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

Thanks, everybody, for joining us, and thanks for joining us on the webcast here as part of the Morgan Stanley TMT Conference. I'm very pleased to be joined in this session by Mimi Carsley, CFO and Treasurer of Jack Henry. I'm James Faucette, Senior Fintech analyst at Morgan Stanley. Before we get started, I do have a quick disclosure to read. Please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. So Mimi, great to have you back at our TMT conference again.

Thank you.

We love having Jack Henry and you here to talk about the business. Maybe quickly, I know that especially with everything going on in AI and so on. We've gotten a lot of inbound calls around, hey, what is this Jack Henry? What do they do, et cetera. So maybe you could just provide a quick overview of kind of the 3 core businesses at Jack Henry as well as talk about some of your customers.

Sure. So this June, Jack Henry will be celebrating 50 years of business, which is a remarkable occasion, and we're quite excited by that. We serve banks and credit unions predominantly in the U.S. So it is our mission to ensure that banks and credit unions have vibrant in the communities they serve and that they're able to compete across a very dynamic and evolving ecosystem. And so the products and services we offer, we operate in 3 main reporting segments. One is core. So think about core processing. That is mostly kind of back office operational, think about account setup, mortgage interest calculations, a lot of the regulatory paperwork that you would need to have around client files, et cetera, the day-to-day, how to calculate interest, distribute yield, think about deposits and lending. So that's kind of core processing. We do that for over 1,700 customers, both banks and credit unions, and average institution size of about $1.5 billion on both. So from there, you think about payments. So that is card processing. We do card processing, predominantly debit card focused. So we serve over 1,100 banks in credit card and debit processing services. We also do enterprise payment services. So think about there's still a lot of paper checks floating out there, especially in business today. So a lot around the remittance business, helping on the bill pay business. We also have embedded payments business and then in a lot of the exciting new evolving areas of payments around the faster payments. So you think about all the new rails that exist in the U.S. And that's also where a lot of our small business initiative is helping banks and credit unions to serve those small businesses. So that's our payments segment. That can be outside our core customers and core customers alike. And then the last segment, I always say if it's not core and it's not payments, it's kind of the all other catch-all bucket, which is complementary. And that's the suite of surrounding products to help a bank or credit union function every day. So think about fighting fraud, think about lending, thinking about account opening, thinking about a digital offering, all of the other ancillary services that would support them in growing.

Got it. So let's talk about this core business, which is, like you said, is kind of the central part of a bank's operations. And interesting competitive dynamics, I think, in that part of the market and certainly one that a lot of people are paying attention to and probably incrementally. And that's because one of your main core competitors is on the cusp of a material platform consolidation. And it seems like that should create a lot of incremental at bat opportunities, if you will, for Jack Henry as some of those platforms are sunset and that competitor attempts to migrate them to new platforms, that can be incredibly disruptive for a lot of people. And if forced to do it, they may choose to look elsewhere anyway. So a few questions on this topic. For you, in the growing pipeline, what's changing more? RFP count or average deal size. So help us think about what's happening right now with the existing pipeline before we start to have impact from that competitor move.

So as I -- if you think about today, the industry has been consolidating at roughly 4% a year for over 4 decades. There are roughly 9,500 banks and credit unions across the U.S. In a given year, our contract lends to about 7 years. In that 9,500, if you think about that as a pyramid from a stratification of assets perspective, we intentionally don't serve the largest Tier 1 banks. We don't find that to be a lucrative nor a valuable partnership arrangement. So we serve the rest of that pyramid with a growing focus on the regional and super regional capabilities. So as our clients have grown, as we attract larger clients from the outside, that stratification has allowed us to kind of move up the pyramid. And I say that because if our average contract length is about 7 years, then we say like there's probably around 200 banks or credit unions in a given year that are in play. Now half of those probably won't make a change. They may make an RFP just to see what's out there or maybe it's required by their Board or state regulator. But roughly, call it, 100 are truly kind of in motion. Of that, we have won 50 to 55 cores a year for many years consistently. And this year, we not only think we're likely to win 50, we say we're feeling really good about it. So this opportunity that you spoke about with one of our competitors in the space is a kind of, I won't say once-in-a-lifetime opportunity, but certainly in our industry, you don't have that many incremental opportunities in play. So we're quite excited about what that can mean. In terms of your direct question of like what we're seeing from a dynamic in our pipeline changing, the last 10 years, I would say the pipeline has grown in the size of the average account. So a couple of years ago, if we were on stage, we probably would have said our average size is $700 million institution, whereas today, it's almost $1.5 billion size institutions, both from who we're attracting in and them growing. So we talk about in our quarterly wins, we announced how many new core logos we win. Those are completely new core customers to Jack Henry. And we call out how many are over $1 billion in size. And if there's any that are truly large, we also call that out. And so that number has been growing quite a bit in recent years just to demonstrate our success. So I think to your question, the pipeline is filled with larger accounts. So I think the size of the pipeline has grown overall, but the size of the accounts have been growing. And now with this new consolidation opportunity, we think there's going to be more at bats in play because if you're being forced to make a change and you're going all of the -- through all the change management that, that kind of results in, why you wouldn't just see what's out there and explore and do your fiduciary duty, like I think there's going to be more opportunities.

So let's try to quantify that or at least have some idea. So I think when we look at the banks that are using these platforms that are intended to be consolidated away from them, it's about 1,500 banks or so on those platforms. When you think about other periods of platform consolidation, how would you think about what would -- what portion of those would typically look at an RFP? You mentioned 200 a year, so that's pretty typical, but then these 1,500, almost at least some significant portion of those would be incremental. So of that 1,500, how many of those would you expect to eventually go through a process?

And we've heard the number like 1,400. So I think certainly in the right ballpark. It will be interesting to track them over time because I think some of them will get consolidated away as well, the banks themselves because you have a choice as a bank, CTO and CEO, do you go through this conversion?

And it's not painless.

And it's not painless and say, on the other side, we're going to grow and we're going to be more nimble and faster and more agile. Or do you say, we were thinking about selling anyway or succession planning anyway. Okay, maybe this is the straw that breaks the camel's back and they do it. The challenge is in part, and you referenced it earlier, like there's no set time line. And so it's a question -- I think we're in the first lap of might be like the first opening sprint, but it's going to be a marathon of opportunity. So I view this as 3 to 5 years of potential opportunity. And the way the sales cycle works in our industry is, let's say, you have that 7-year contract, well, and you think you might be willing to make a change. Well, you don't want that clock to run out on you. And you have some time to -- it's going to take you some time to make that change. So you really start talking to vendors maybe 2 years in advance of making that termination of your existing contract because if it takes you a year to make a decision to pay for the deal and make your selection, then you want to give yourself at least a year to make all the change management happen. And there has been some -- I'm sure we're going to talk AI. It would not be a conference if we didn't talk AI, James. But part of that is today, that year to 1.5 years on that implementation, it's really due to the client readiness. It's not the data mapping on our side. We've mapped every core that there is. We could do that faster than a year for sure. And yes, some banks might have some customization that might be interesting tweaks that we haven't seen before, but we know how to map to everything that's out there. What the harder part is on the institution side. They have to do all the training, all the readiness, all the procedural rewrites. All of that needs to happen to ensure to their regulators that they'll be just as confident operationally after the change as before the change. And so there's a lot of human change management to go through as well as operational uplift. And so that could be a use case, an interesting use case for AI to say, "Hey, I'm on XYZ core today. I'm moving to Silver Lake. Help me rewrite my procedure docs. Help me train my employees faster. So the interesting thing is, for us, if we could shorten that implementation time, that's great because we don't start collecting revenue until they're on the system. So we're very much aligned. If there's something that helps them to ready themselves faster, we'd be all for it. But if we think about that opportunity, that's why I say it's kind of a marathon because if they're starting to talk to us today, they probably have 2 years left on their contract. We're probably not seeing that revenue. We think there'll probably be some wins we announced related to it in FY '27. We're a June 30 filer, but FY '27 with revenue starting in FY '28.

Right. So just to summarize that. So if there are people that want to look they choose you, you could see those announcements really in the next 18 months and really starting 6 months from now, roughly. And then you would start to see revenue beginning another year after that. So it's really kind of fiscal year '28 where you might see some uplift.

So we announced 22 new core wins this quarter. Some of those wins were off of those consolidating core customers. But they've already been in our pipeline already. So what we're doing now is we're tracking all of those impacted customers, mapping out when we think or know their end dates are doing outreach to them. And so that hopefully, we can start to share more metrics of what that distribution looks like of contract end dates and sizes.

Got it. So let's ask about complementary attach, so other services and capabilities that can be attached to a core. Do you tend to see that incremental complementary attach at the time of core deal signing? Or does it come in subsequent periods? So just trying to get a sense for the incremental revenue opportunity and where that might fall. So if you imagine a world where you have announcements next fiscal year and not just for these transitions, but generally. Announcements next year, revenue the year after that, do you get this complementary attach and revenue uplift at the time? Or does that tend to come subsequent and in future fiscal years?

Yes, it's a great question. There's -- because no one buys core in a vacuum. So while it is such a critical part of a bank operation, at the time you're making that change, there are complementary -- not to use the word of excitement but there are systems that kind of plug into that stack very nicely. So today, when someone is a new core customer, they tend to buy somewhere between 30 and 50 of our other services, whether that be complementary or payments-related services. Sometimes it's a day 1, what we call a day 1 product, installed together. Sometimes it may be a more complex and they may choose to bifurcate that into a day 2. So I would say it depends on the institution. The interesting thing is from a Jack Henry perspective, we offer contracts that are coterminous. So if you buy the 30 complementary and payments products and core and you went 7 years, we say that's 7 years for all of them. Not all of our competitors do that. It's actually a sticking point in the industry because some feel it locks you in that you're always walking away. If you want to walk away from your vendor, you're always going to owe them something because you're always mid-cycle of one contract or another. But the interesting thing on that is that's actually an opportunity for Jack Henry because we can go and sell particularly on these clients are going to be impacted, we can start to sell them some of the other real anchor products at Jack Henry so that then when the core comes up, it's an easier sale. But we serve over 6,800 noncore customers. So most institutions in the U.S. have at least one Jack Henry product.

Got it. So let's talk about demand. You've routinely referenced the Bank Director survey and noted that the median growth in tech spend is still really healthy. I'm curious, just given where we are in the deposit cycle and the prospect of accelerating loan growth for next year, which is kind of what our bank's analyst team anticipates. I'm hoping you can help us to stratify the differences in demand from your customers for deposit attraction versus retention tools and lending and whether or not you're allocating incremental resources to the lending side of the ledger, especially since that seems to be where people are anticipating some acceleration.

So we put out an annual survey to our customers. It's actually going on right now, where we ask bank and credit union CEOs what their priorities are. And consistently for the last several years, the top 3 have been gathering deposits, lending and then efficiency. And I think if I were to say a fourth for most of them, it's fighting fraud...

But that's also permanent. I'm not sure that moves...

Yes. And so I think they're always looking. My point is regardless of this where we are in the cycle of deposits, they're always looking for some. And we're post the surge of COVID where you saw the spike up in deposits and then this kind of trough. And so now they're on the other side of that trough and the need to get the deposits going again. The challenge was because of both the stickiness of interest rates, the lack of turnover in real estate market, there wasn't a lot of car buying as well, like you didn't see a lot of new lending going on. Hopefully, the administration has talked a lot about kind of resuscitating the real estate market. If interest rates do come down, you also have a big pool of refi opportunities that could hit for lending. So I think there are some signs that there's some opportunities from a lending perspective.

Got it. Got it. So let's move to AI. We mentioned in the past a moment ago.

We went 15 minutes of that...

Exactly, it's time, it's time. So let's start with the existential questions first. Like how do you think about AI and AI solutions, and the ability for those to displace what Jack Henry does at your customers? Like where might that might make sense, if anywhere, and versus where do you think that probably does not make sense? And how do you think about that?

In general, we view it as more of an opportunity than a disruptor. We're excited both from the efficiency we've gained internally. We've been able to limit headcount growth to less than 1% for the last 5 years. We've always been a continuous improvement, zero budgeting kind of shop. But the opportunity to just get higher productivity to get -- do more with the same as kind of our internal brazing around it is great. The throughput we're seeing from all of our developers who are now using. We have over 100 approved AI tools in use in-house. And so we're seeing upwards of like 70% on greater throughput and productivity, which is fantastic, especially given more of our products are in the public cloud. So you can get that innovation in the hands of clients faster, what you have on some of the traditional software annual updates and releases. And so in our new tech modernization and digital core, like we'll be able to distribute that innovation quicker into the hands of the customers. So in general, I think it's a positive. I think the dislocation you've seen in the market over the last several weeks has been unfortunate because I think people haven't really done the work to think about different business models and different moats. And yes, you can by code certain things. And if you're a small business, do you need Salesforce? Maybe not, right? You probably weren't buying Salesforce anyway if you were like 30-person shop, but could you now by code something that's custom up and bespoke to your own firm? Sure. But for the bulk of what we do is mission-critical operational systems. It's not a technological challenge. It's an operational challenge. It's an executional challenge. It's what is the uptime reliability of that system. It is, will your regulators feel comfortable in your audit for the superveillance of that system. Do you know how it was made? Do you know the workload? Do you know how a bank operates? It's not just generic software. So I think there's listen, if you want to convert something to a PDF or back and forth or we have AI for contract management and red lining, great efficiencies and exciting opportunities from a use case. And even the use case we talked about before, rewriting procedures or audit docs, but that's different than let me run my bank on software and be able to tell the regulators and be able to rely on it and be able to rely on how that third-party systems plug into it as well. And I think the reality is most institutions don't have the staffing to support not only the origination of that code, but the ongoing maintenance and support of what that would be. So I just don't think the mission-critical, highly regulated space. And the reality is we compete with over 1,000 fintechs today. And if you think about the European core entrants or the side core entrants in our marketplace, like they haven't been able to gain significant traction. And it's not because of their feature set or their technology, it's because they can't show we know how to operate this. And we have 1,000 customers running the system at scale every day with 99.99% of reliability. Like it's just -- that's the key of our industry. It's not necessarily like a mathematical problem to go solve that now we have the compute capacity to do.

Right. No, I think that's right. And I think there's -- I guess we could spend an hour talking about like the hurdles that would be tough to clear from a variety. And just like back to your point, is like if 200 out of roughly 8,000 institutions are changing their cores at all. And forget about like moving from one to another, it's the returns and benefits are going to have to be incredibly high, and so a lot to do there. So let me ask...

Let me just add on one thing to say, James, which is I think what the exciting part of what AI can unlock is there's a lot of manual processing in an operation of a bank. Like there's a lot of actual physical paperwork still. There's a lot of rekeying that happens. And we've already been moving people through straight-through processing, robotic, bots and that type of workflow enhancement. But this could really help a bank or credit union improve the efficiency of their own organization. And nothing we sell is tied to the number of employees at a bank or credit union. It's their account holders or the number of members or active users. So we love to make them more efficient. And if they can spend less on that, they can spend more with us in other areas to help growth for their business. So one of the things, especially in our client segment, how they differentiate and compete against the bulge bracket, large banks and the new start-up digital-only is service, trust, reliability. And so how do we, through the volumes of data that we have for them, their data that they can use, how do we help them to have personalization, ultra customization of offerings? How do they know that a certain population, a large population of a bank in Wisconsin all goes to the same Florida town in the winter and open a branch there or that they serve a significant number of dentist practice in their office. Like how do we get them the data, their data in a way that's usable, digestible so that they can put AI against that or we can help them with AI and insights against that so that it really can help them develop niche strategies to grow.

So let's take quickly the other side of that. So if you can improve the benefits, if you will, from -- for your customers taking advantage of AI with your own development, et cetera. On the flip side, can that short implementation times? Or is there a path to even increasing the churn of core systems because like I said, it's very low now.

Yes. I think as we talked at the start, more of the implementation cycle time is driven by their readiness. So could AI help them, if I think about the wealth of information we have on knowledge enablement, for example, training videos, white papers, tutorials, webinars, can we put that into a system to help them train their employees faster? Potentially. Can we help them rewrite procedures faster? Potentially. Like so I think there may be use cases to explore that help them on their readiness journey that might shorten that cycle time, which would be a great thing for us. In terms of does it make someone less or more likely to switch core vendors. Certainly, having things that are in the public cloud so that you can take advantage of that faster development time that's coming through with AI tools is important. If you only have software where you're getting an annual expectation of a release cycle, you're going to fall behind quickly from an innovation perspective of your competitors. So I think that will still be a driving force to get people to switch the number of APIs that integrate a core system with a digital banking system, for example. There's over 50 API calls. That's super important. So I think it really comes down to the ability to ingest and deliver data in and out of the systems, the connectivity between systems and then the pace that you're able to deliver innovation.

Right. So I want to ask about a couple of at least interesting to me, ancillary businesses. You talked about the core and then the complementary. But then within the payments there, you have a partnership with a company called Moov. And how meaningful is the Moov partnership going to be to the payments business in the next couple of years? When does it start in your mind, to produce material revenue growth and uplift to the segment?

Yes. So we've talked about -- we have roughly 500 of our banks today that have gone live with the Tap2Local, which is a small business merchant payment offering. We plan to have that available to all of our Banno banks and then eventually outside the base Banno Banks. So we're starting to see data on volume as people are starting to use it as people have gone from like a closed beta to like a full scale. And we've done no marketing so far. So it's just, it's on the pane of glass when you use Banno and it's driving insights of like, hey, we think, James, you might have a small business. And even at that, we're seeing like the pull of customers on their own merchants. These are the customers of the financial institution, starting to transact, get approved in a very frictionless way to accept those payments. So once we really turn on that engine and we start to see what are the adoption rates for merchants and then what's the dollar volume, we're going to -- then we'll really know. But our hypothesis is that in the next, call it, 3 to 5 years, this could be the biggest segment of payments from a growth perspective and a meaningful revenue contributor. So we've talked about that at the May upcoming earnings call, we'll have more data points to share. We just need to validate all of our hypothesis of this.

So quickly, just from a market fit or positioning standpoint, how do you compete with that solution versus somebody like a Stripe or a Square on pricing, if at all? Or is your edge really through the distribution of your bank partners, et cetera?

I think the pricing will be pretty standard in the industry. I think the difference is I believe that people will be multi-acquiring. And you might have and we don't need to take switchers to get growth. So the thing is if you -- let's say, you have a cafe or you have a store, a hardware store, you can accept at your register through whatever hardware unique device. But then when you go in home, in particular, like we think more of the real micro side of small business, the sole entrepreneur, the people who come into your home, if I think about the piano teacher, my lawn care service provider, the plumber, not every shop has like an iPad with vertical software and takes payments. A lot of people are like call back to the office with your credit card or I'll give you a paper invoice and you mail a check later to me. Like those are the type of service providers that are on analog today and aren't accepting payments or they can just be switchers, so they can have their terminal at their store. But when they're at the farmers' market, the phone is the device. And so if you don't need special hardware and you can get on within minutes to get approved and start collecting payments and then through our -- one of the other kind of selling features is the continuous reconciliation since we have all of the payments and core data, we can make it much easier to then go into AutoBooks or QuickBooks or Xero or whatever your back-end system is as a small business. So we think you can do both. You don't need to be a switcher.

Right. Last couple of minutes here, Mimi, capital allocation. Historically, Jack Henry's favorite dividends, reinvestment, selective M&A over large-scale buybacks. How do you think about the magnitude of buybacks becoming a more meaningful lever in your capital allocation, especially given some of the recent tax-related free cash flow tailwinds you're experiencing, et cetera? Does that make more sense for return capital allocation?

So a great question, one that's near and dear to my heart, thinking about dynamic capital allocation and the ability to generate real shareholder value through it. As you said, we have a 22-year consistent growing dividend policy that we're very loyal to and serves a good constituency of our shareholder base. R&D is our first priority. How do we continue to reinvest for the future. We are open to M&A. Historically, we've done a lot of tuck-in size M&A. There just isn't a lot interesting. And the interesting thing is we don't have a lot of gaps at the moment either. So it really needs to propel us forward in our tech modernization strategy to be compelling. So then that leaves a lot of -- we have zero debt at the moment. So it's a great opportunity, especially with the dislocation in the market to lean in on buybacks.

Love it. Well, that's all the time we have. Mimi, thanks for joining us here at the Morgan Stanley TMT Conference.

Always a pleasure, James. Thank you.

Thank you so much.