Jack Henry & Associates, Inc. ($JKHY)

All right. Good morning, everyone. Why don't we get started? My name is Dave Koning. I'm a senior analyst at Baird covering payments and services and thrilled to have Jack Henry with us today, represented by CFO, Mimi Carsley. Jack Henry is a core processor for banks, meaning they run the deposit and loan operations for many of the banks across the U.S. with one of the leading shares.

Mimi, maybe you can just kind of kick it off with a little overview of what you do and how you've been able to grow really double the industry for not just 1 or 2 years, but probably the last 30. So kick it off.

Yes. So as Dave was saying, Jack Henry is a technology provider to banks and credit unions in the United States. So we do -- we have 3 main operating segments, then we have a fourth corporate segment. But of those 3 main operating segments, we have core, which does the critical processing, think about account opening from an account management, posting interest, general ledger, wires, all of the major functions, calculating interest for loans, recording those, all of the major processing. We do that both on-premise, but 79% of our customers have it hosted from a subscription model in a Jack Henry data center. And then our payments business, we do card processing, both debit and credit card processing. We're not a merchant acquirer, but we do card processing for our customers. We also do enterprise payments. So think about remittance, check processing, bill payments. And we have a payment hub around faster payments. So think about RTP, FedNow, Zelle, having all of the payment rails capable for banks, both core banks and noncore banks. And then we have -- and we have a small business initiative around payments as well. And then we have our complementary segment. And there, think about all of the ancillary services that a bank or credit needs to function. So think about lending capabilities, think about fraud capabilities, think about digital capabilities, account opening capabilities. So a lot of different solutions, over 200 solutions. We have been in business. We're just celebrated June 2. We celebrated 50 years in business. 40 years as a public company. So a lot of execution. We talk about the 5 key differentiation points for Jack Henry, and that's culture. We're a very people-first culture. So it's culture, renowned for service excellence, then it's around strategy, innovation and execution.

Yes. Great. Thank you. And maybe if we look at the core processing segment, about 1/3 of revenue, there's maybe, what, 9,000 or so banks in the U.S. You work with 1,700 maybe. Every year, only about 100 really flip, right, turn to someone else. And you win half of those. You win 50 almost every year. Why do you guys win so much in the market?

Yes. So -- and as you said, this is not a 1-year phenomenon. For many years, we've been winning about 50 to 55. This year, we said we're confident to be at least at the high end of that, if not exceeding that with a pipeline that's been stronger than ever. And so part of how we win is that service and innovation. So Jack Henry is not the low-cost provider. It's a very competitive marketplace. There's a lot of formidable competitors in the space and an industry of consultants that are also very influential in the space that kind of keep pricing pressure on all of the players in the space. And yet it's our innovation, it's our service. It's the transparency of where we're moving to. So we have, for the last 5-plus years now, been talking about our public cloud journey from the core, our tech modernization efforts that we've been talking about. And we now have over 20 components of that either in the market or in the hands of clients. So that's talking about moving the functionality, first of all, decoupling the functionality of a core system and then moving it into the public cloud. So the regulators aren't fully ready to do the surveillance and compliance today. We think that will take a couple more years to ready them, but we've started to put modules out there. But just the clarity of that from a road map strategy, Dave has really helped especially win larger clients. In the last 10 years, we've really been moving up tier. We announced 2 weeks ago a great win of a $9 billion institution. And part of the reason they chose Jack Henry in addition to the fantastic service was they knew that SilverLake would meet all of their needs today, but they knew the tech modernization journey story that could help them in the future.

And just to put that into context, I mean, the $9 billion bank, I don't know, have you said about how big an average bank is like that's probably worth what, 10 normal banks?

Yes. So our average is about 1.5, both on the credit union and bank side. Our business model, if they -- we sell today primarily in the hosted environment. Very few banks buy on-premise, if anyone buys on-premise today. But we're 79% in our private cloud, the Jack Henry private cloud. And that model is based on number of accounts or number of members. So $1.5 billion bank average -- so a $9 billion bank is big. We've been talking about how many we've won. We've won over 12 over $1 billion size institutions. Our largest institution to date is about $50 billion on the core side. We serve up to $200 billion institutions on the payments and complementary side. But -- and every one of those banks over $10 billion have crossed that threshold that's in a very important regulatory threshold, have crossed that threshold while being at Jack Henry. So we've been able to help support them from that regulatory duress and business model change of crossing that $10 billion demarcation line.

Yes. Where debit interchange, all of a sudden, they get paid...

Yes. Yes, it's a big change for a bank.

That is. Yes. Now the public cloud that you discussed, right, for years, it was a huge tailwind to go to the private -- your own private cloud from banks running -- used to run their own software that Jack Henry provide, they run it themselves in the private cloud. Now you have 79% on your private cloud. Now this moved to public. What does that do to the financial model? Does it lift revenue? Why do banks want to be in the public cloud rather than your hosted solution?

Yes. So when a bank makes that change from a revenue model implication, it's about 2x revenue. at very, very high margins. And you may say, why would a bank pay you twice as much? And the reality is from a net outflow from them, it's similar. But think about all they have to spend when they manage their own data center. You're talking about $1 million IBM hardware. You're talking about having all the data recovery, all the backup, all of the CIO work, all the CTO work done in-house. And it's interesting. So I've been at Jack Henry now almost 4 years. And when I joined, it was like we've been on this march for like 7 years of watching at a very steady clip around 40 to 50 clients per year making this change to being in the Jack Henry cloud environment. And I was like, who wants to manage a data center these days? Like that's not what they do best, right? What they do best is serving clients. What they do best is creating bespoke lending to support small business growth, deposit gathering, et cetera, not necessarily like wanting to run a data center. But what I think is interesting -- so the ones that are left, we may only get to 30 or 40 this year, but the ones that are left are larger institutions, which makes sense because to still be running a data center in this day and age, you need to be near tech talent to probably near university. You need to be larger to have the economies of scale to be able to still be doing that. But the thing I think is pretty interesting is I think there might be extra tailwinds to accelerate that shift. So we think you ultimately get to around high 90s in the Jack Henry cloud. So we've said, oh, we have 7 more years of this great tailwind of 2x the revenue. This is fantastic for revenue growth. But I think it could accelerate. And the reason why I think David could accelerate is think about -- and a lot of people are talking about ethos and frontier models and the vulnerability assessments and a high -- an increase in patching velocity that's going to come from the exposure of vulnerabilities in infrastructure, particularly around infrastructure and endpoints. That will make the burden of care even harder of managing your own data center. And I think whether it's the institutions themselves or perhaps even the regulators will get to a certain point to say, maybe you shouldn't manage your own data center to these institutions. And so I think we could see -- typically, what tends to be the tipping point is when they have to make a refresh of hardware purchase or when a CIO is like retirement, that tends to be the tipping point where they rethink, hey, do we want to manage our own or do we want to move to a Jack Henry hosted environment. But I think we could potentially see over the next coming years an acceleration of that trend, which would be a great catalyst for revenue.

Yes, that's interesting. And as you go from private cloud to public cloud, how does that shift work? And what does that do for economics?

Yes. So it's about a 25 basis point uplift moving from the Jack Henry data center to the public cloud. Mostly because it's a similar product. It's a similar delivery mechanism. So it's not as much, okay, you're giving up all of these costs, therefore, you would pay more. But what you do get is better burst processing capacity. You get better uptime reliability today. We have very strong uptime reliability, but we think you could get to at least four 9s, if not maybe five 9s of uptime reliability in the public cloud. You get all the DevOps benefits. But if you think about Banno today, everything we've built over the last 5 years has been digital cloud native, API first. So a traditional core processor, and this is anyone in the industry, you get 1, maybe 2 upgrades a year. So think about more monolithic kind of software releases. But Banno, you could have 10 a week, 10 a month. It's like your iPhone. Whenever there is new functionality, whenever there is an upgrade, it just comes straight through. And you get the same in the DevOps environment in the public cloud. So that's going to allow us in the core side of the house to increase the velocity of functionality and innovation into the hands of our customers. So you get a lot of -- you get enhanced security. Our security is great, knock on some big goals here. But even in a major cloud providers, we're a Google partner. We also have a very strong partnership with Microsoft. They know how to do this even at scale and for even more so than in Jack Henry. So moving to the public cloud is going to be a continued uplift, but we also think it will be an improved margin. So we have a project underway internally we call EC 2030 or enterprise compute 2030, which is the journey to get out of the data center ownership ourselves where we're going to move to more of a colo facility. So it will be a public cloud plus colo facility, which we think will be near term, there's going to be a lot of work and spend to move that as part of the R&D efforts. But long term, it's going to be a great margin catalyst as well as we get out of data center ownership.

Yes. And then maybe turn to AI. Clearly, the market is looking at any software firm and saying this is going to be a problem. How do you see it in what you do, maybe describe if regulatory impacts help you, right, in AI that really AI can't come in and you probably save a lot on cost, too. Like how do you see all the different things?

Yes. I think that, unfortunately, the market right now is grouping everyone together and not seeing differentiation in business model, which is unfortunate. I do think that from a Jack Henry perspective, it's more of an advantageous situation. There's more opportunity than there is disruption risk. As you say, like I think about -- particularly in the core side of the business, there are 25 core providers that no one in this room has ever heard of, right? Like very small, maybe has 1 customer, maybe has 5 customers. It is not an easy business to operate in. There's a lot of regulatory duress. There's a lot of regulatory update requirements. There's a lot of functionality from a code perspective. And there have been new entrants over the years that have attempted to come in. If you think about the European competitors that have tried to enter the U.S. market and have not been as successful. So I don't think it's been a technology challenge. It's an operating challenge. Like you need to be able to have service quality. You need to be able to have uptime reliability. You need to be able to know how to operate in a highly regulated world. So I don't think that the opportunities that AI presents will be disruptive to that because I don't think it's a technology challenge where all of a sudden you're unlocking compute capabilities or something else. And you really have to know how a bank or credit operates. And that is a key knowledge, institutional assets that a lot of firms wouldn't know. Like you have to ask the right questions. Claude is not just going to figure this out for you. So I think it gives us a benefit. We recently put out our annual client strategic benchmarking survey. We've been doing it for -- I think this is might be our second year, talks about it's CEO clients answering what are their top priorities. It's listed on the Jack Henry website. So for the last several years, deposit gathering has been a top priority. Lending has been a top priority. Efficiency has been a top priority. For the first time, AI entered that list as a top priority. But AI, I think, will help drive efficiency. There's a lot of manual processes at a bank, a lot of workflow movement, a lot of duplication of tasks, a lot of silos of functionality that AI will help. But you have to understand the underlying processes under that, the human processes that occur in a bank to understand where those opportunities are. So we're using AI internally. Our developers have tools. We're getting over 70% efficiency from a code production velocity. So we're quite excited. We think that there's a ton of knowledge enablement tools and white papers and videos and case data from call centers that we have about our products that we can embed through AI and natural language to make the product easier, more intuitive, more automated steps to drive efficiency. The reality is it helps us to drive efficiency at a bank. Nothing in the way we charge from a business model is tied to the number of employees at a bank. So we've always been aligned with our customers and helping them drive efficiencies from an institution. So I think there could be potential threats. I don't think it's on the core side. In the complementary side, we compete with every point solution that's out there. If you go to our client conference, you will see 300 booths of competitors on point solutions. So today, a vendor -- one of our clients could choose a third-party vendor. They could choose a Jack Henry. It's a very open architecture approach. We have a lot of APIs. But again, we compete with those today. So if there's a new incumbent based on AI, we will compete with them. And on top of which we know banking, we know our clients, and we have the data to be able to help them. So we're going to use AI to both enhance our products, enhance the efficiency. We have a number of products already using AI, whether that be fraud detection products, whether that be AI Banno Assist conversations to help in the customer service area with AI, whether that be exception item processing. There's a lot in financial crimes around SARs reports or government reports that AI can help, the bank employee write and automate and save time. So there's functionality that we're releasing that has an AI embedded to help the bank or credit union.

Yes. That's good to hear. If we move to payments, about 1/3, give or take, of revenue. it's a very stable business in terms of more than half is debit processing, just Visa, Mastercard debit transactions grow reasonably stable. Little bill pay, some enterprise transactions you called out. Is there anything either from a share perspective or from a new product perspective, like the Moov partnership or RTP or some of the newer Zelle, all that stuff that could accelerate revenue growth?

Yes. So we've been selling a lot more credit lately. So our credit sales have been double what they've been in the past. Now it's not huge numbers. We've been in credit for a handful of years. And typically, a bank or credit wants to do debit and credit through the same provider. So we have a single platform that enables those transactions. But credit has been on the rise, I think as banks continue to feel comfortable in the tools, the risk tools, the dispute tools to handle that and on the lookout for more diversified revenue streams. So credit has been very strong. The health of the consumer has been, I won't say vibrant, but more stable than I think some of us a year ago would have maybe been nervous about. Some of the areas that are very interesting from catalyst growth perspective are those faster payments. So if we think we have roughly, call it, 500 clients on each of the faster payment rails today, but very little volume is going through send right now on FedNow, but the government could turn it on more aggressively at any point. That's exciting. Zelle has been very strong this year, the adoption and usage of Zelle. So while still modest in terms of the size of the dollars and the faster payments, that's within our PayCenter hub functionality, it's been great growth rate. So I think that's something. You mentioned our partnership with Moov. So our small business initiative that we launched just this year, we have 2 main flagship products with the first kind of solutions out the gate. One is Rapid Transfers, which allows through the debit rails, tapping on your Banno on your phone, both iOS and Apple to move money. So let's say, I could move money from my [ PNC ] to my IncredibleBank account. And it's instantaneous movement. And there's only 3 institutions in the U.S. that have that functionality today. So empowering community and regional banks and credit unions to have that at their fingertips really helps from an account opening perspective as well as from a deposit gathering perspective. The second is tap to local. So that's a merchant acquiring. But instead of going around the financial institution, it's giving the tools to the financial institution to hit their underserved business customers. So a lot of small entrepreneurial customers, smaller businesses. I'd like to think about like if you run a bakery, you may have a Toast machine in the cafe, but you're going to work at the farmers' market and you want to collect payments there or the piano teacher who comes to your house or your lawn care or your plumber, a lot of those kind of in-home where you don't send an invoice, you don't want to call and give your credit card over the phone, they can do tap to pay instantaneously. So I think people in that space will be multi-acquirer. They don't have to switch from their existing provider, but it allows them to have an alternative or a backup system. It gets frictionless, very easy to turn on. It's automatically turned on for all of our Banno institutions. So we have 1,000 institutions turned on for that service, and it's a rev share for the bank or credit union. We partner with Visa and Mastercard. So we have yet to turn on the marketing engine behind that. So people have kind of just been self-discovering it through Visa, through Banno and already using it. And so it's been great to see that start, but we're going to turn on that marketing engine and really excited to see we have over 10,000 merchants using it already.

When is the marketing engine going to be turned on? And where does this hit your P&L?

So today, it's a rev share with Moov. And so you see that through payments and you see that in digital. It's not huge dollars today, Dave, and it's just growing. So even in '27, it's going to be modest. But we think over the next 5 years, it could be the second largest engine in the payment segment.

Wow. So debit, obviously, 60%. That's not...

No. So that's in addition to debit. That's just the rev share alone, we think, could be that large.

Wow. So move above like bill pay or enterprise in terms of percentage of payment.

The interesting thing on bill pay and enterprise since you mentioned it is the Payrailz acquisition we did about 4 years ago, has really resuscitated that business. You had a pretty mature business in iPay, but the combination of Payrailz and iPay has been great. We've seen a number of sales this year and just really nice growth. So we're excited about how that acquisition is going. The other acquisition that's helping in the payment space was our acquisition of Victor Technologies. So that's embedded payment capability. So that allows a bank or credit union to offer payments as a service, again, a revenue diversification opportunity for the bank or credit union. And it allows them to offer to either fintech or to their sophisticated commercial customers through treasury management the ability to do payment servicing. So think about today, Victor does a lot of digital asset providers. They do some gaming companies. They do other -- think high-volume end user. They do a lot of sub-ledgering capabilities. So you don't want to have 1 million users as entry into your core system. So it does kind of a master account with sub-ledgering capabilities. And then it does the KYC, KYB for the institutions. And then the banker credit facilitates the payments. So that's been really exciting to see the success of that acquisition.

And I'll talk about complementary just a little bit, but really just as we think of the business, when we think of -- in the core segment, you're winning more in bigger banks. And some of your competitors have -- well, one of your big competitors has noted some potential they were going to force some conversions. They aren't now, but I assume you're still winning share there. So that's all a benefit to core. In payments, you have the Moov that's going to start to be more material. And then I guess, in complementary, is there something like that? And when you put it all together, is '28 kind of a breakout year as all this kind of develops?

Yes. So complementary is a collection of a lot of products. We have over 200 solutions. But if I think about some of the anchor capabilities, you think about lending products being in complementary, fraud products being in complementary and digital. And when we say digital, we mean more than just Banno. So we think about anything that end client user needs to do to open an account, get a loan, any of the services that an FI offers without going into a branch. So that would be digital. So that's a big grower as well, things like treasury management and now that we have Banno Business. But if I think about the other catalysts going outside of the base today, Banno is only available to our 1,700 core customers today, but we're going outside the base with Banno. So that's another catalyst for growth.

And would you say because of how sticky your business is, I mean, you have like 99.5% retention. I mean it just doesn't change. Your revenue growth doesn't change. It's 6% to 8% just very consistently. But it seems like a lot of things, while they probably don't immediately impact '27 because it's like a slow progression, '28, it seems like there are so many different catalysts that all collectively could make that just an incredible year.

Yes. And I think it's not just '28. I think it will be setting kind of a new level for the future. And I think it's not just from a revenue catalyst, which is exciting. It's not just one area. So from a perspective of diversification, I think there are several we talked about just now. But a lot of those are also very attractive from a margin perspective. You continue to get the margin expansion from moving to the private cloud and to the public cloud. The rev share opportunities, the newer products that an upcharge have a better mix blend. So I think there's also a lot of nice catalysts from a margin expansion as well.

Okay. And when we think about margins, I know this year and last year, too, really good margin expansion. Yes. Really good. You have a little bit of a headwind, which you've been more -- way more than offsetting, right, the colocation. How do we think about that the next couple of years, colocation costs keep going up, but incremental margins are really good? Or how do we think about that?

Yes. I think there were some things this year that we called out as more onetime benefits that are less reoccurring. We have a self-funded medical plan that in the first half of this year, we saw less claims around, and we've already started to see that normalize, and we've talked about that on the most recent call. So that was just kind of like a windfall that I don't expect to repeat, but there are others that will. We also have some growovers next year because of that, because of hiring, because of some of the infrastructure investments we're making. But I think the base foundation of the model intuitively is a margin expansion story will continue.

Yes. Okay. So solid margin expansion continues. And then when colocation costs sort of run out and all of a sudden, you just have your single location much -- you shut down some data centers, how far in the future is that?

That's a couple of years from now. I think it will -- today, we have some of the moving loads to the cloud from a product perspective. And then as we move the infrastructure support of the data center into the cloud, that's going to take us a couple of years to handle. But we spend about 14% to 15% on R&D. I don't see that increasing. We've been able to do all of the tech modernization work for the last 5 years, still under that 14% to 15%. So I see us continuing to be able to innovate at an accelerated pace while spending the same 14% to 15%. So I think by the next couple of years, you're going to continue to get margin expansion every year, but I think it can really start breaking out over the near-term horizon.

Nice. Okay. And 2 quick ones. We have about a minute left. Free cash flow conversion, you're back to close to 100%. Is that sustainable? And then is there anything that is a headwind to growth? Like there's so many growth drivers right now, but law of large numbers, maybe anything else?

Yes. So it's a great year for free cash flow. The clarity that we got from Section 174 essentially added excess cash because we had overpaid in taxes in retrospective. That's been a great headwind. But the natural free cash flow, I think, is going to be in that 90% to 100-plus percent. It's enabled us to spend almost $300 million on share repurchases this year on top of dividend growth and reinvestment in the business. So I see absent M&A continuing to have free cash flow allocation to all of those areas. We'll continue to explore M&A. But in the absence of that, it will allow for share repurchases.

Yes. That's good. And any like headwinds to revenue...

Headwinds to revenue, first of all, I would encourage everyone to look at us on an annual basis. There is -- Q4, for example, this year is a little lighter. That is no way indicative of any kind of annualized go forward. It just is the way this year's plan worked out. So please look at us on an annual basis. In any one year, depending on how M&A goes, in general, it tends to be a neutral to slight positive for Jack Henry. But in any one year, while that deconversion or think about the termination, exit of a contract is great. It's nice free cash flow, but that creates a pothole of revenue in the future. And so if you had some lumpiness related to those potholes, but our industry has been consolidating for 40 years, and we've been growing at 7% to 8%. So we've been able to overcome those potholes, but that could create lumpiness from a headwind in a particular year if it was all a sudden concentrated.

Yes. Makes sense. Well, that's all the time we have. Please join me in thanking Jack Henry's Mimi Carsley.