfortunately, after SVB and Signature and others, the compliance world has definitely peaked as far as a lot of scrutiny and a lot of things that we have to look at is like everybody else, so there's been a lot of investments. So we still have -- and we're building out like a sales force implementation right now, and we had some increases in costs. So we have several things that have increased from a standpoint of building the scale, building what we have to do to really run the business, but a lot of that should dissipate over time just because we'll already have made a lot of significant investments. And so there'll be a leveling off there. But what we are seeing is that what we're doing from a continuous improvement standpoint, what we're doing from an AI standpoint to build a lot of our technology with inside of the walls. We have -- we're taking an approach that we're calling responsibly bold and balanced, where we're actually making sure that we manage inside the walls of the company, leveraging tech opportunities, leveraging service and bots and other stuff that you can do both from an AI and generative AI. So I think you're going to continue to see opportunities for us to lessen costs and head count. We've done a really good job of head count over the years we always have. But doing that. And our big mantra with our team back to culture and back to is we've never done a layoff in the history of our company. So 48 years. That's a pretty remarkable when you got 7,000 employees. And so that's back to culture. So what we end up focusing on is that our mantra to our team is we do more with the same, not more with less. And that's really the message. So we end up not hiring people that we would have hired because we're able to do more with the same.

Yes. Got you. And then maybe finally, just cash flow. Some investors have been -- I guess cautious on the stock with cash for a couple of things. One, just the core cash flow, about 85% conversion to earnings. But then I think this year, a tax impact caused even a little less than that, maybe talk through that a little.

Yes. So we're overperforming what we gave as guided at the beginning of the year for both margins and for forecasted cash flow. So we just at the last -- we're around 75% now. Really what's happening, and I think most of you know, so development costs, the ability to fully amortize those and development costs came away, ended with Section 174 kind of expiring. So we're looking at it in 2 different ways. So one is that we feel that in 2025, with whether there's an administrative change or not in the President's office, we feel that there's going to be an opportunity to offer this in 2025, if there isn't for some reason, we are actually taking the approach that over the next few years, we'll be able to continue to increase our cash flow as we're able to build up kind of a reservoir of development costs that you can depreciate over that 5-year period. So we're highly focused on that. I can tell you from a leadership team and a management team, we're focused on our 7% to 8% and hopefully getting closer to the 8% and above over time, margins of 20% to 40% as we mentioned, and hopefully getting above the 40%. And then from a free cash flow getting closer and closer to that 90% and 100% that we've had in years past.

Yes. Well, that's a great review. Thanks so much and yes, that's all the time we have. Please join me in thanking Jack Henry and Greg Adelson.

Thank you.