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

All right. So we're going to get started with our next presentation here. Please welcome CFO from Jack Henry, Mimi Carsley. Mimi, thanks for being here. Mimi has been CFO and Treasurer at Jack Henry since August 2022 now. It's been a while. And she has over 30 years of experience in financial planning and corporate finance. It's a pleasure to have you here Mimi.

Thank you for having us.

Yes. So maybe we will start with your recent results because you just reported results. Top line outlook this year, it seems to be a little bit more back-end loaded than your typical year. So maybe can you talk about what's different this year versus typically and what will drive this acceleration into the second half?

Sure. Happy to. So I would say, first of all, Jack Henry is not really a quarterly number type of company. We're really -- because of the nature of sales and implementations, I really recommend the company like ours, you look at it on an annual basis. That being said, the cadence and flow of this year was even more pronounced to have an acceleration throughout the year. So the numbers that we just announced about 1.5 weeks ago or so, really did come in, in line with the Q1 being a little softer, and then you're going to see that sequential acceleration as the year goes on. There's a couple of reasons for that. One is just the nature of some of the comps, then you have some kind of outlier issues like hardware sales, which are somewhat unpredictable for people buying on-premise, mostly IBM type of equipment, that created about a $7 million headwind year-over-year comparison in the first half of this year compared to last year when we had such strong hardware sales. So some of that is just the timing. The other thing is, while we win about 50 core new wins, that's completely new logos of financial institutions onto our core platforms. Those sizes can vary quite dramatically. And so then depending on who's framing up into the implementation queue in any one quarter can impact that quarter in terms of the growth. And so that's why I think it's better to look at the year on a totality versus a quarter.

And the hardware sales, like I imagine those are very lumpy, but is there any sort of rhyme or reason to how those grow?

Yes, they are quite lumpy. IBM did some promotions last year. It has to do with hardware releases, refreshes of equipment on the server side. It also depends on the individual customers, the particular age of their hardware configurations. But as we now are over 73% hosted in the Jack Henry environment, it has a lesser impact. There's just less people on-premise running their own data center. So over time, you'll see hardware be less of a contributor to our revenue as more and more of our clients are in our hosted environment.

So I've lost count for how many quarters you guys have now been seeing record sales momentum. So maybe talk a little bit about what's driving that strength.

Yes. We've had ever since I've been a part of the company, so at least 2.5 years, just a tremendous runway of success. I think that's in part to, I would say, 3 main sources of momentum contributors. One is just the level of innovation, the transparency of which we're talking to our clients and prospects about our road maps, what we're doing, where we're headed from a tech modernization, where we're going with our public cloud native core help sales both today and in the future. I think the other would be, we have a roster of great new complementary products, whether that's Banno, whether that's LoanVantage, whether that's Financial Crimes Defender. So that totality of innovation, that totality of just things to talk about solutions to help FIs with also help from -- so it's not just we're only seeing core wins. We're seeing other wins as well. And then I think the third thing is just around -- we've been doing what we call One Jack Henry, which is simplifying and unifying the experiences of our customers and how we operate across our company. And so there, I think it's everything from the customer experience in one bill, to how our sales teams do prospecting to the CRMs and the experience they have when they're migrating. And so that simplification and that just ease of doing business with Jack Henry has translated into a great customer experience. Jack Henry is known for our service excellence, but I think we've upped the game even more, and that's translated into sales.

And then I think one area of strength has been to score wins greater than $1 billion, which has historically been not where you guys have played. So what's enabling that? And then also help us think through implementation cycles because these are bigger deals. Does it take longer to implement these and the revenue potential? How different is it from your average customer?

Yes. So Vasu, if we were sitting here maybe like 5 years ago, I would say, our average would have been about like $700 million institution. Our average today is over $1 billion. It's closer to like $1.2 billion, $1.3 billion in size and growing. So of the 6 new core wins we got in Q1, over 3 were over $1 billion with one of those being over $8 billion size. So we're getting a lot of customer validation and feedback on our tech strategy, on the modernization, on the integration of that into our other complementary products. So that has really been a great momentum, and it's been really reassuring not only to those new prospects that are larger in size, but also to our clients today that tells them they can stay with Jack Henry as they continue to grow. So our largest institutions, institutions that are $30 billion and up, close to $50 billion, they want to be a $100 billion. And knowing that our technology supports their growth, our team will, from a strategic perspective, be here to support them, help them, but it also is a great validation point to larger customers. And I would say, historically, it would have been rare for like a $8 billion or $10 billion or $20 billion size institution to call Jack Henry and not today. We're having a lot of those conversations.

And just in terms of implementation times and revenue potential, how meaningfully different are those?

Yes, I'd say the sales cycle is slightly elongated. It's a more complex scale when you're talking about a $20 billion size institution. I wouldn't say the implementation timing is that much elongated. A lot of the implementation time has very little to do with the data mapping or any of the preparation work we do on behalf of the FI. It's really around that institution because a lot of it comes down to the training that they're going to need to do to their staff as all of the processes will change. So I don't think you're going to see much in the way of changing to migration or implementation time slot. I think it's just a little bit more complex decision for a larger institution.

How would you characterize the competitive backdrop currently for core processing? Has anything changed in the macro environment and fintechs are always trying to compete in this space? Sort of how are you feeling about the competitive backdrop?

Yes, I think it's -- I don't think there've been radical changes. You have 3 larger sized players, but people don't know, but there's like over 30 core providers. There's a lot of fragmentation, especially at the lower end of the industry. There are people that play only on the credit union side. There are people who play on both. There's a lot of customer choice out there, which is a great thing for financial institutions. I think what you're seeing, and it's more pronounced, even more today, is where innovation is happening and where it's not. And I would say the great thing about Jack Henry is we can build or buy. And we've built our cores inside. So the ability to kind of take that tech modernization forward. We've been very transparent. We have over 60 road maps published for our clients that we refresh every 6 months so that they really know where we're going and the time frame we're doing it in. So I think that's kind of changed. I do think there's -- as some of the institutions are focusing on payments more than core, there are some changes within our competitive landscape. But it's always competitive. We see our largest competitors at most RFPs go head-to-head with them every day. And yet, we have over 99% retention rate of clients ex M&A. So we continue to win about 50 new core logos a year and certainly retaining our existing clients.

What would you say about the pricing environment? Does that typically go down when contracts come up for renewal? I know there's always a lot of cross-sell that happens. So your total contract value is probably still going higher, but apples-to-apples, how can you think about...

[indiscernible] we have pricing power, and we do not. You would think with 3 predominant core providers that we have pricing power. And unfortunately, we just do not. It's not the situation. Most institutions hire a consultant to help them with their technology decisions, with the legal language and with price. And so it's always kind of an elbow-to-elbow battle there around it. We do not compete on price as our primary differentiator. At Jack Henry, we believe that we are the value provider. We're not going to be the lowest cost provider necessarily, but we're going to give you the innovation. We're going to give you the service. We're going to give you the support.

So one of the areas of real strength has been and continues to be Banno retail and now you also have added Banno Business. Can you remind me how penetrated you are within your base? And what type of attach rates do you see with your core clients using Banno?

Sure. So we have over 12 million active users on the Banno platform today and growing, roughly 200,000 active users, registered users, active users at the platform on a monthly basis. We have about 950 institutions on the Banno platform. You could say Banno retail or Banno platform, because then Banno business or Banno Conversations or Banno for Spanish, those are all kind of add-ons in an ARPU model style business model. We have over 950 Banno retail users today. We have over 180 Banno Business users, financial institution users today. So most of the users have been a migration from our NetTeller product, which was our old digital banking product to Banno. Today, we have less than 300 clients left on the NetTeller product base. And so we're pretty well penetrated from a conversion perspective. But as we think about our outside the base strategy and then as we get deeper and deeper user penetration within institutions, we'll provide acceleration for future growth.

So maybe switching to the payments business for a bit, still healthy growth, but it slowed a couple of hundred basis points, I think, over the last year or so. I know some of it was macro driven because we saw a debit slowdown in the U.S., but is the growth trend also reflective of a more mature business there?

Yes, I think that's a fair assessment. So within our Payments segment, about 60% relates to the card business. We have over 1,100 card customers, very heavily weighted to debit versus credit. We just reentered into credit just a handful of years ago. But it gives our customers a chance to have -- it's as much an offense as defense play because most FIs want their credit and debit at the same institution from a processing perspective. So yes, I mean we have good penetration on that. Even though it's debit and we don't partake the interchange of it, we are subject to some exposure from a consumer sentiment perspective and that's been modest, particularly in the last quarter. We suspect that spending will pick up in the latter spring type of spending for the U.S., but we don't see like rapid exuberance. But that's about 60%. Our EPS, our enterprise payments business, is a decent grower as well. That's been good. And then we have the PayCenter business, our payments hub business. And there, I would say, well, it's only 15% of the segment, you have some exciting new growth areas, particularly around the faster payment rails in those businesses. And so as we see the adoption of RTP as we see the adoption of FedNow, and we're starting to have some partners like Victor FI, we announced that are on the faters rails payments and starting to see send solutions there. It is an exciting area for growth because it's coming off of like a near zero base. So that's going to be another growth for both the second half of this year, but also for years to come.

That's very helpful. You were talking about the net dollar product a little while ago, and you've talked about sunsetting some other slower-growing businesses as well, which are less profitable or just not going that fast. Can you help us dimensionalize, like what percentage of total company revenues those are? And any color on what time periods we will see this transition take place over?

Yes. So we talk about having roughly 300 products. Some of those are less of product and more of like a SKU. So it's not a stand-alone solution that you might see a competitor in the market for, but more something that helps from an end-to-end processing like a workflow or document retention or an e-sign type of image capture, those types of functionality. I'd like to think about it as 70 product families. So if you think about lending and you think about payments and you think about deposit gathering or fraud, those are kind of product families, if you will. There's a lot of migration that's going on because of the amount of innovative new release products we have that are complete rewrites, like Financial Crimes Defender is a complete rewrite, new product. You're going to see, over time, things like people moving off Yellow Hammer, moving on to Financial Crimes Defender. At a certain point when we have very low usage, we have a product life cycle management process. We will give our clients notice. Now that tends to be anywhere between, call it, 18 months and 36 months, depending on the product, the complexity for them to move off. So some of the product rationalization efforts will be very much behind the scenes. If it may be something that is just sunsetting, we're probably not spending a lot on that today, but we're going to be very thoughtful on the amount of spend we're doing, both CapEx and OpEx around these lower growers. And those will just kind of sunset. Then you might have things that we may divest. If it's a very attractive business, but maybe it's just not a needle mover from a revenue size or it's not something that our clients want us to provide, then we might end up selling that. And then there might be things that we just cash cow as well for a time being. So I don't see them really stacking up in any dollar material way where you would see in one quarter, like, a tremendous amount of revenue hit or anything else. But over the next couple of years, we're just being even more thoughtful to prioritization and then what are our customers telling they want from us as a vendor and then what really is most paramount for our strategic objectives. And so there's a chance that it might be small numbers here or there, but I just don't see it like in any one quarter. Obviously, we would announce it and give some notice to it, but I don't see it materializing into a huge number in any one quarter. But over time, it will help our growth rate as some of those are obviously lower grower numbers, and it should help our margins as well as we refocus those resources to more profitable, higher growing areas.

And any revenue falloff is sort of contemplated in your 7% to 8% that you guide to on a long-term basis? That's helpful. So recently, you announced a new SMB strategy in partnership with Move, which is a payments processing platform. Can you talk about the strategy and vision there and what role Jack Henry will play? And how are you thinking about the revenue potential? I know a lot of questions in there.

Yes. No, it's a super exciting partnership, a couple of things personally around it. And we did talk about it at Investor Day, which is available through our Investor Relations website. We had the founder of Move, who was the co-founder of Banno with our CTO. So it's kind of like getting the band back together, if you will. So the exciting thing is if you talk to a lot of our customers and just FIs in the industry, they would say, and statistically like, the SMB market is very underserved. It's an underbanked market, underserved market and business deposits are about 4x the volume size of a retail deposit. So very attractive in a world where growing deposits and getting new account holders is paramount to the growth success of financial institutions. So it's strategically a really important growth area for financial institutions, a lucrative area. And so for us, -- and we get the question a lot of like, did you want to go into merchant acquiring? Are you going into merchant acquiring? And the answer is no. We were really intentional and very thoughtful. We did not want to go into merchant acquiring because we didn't think our business was the dry cleaner or the bakery or the coffee shop or the mechanic. Our customer is the FI. And the great thing about this solution is we're going with the FI. We're empowering the FI. This is through the FI. So the FI gets to benefit and instead of being a deposit motel where someone -- the first thing you do when you're a small business after you like figure out the name and you get an EIN, is you go down to your local bank and you open a bank account. Well, people do that, but then they leave. They go to other payments companies, other vertical software players. And so those deposits, those business relationships become fragmented at the FI level and they lose that relationship. This returns the relationship. This puts the FI back at the hub of the small business experience. So it will be a solution through Banno. It will be out of the box with Banno. So it doesn't require our sales force to sell it to RFIs. It's free to RFIs. And then that experience to the end user, if you're a small business user, you already have Banno business, maybe you already have Banno retail, you will see the functionality within Banno. And some of the great things about the functionality is, it allows things like 8 times a day money movement settlement, which -- cash is king, especially for a small business, and that's just not available anywhere else. And then it frees the small business because the reconciliation, mature reconciliation of their transactions, this frees them up because we have all of that data. We also have a lot of the data about that business already in the core system. So we can create a frictionless startup account opening experience because we have all the data in the core already. So it really is going to be a very seamless and slick kind of experience for the SMB, and we're excited. And you'll see that in the -- pretty quickly, we're into beta in the beginning of the calendar year.

Great. And so have you had any conversations with some of your larger core clients about their interest level in this solution?

Yes. So we just had our Connect Conference, which is our biggest user conference of the year, and the place was buzzing about the SMB strategy. And as I said, like most of these bankers have been trying to figure out a way to solve the SMB need and to be able to serve them better. And so they are super excited as well as a way to put them back at that center hub experience instead of losing those customers.

Okay. Moving on to the tech modernization strategy. The focus there has been unbundling the core. Can you update us on where we stand in terms of unbundling the features? I know you've talked about wires was the first product we work with. So where -- what products are sort of in the market on an unbundled basis at this point in time?

Yes. So I would say it's a couple of things. It's about putting the modules, unbundlizing or componentizing. There's about 30 key bits of functionality within a core system. So how do you componentize them to, one, make it easier for people to get that innovation and update. Also makes it less of a big bang on a migration. Right now, if you're doing a core change, and replacement, you're down on a Friday and you're just holding your breath until Monday, you open up with a completely new different system. This way, they'd be able to -- whether it's the wires, whether it's deposits, whether it's the GL, they'd be able to potentially do over time, sequential mini upgrades and migrations rather than just one. So today, we have the wires, domestic wires, international wires. We have authorizations, which is around roles and access empowerments and entitlements functionality. We're working on GL. We're working on a couple of different modules. So we're still in the early days of having those complete set of functionality. It's probably 3 to 5 years until you have a full public cloud native core available. But the great thing is, let's say, the wires module, for example, in your Silver Lake customer or maybe your Symitar customer on the credit union side, you could put that module in today and use that functionality. And so we're going with a couple of different concepts in the way we're architecturing it, and one of it is just a shared services mentality on all of this functionality. So it will continue to benefit the core users today as well as the future accounts.

And I know one of the focus areas was that as you sort of unbundle the core and modernize your tech, there would be room to go upmarket in the regional bank space because like to your point, it's easier to migrate because you can migrate service by service. How is that panning out? And like what kind of discussions have you had with regional banks?

Yes. It's -- we've been having a lot of external validation of both our architectural approach. People love the derisking. They love the componentized approach, to be able to do it over time. It also allows a larger institution, either in a time of an acquisition or something else to not change their entirety of their systems. So our sales team has been having really fruitful conversations with extremely large institutions. And I keep saying like any day now, I'm going to announce like a huge one, and I'm -- it's any day now is what we're talking about. But it's been really exciting for us and our team to get that validation from our existing customers that want to grow and then the new external customers as well.

So I have a few more prepared questions, but I want to see if the audience has any. Anyone has any questions or I can keep going? No. Okay. I'll keep going. So maybe then moving to margins. We've talked a lot about revenues and the strategy and the vision. Just moving to margins, I think you've outlined 20 to 40 basis points sort of long-term expansion. Is that potential for an upward bias here as you talked about the product rationalization that I'm guessing should help? And any other puts and takes to think about over a long period of time?

Yes. I would say the first is we're all keenly focused on it. And we all have an internal bias to try and produce more. And it's one of the ways I'm gold and our leadership team is gold is around not just 1 year, but 3-year CAGR compounded. And that's the thing we're really focused is, it's around that sustainability of margin expansion. Not just in 1 year you can do things, but over time, how do you keep layering in additional profitability. So I think right now, what we're seeing because of all of the innovations that now are hitting GA and live, we're having some amortization hit the books. I would say 2024 was the first normal year we've had after COVID, after the resignations and after rehiring. So that gives us a baseline of the business. But I think once we get over this, a little bit of a rise between the investment spending we're doing, the amortization that's hitting our books, the talent we've brought on, I think there's room for the upside. There's a number of reasons. You continue to see the shift from private cloud, on-premise to private cloud. That's an attractive margin. We think that will, in turn, eventually go to public cloud. There's a lot of cost benefits you get from public cloud environment as well. That shared services mentality of code that I just talked about, there's benefits of that. The more common code we have and the more you essentially start migrating to essentially kind of one core system, if you will, that's the less you have to technically support, right? That not only improves the velocity of innovation, but that leads to margin expansion as well. And AI and continuous improvement, there's just a lot of things to think about that I think drive bias to the upside from there.

That's great. Free cash flow conversion, always very topical.

Always a favorite.

You're targeting 65% to 75% this year. Just help us understand how you expect that to evolve over the long term because I know you guys used to have much higher free cash flow conversion. There have been some moving pieces in there? And just how you think that evolves over time?

Yes. Vasu, it's been a roller coaster of free cash flow over the last 2 years. And part of that was the Section 174, the deductibility of R&D. And as a big U.S. domestic R&D shop, you went from overnight being able to have 100% on your tax books the deductibility of that R&D. Now GAAP is different. But for tax, you used to be able to expense all of that R&D expense in 1 year. And the IRS, like that just went off the books overnight. Over time, as that has not been rectified in Congress yet, you had greater clarity from the IRS and bulletins to like defining what that meant. That lessened the blow a little bit. We're hopeful that under the new administration, it's a topic they will address and hopefully on a more permanent, rather than a short-term fix. But if you look at the trailing 12, and again, I'd recommend looking annual at our business versus quarterly, the trailing 12, we were about 72%. So returning back to that 90-plus percent type categories. Even in Q4 to Q1, we had some noise around our annual maintenance. So our collection of support, annual maintenance. We send out invoices in May. And depending on if a client pays them in June or our client waits to pay them July 1, it can hit 1 year's cash flow versus another. And so last year, we actually just saw a lot of people paying early. In fact, more than -- it surprised us, more than we would have expected. And so that was about $60 million of goodness that came into Q4 that led to the 88% free cash flow conversion in Q4. If you normalize those ratios, that was about a 65% free cash flow. And then in Q1, you saw the other side of that unwind where you saw a 50% free cash flow conversion. And if you add that $60 million back there, it would have been close to 100% free cash flow. So I think we feel confident that you'll start reverting back to historical norm territory in the short order.

Helpful. And then capital allocation, M&A versus buybacks, how do you think about that and then maybe talk about the M&A pipeline.

Yes. So I would say the consistency in our allocation philosophy of being good stewards of our shareholder capital. The first is just the amount we reinvest in the business for continuing growth and innovation. So that's a big chunk of our cash. The other is we have a long-standing dividend program. We have 20 consecutive calendar years of dividend growth. That takes a good chunk of our cash. The other is we've been on a debt pay down cycle for the last 1.5 years, 2 years to very low leverage, but we do have a little bit of debt outstanding remaining. And the last is just share repurchase, whether that be to offset dilution or to be opportunistic. And certainly, in the recent period where we've had a dearth of M&A, interesting prospects, that's allowed us to spend more on debt pay down and a little bit of buyback. So hopefully, I think all the bankers, including your bankers, are calling for a reacceleration of M&A and the fintechs. Certainly, in banking, people are anticipating, I think, frothing at the mouth of excitement of bank M&A returning from the really low levels we've seen in the last 2 years. So we're always on the watch. But for something to -- for us to buy a property, it certainly has to be API first, digital cloud native. It has to be an acceleration to a road map plan we had already planned. It has to be a cultural fit. It has to be financially interesting. So we think there's a ton of upside in our current strategy. So we're not looking for wild adjacencies at this point.

Since you brought up bank M&A, just one last one. With the new administration, obviously, everyone is expecting we might see sort of an acceleration in bank M&A again. What does that mean for Jack Henry?

Yes. So I think for us, our June 30 fiscal year-end, I don't think it will have very much impact for us this year. I think as soon as you have the administration come in, there is an expectation that they will be more business friendly, more M&A conducive. I think the challenge in the current environment is you both have an elongation of approval cycles and you have less certainty of approval. So I think a lot of people are hopeful that, that will flip and be more conducive to M&A. We know that we've had outreach from a number of our customers. We even said, I think 2 earnings calls ago, that we stood up another team to help with implementation and migration. We've had a couple of clients where M&A is a very active part of their growth strategy, asking us for dedicated teams as an option as well. So I think the only remaining question -- well, one is does it come to fruition in terms of an administration that is more M&A friendly. But then I think there's a secondary question to that, which is, are you going to see banks do larger acquisitions? Or are you going to see them just line up serial acquisitions? I think a lot of banks have historically loved to be smaller serial acquirers. It's less risky. It allows them to do it over time. It's less of a shock to their internal policies and procedures and their culture. But if you're only going to get one approved, people have then said, okay, I'm not going to waste my one card on approval, I'm going to do something really significant. Well, if you get back into an environment that they allow multiple M&As, like do you see more small properties where they line up consecutive deals versus these really mega size mergers?

Well, we'll end it right there. Thank you very much.

Thank you so much, Vasu.