Hello, everybody.
Howdy, howdy. Thanks for being with us, Mimi. I'm James Faucette, a senior fintech analyst here at Morgan Stanley. Before we get started with Mimi Carsley, CFO and Treasurer of Jack Henry , I do have an important disclosure to read. Please see the Morgan Stanley Research Disclosure website at morganstanley.com/researchdisclosures. As a reminder, the taking of photographs and use of personal recording devices is also not allowed. If you have any questions, please reach out to your Morgan Stanley representative. Mimi, great to have you back here at our conference. We really appreciate you being here. Maybe we'll start off with, I'm sure, how every one of your conversations starts off. Can you outline for us kind of how you would characterize the current demand environment compared to a quarter ago when we spoke to you at our TMT conference?
In particular, anything surprised you of how conversations are evolving with customers?
Yeah, I would categorize it overall, James, as healthy. We're on track for the 50-55 core wins a year that we talk about. That's been a multi-year trend. We expect that we will see that this year as well. The year-to-date results, roughly call it 26-28 wins thus far, totaling over $30 billion in assets. It will lead to a stronger fourth quarter. We think that there's been continuation of sales momentum, sales contracts, decisioning. We see no slowdown. I guess what surprises me, if anything, is the uncertainty of the overhang that we've been feeling economically for the last 12 months. Yet, we're still trudging along here. I think we get caught up in the headlines and the ambiguity. While we're still always a tweet away from upheaval, overall, the banks are feeling strong.
They're continuing to want to drive efficiency. They're continuing to want to drive deposit gathering. They were continuing to want to get loan growth. In order to do that, they need innovation. They're certainly making decisions about technology and not slowing that down. I think regardless of economic certainty, obviously, if something was really out of line, like recessionary, you may see some different buying patterns. Other than that, they know that they need to stay competitive. In order to do that, no matter their strategy, technology is going to be the heart of that purchase.
Right. Yeah, I think a lot of the comments you have there about how you interpret your customers' mood and how they're approaching the business echoes a lot of what we've heard so far here at the conference with banks and other financial institutions saying, hey, we're all very attuned to politics and the news flow. The world's kind of moving on and doing so at a very consistent pace compared to what we've seen the last few quarters, at least. I guess talking about that sales pipeline, though, talk to us a little bit about how that has been evolving. I think most recently, you mentioned that you have about 26 migration contracts, including seven here in the fiscal third quarter. How do you see the next six to 12 months in terms of transition, and in particular to your private cloud?
What is Jack Henry doing right now to optimize these transitions for customers?
Yeah, so again, we're talking long-term trends at work here. That 40-50 migrations now, we're talking from people who host in their private environment on-premise to willing to switch to a Jack Henry-hosted private cloud environment. It really comes down to the individual strategy of the FI. What is the age of their CIO? What is the age of their hardware? How do they feel about being responsible for all of the cyber and the maintenance and the data recovery and the regulatory scrutiny that comes with managing your own infrastructure? Once they kind of get over that decision point, maybe it's around talent, maybe it's around managing that, maybe it's around their own internal prioritization, we see them making the shift. I don't think you'll ever get to a point of 100%. We're at 76% today. That's been a multi-year journey.
We still have a number of large institutions. I do think scale does come into play here. If you are a larger-sized institution, and particularly if you're geographically located in a place where you're getting that tech talent, it may be easier to continue to manage your own infrastructure more than others. I think there's still going to be some people. It's kind of almost like a philosophical debate, a value debate among financial institutions. We'll continue to have some that will always, unless regulatory, they're not allowed to manage their own infrastructure, just like the control factor of it. There's still many more. I think we're still on pace to continue to get to that high 90% watermark is where I think you get. Now, there is a question, do some people leapfrog that and go directly to public cloud? That's a possibility too.
Otherwise, I think you still have 10 years, roughly, of runway of that healthy migration. Just as a reminder, as clients move from their own on-premise to operating within our private client network, that is about a 2x uplift from a revenue. Great margins, great as a revenue driver of growth. As I said, still having a lot of larger clients still making that move has attracted from a growth runway.
Got it. I know we're kind of mixing specifics with Jack Henry and macro, but I did want to go back quickly to a comment that was made last quarter or so. That was you're generally pretty insulated from changes in the macro. You can see that in the consistency of Jack Henry's growth. However, you did call out a little bit of consumer softness last earnings. Has that changed at all, normalized, or with the benefit of a little bit of passage of time, what do you think was happening there?
Yeah, I'd like to say we're not bulletproof, but we're pretty darn resilient. About 25% of our business is tied to consumer sentiment, economic viability, if you will, overall. Most of that is in the payment space, in the card processing space. We're still very heavy dominant in debit versus credit. 90% of our card business is debit as a percentage of revenue basis. I think more for us, it wasn't that we were seeing a falloff in any trends. It was just relative to our expectations for the fourth quarter. We had in our plan a very robust fourth quarter expectation from a card volume. What we started to experience in Q2 and Q3 and kind of staying on that level trajectory, that's where the disconnect was.
We took down guidance because of our expectation, less so a concern of where we were currently seeing volumes.
Got it. Got it. And then once again, just visiting in terms of I think there's been a lot of question, especially Jack Henry historically has benefited from M&A within the M&A and just within the banking segment, for your customers. That does have implications for your earnings, et cetera. One of the things that seems to have been floating around in the conversations, even at a high level over the last couple of days here at the conference, has been the prospect of bank deregulation, particularly for small and mid-sized banks. One of the focuses is the point that those smaller banks are subject to the same capital requirements as their larger peers. How has your view evolved over the last several months as it relates to deregulation and maybe things like capital requirements?
What do you think the impact is on your business if changes here were to come to fruition?
Yeah. Let's talk a little bit about deregulation. Let's circle back to M&A in a second, because I do think that's an important trend as well. I think certainly having more clarity among the regulated bodies of who is in charge, who's setting the standards, who will do the surveillance, who has ultimate discretionary kind of voting, I think is important. I think we are starting to see more clarity in that. Overall, I would say we're seeing a de-escalation of the level of regulatory, not the level of oversight or things where it's all of a sudden gotten lax. I don't think that. I think there was almost an overreaching point of operating pressure before that may have been an overreach, if you will.
I think we're coming back to what is a healthy amount of surveillance, a healthy amount of oversight, a healthy amount of clarity in terms of positioning from the regulatory bodies. That obviously makes it a little easier for our clients. Now, we're subject to the same testing standards that our clients are. That makes it a little easier to have operating clarity for ourselves. We're not in the reg tech business. We don't really benefit directly when there's more regulation. I think everyone believes that there should be oversight, but there should be ability to run the financial institution. We think in general, the trends are favorable for an operating environment for folks. We also think that you don't want to get too far. Regulation is a good thing. It not only protects consumers, but it's a good thing overall.
I think if it were to be too low, that does create a lessening of the moat, if you will. It does create some uncertainty. You are likely to then have a reversal of the pendulum in the next administration. What we like is just more like a level playing field and clarity and transparency so that you know the rules to operate in.
Got it. Let's talk about your business and strategy on a go-forward basis. One thing that you have talked quite a bit about over the last couple of years has been winning larger core competitive deals. In particular, you've cited that aggregate assets of new core takeaways have more than doubled over the last couple of years. How does that asset growth compare with the broader industry? I guess maybe what I care about more is what is resonating with these larger institutions in the Jack Henry office?
Yeah. So it's both organic and inorganic. Our clients, our largest clients, are growing both organically and inorganically, as well as we're getting new logo wins of larger clients. So our average now is $1.3 billion, both on the credit union and bank side, interestingly, same statistic. We are at more conversations in more RFP competitive battles for $5 billion, $10 billion, $20 billion size institutions. We are winning more merger of equals of large-sized institutions on a combined basis. I think what's really resonating with them, one is the transparency of our direction. We put out over 70 roadmaps twice a year that really give our clients and our prospects clarity of our direction architecturally, our approach, and just feature what's coming down the pike.
I think people, particularly those who are on older technology, maybe less supported competitor technology, they do not have the clarity of when they are getting that innovation. I think what we are talking about from our tech modernization, we now have over 10 of the modules kind of in production and in testing. We are delivering on that roadmap. I think people really like the idea of taking the components, decoupling the core, if you will, having that module, having it be public cloud native, a true modern direction from core, and then just the level of integration with things like Banno, our payments, and other tools. I think really those conversations, as well as our outstanding customer support. You have the blend of executing on the innovation plus the service level excellence. That is, I think, what is resonating most.
Got it. You talked about you'd seen a significant or you expected a significant increase in competitive core wins in the fiscal fourth quarter. The macro and some of these other issues that we've talked about, does that complicate that? Do most people feel sanguine and relaxed enough that they can go ahead with those?
We haven't seen any pause on the ultimate decision. Again, that comes down to what's the strategic priority of the FI. If they want to get deposit gathering, if they want to get efficiency, if they want to fight fraud, they need the technology. They need to know that they will have the technology in place to execute on their strategy. We haven't seen any pause or elongation of cycle time. Sometimes it's just, listen, you have December year-end. Sometimes that's their year-end. They know ours is a June 30 year-end. You have salespeople who are naturally inclined to want to make their numbers at year-end. For us, Q4 is always a huge surge. We see great clarity in the pipeline to get us there.
Got it. I want to ask a philosophical question. This has longer-term impacts, especially as it relates to pricing and engaging with customers. A good friend of mine, he's in charge of the IT systems at a small bank. It's small. They're a Jack Henry customer. He was kind of laughing. He's like, our contract with Jack Henry has been unchanged for decades. I think the point he was kind of driving at is, should there be more or what he was basically saying is like, look, we're surprised. There's technology is always changing, et cetera, but we have these very long-term agreements. I've had this conversation with investors as well. Should there be more push to try to re-engage with long-term customers, revisit pricing, create opportunities for upsell? What's the right thought process that we should have around that from a strategic perspective?
Sure. First of all, we have a lot of CRMs. We have account managers. We have aides who are assigned to accountants to always be having that conversation, one, to understand what their goals and priorities are, and two, to be able to translate what are we doing, what's new, what's out there that might service their needs. We do try and have it's not just kind of sign it, put it on a shelf for seven-10 years, and never touch it again. We certainly do have. Now, over 20% of our bank customers have been with us. Sorry, over 50% of our bank customers have been with us over 20 years. There are some long-term contracts probably still out there. Our legal team does try to modernize the language at every opportunity.
I would say we certainly do not kind of set it and forget it. There are conversations to make sure because we feel like it is our job and it is our mission to make sure banks and credit unions win, that they stay relevant, that they thrive. That is incumbent upon us to make sure they know what tools are out there to help them meet their account holder and member needs.
Let me pose a question from a different angle then. Is the level of lack of churn and retention within the industry a good thing for you? Could we be better served, at least from a business perspective, if you or others were pushing the price issue a bit more, even if it resulted in a little bit more churn?
Yeah. It's a great question, James, and one we debate internally quite a bit. The consultants have done a great service to the industry in being a thought partner and a leader and a guide along the way. They also have their influence on terms and conditions and contract length and price, et cetera. We have over 99% ex-M&A client retention. There is sometimes a question of, is that too high a number? The reality is we're never the low-cost provider. We view ourselves as the value provider. There are many times that we sign a new core win, and we will hear after the fact of, hey, you know there were cheaper deals in the desk drawer we didn't sign. We feel like if someone's coming to Jack Henry, they're coming for the technology. They're coming for the innovation.
They're coming for excellent customer service. They're not coming to us for low price. I think there is a question. We look at deal by deal. We have a deal analyzer spreadsheet that we say, what's the margin on this deal? We're not going to give away deals for free. The challenge is there's only so many FIs in play in a given year just based on their contract termination. If you have a seven to 10-year contract and you want to start that conversation two years before the runway is out, there's only roughly 200 in any given year that are kind of coming up for renewal soon. 50% of those don't want to make a change. While it'd be nice to kind of increase the TAM, if you will, that's hard to do.
Now, I do think you raise a great question that as you start to move into the public cloud and everything else, should the contracts be less than 10 years? Should you think about the ability to foresee costing or pricing or innovation and the rate of innovation getting faster? One of the great things about the public cloud is the DevOps time. We're going to be able to put out features much more rapidly than you do today in more kind of monolithic software architecture ways. Today, a core system, you get two updates a year, two main updates a year. Banno can update every day. We can update multiple times a day. It's much more of like an iPhone experience from an app perspective. I think as you start to think about that, does that then change where you might be thinking about lower contract terms?
The reality is you also do not want your clients to have, I mean, it is a major effort to go through contract negotiations and go through all of this. You want them focused on serving their customers. It is not necessarily something that benefits everyone to think about doing a two-year contract or a three-year contract.
In this same conversation, I posed the theoretical, what if you did switch? He was like, that's probably once the contract and the decision is made, it's probably a four-year process in their particular case.
Yeah. You're going to start two years before the contract's done. Then you're going to take 12-18 months to, if you're making a change, to think about that change. Then you have some day two product that you want to install after the core. It is a lot of change management from an FI perspective. You want to, I mean, we try and lessen that as much as possible. Some of that is on the FI processes and training and culture of their organization.
Right. No, that's exactly right. We've been going for a little over 20 minutes here. Want to see if there are any questions from the audience. Do you have anything, Michael? No. Okay. All right. I want to go back to what you mentioned on your kind of the targets that you had for the payment segment, Q3. Maybe you were aggressive and optimistic there. It came in a little softer than you thought, even if there wasn't much change. Just give us a little insight if that, how much you moderated or changed your outlook for the rest of the fiscal year once you kind of saw what the year was actually developing?
Yeah. With only one quarter left, I mean, there just was not that much runway left to the end of the year. Just the range of outcomes is shorter with only three months remaining. By the time you are in guidance, you are kind of a month into the three months remaining. Again, it was not that we saw a precipitous drop in actual and the trending of actuals. It was just relative to the expectations we had of it being an acceleration of positive volume flow. We just felt like that probably, given the uncertainty of the economics at the time, the macro, and the recent trend of actuals, it probably was more realistic to lower that guide down.
No. Just want to make sure that we're on the same page there. What I really want to talk about in this subject or area is your partnership with Moov for merchant acquiring. To me, it's like a very interesting and compelling potential offering that you have for your financial customers and being able to take advantage of the things that Moov has built. Can you give us some early indicators from the closed beta that was planned for June or how you expect that to develop? Ultimately, I guess, how do you see this impacting your business and the payment segment broadly?
We are super excited about it. You're not alone in thinking that this could be a huge positive for us. MasterCard and Visa are super excited about it. Every bank and credit union that we've spoken to since we announced it around Investor Day last year, resounding positivity in terms of the feedback. We do have a closed beta going on where they're actually making transactions on the system. It's not just a theoretical. It's in operations. That's going smoothly. In terms of what excites us about this, again, we view it as our mission to make sure that banks and credit unions win, that they have the trust, the service, the execution for their account holders and their members to compete with the largest size institutions in the U.S..
Part of that is an underserved segment of their market being the small and medium businesses. Our SMB solutions at start are much more in the S and the small S side of the house than really complicated. We do have Treasury, and we have other commercial products that FIs can use to serve those clients. This is really the underserved. There are a lot of businesses hiding in personal DDA accounts, a lot of side hustles, a lot of I am a caterer on the side, or I make wedding cakes, or I sell on Etsy, or I sell at the farmer's market. There is a lot of that type of microeconomy going on in the U.S. Moov does not require switching. We believe that people will be multi-payment, multi-modem. It does not require new hardware. You are using your Android or your Apple phone.
It reduces these points of friction that exist today. If you think about the kind of end-to-end workflow as a small business, I know my husband loves opening LLCs. The experience is quite a lot in the Carsley vessel. You already have a local bank account. If you want to start doing things, let's say you were going to a competitor, you're going to wait three or four days. You're going to send them your articles of incorporation and all these documents to open an account. We already have the KYC, all the information at your financial institution. Using Banno, using the pane of glass you're already using today, it may say, hey, we noticed you might be a small business owner as well. Do you want to set this up?
We're talking minutes, not days, of being able to establish that account and then make it operational. Within a half an hour, you can go from zero to accepting payments, totally reducing the friction of that experience. The other point of friction is typically on getting that cash as a small business owner. Most is a multi-day wait, or it's one cycle time a day of a payment window. We are able to take advantage of the eight settlement windows that Visa and MasterCard offer through Moov. That's talking about recycling that cash back to that small business owner for liquidity management much quicker. The next is, again, you don't need specialized hardware. There's no dongle you're waiting for in the mail.
If you have a, I like to use the example, let's say I own a bakery or a coffee shop, I can still use some hardware device in my cafe. When I go to the farmer's market, I can just use my phone. I don't have to be a switcher. I can use both. Lowering that barrier of switching, getting my cash faster. The biggest point of friction for a lot of small businesses, or if you do volunteer work for a charity, is that accounting reconciliation, doing the QuickBooks or the Autobooks or your back-end accounting register because most just send you the one bulk statement, kind of, you did 2,532 transactions for $10,000. Okay, James, go spend all weekend reconciling what all of those 100 transactions were to that total.
Because we have the core data, we have the payments data, we have all of that GL information, we can do that at continuous reconciliation, we're calling it, so that you can send it automatically back to Autobooks. You can send it automatically back to QuickBooks in all of the detail formats. We think that that point of friction, those hundreds of hours a year that a small business owner is doing that bookkeeping will get removed. To me, it's less barriers, less friction points, and you don't need switchers.
Yeah. No, I think it's really interesting. You hit on a few things, whether it be the upfront underwriting as you're adding a new business or trying to gain the ability to process payments as a new business, plus access to capital, plus the bookkeeping relative to other players in the market. It's an interesting nuance. I'm excited to see how banks decide to bring that to their customers.
It does. That's the important part. Banks bring it to their customers. We're not trying to go around our customers directly to their commercial businesses. This is empowering the banks and credit unions to serve their account holders and members. One of the important things is a business account has four times the amount of deposits that a retail account does. Those are really important customers for the bank or credit union to know about, to serve, to retain, because you don't want that money going off to a Venmo and sitting on their balance. You don't want that leaving your institution and never coming back. Those are important. Those add up to other products. Maybe they need a line of credit. Maybe they need a loan. Maybe they need something else. It's a great introduction point to serving that small and micro business.
For sure. Let's talk about some of the other products where you're already in flight. I want to talk about Banno Business. Just wondering, how has traction for Banno Business evolved since you reached 270 clients? What enhancements do you have slated to strengthen your competitive position in that space?
Yeah. First of all, you have to be a Banno platform or Banno retail customer to then get access to Banno Business. We have over 1,000 FIs using Banno, the platform. As you say, great traction on Banno Business. I think there's still a lot of runway on Banno Business. Not everyone needs to serve commercial businesses at scale. You might have some credit unions in there. I think there's a ton more runway if we think about the 1,700 core customers, 1,000 customers that we have already using Banno, the platform. I think there's more runway for Banno Business. We're continuously adding new functionality to that, whether that be Banno for Spanish, whether that be Banno Conversations, which is a fantastic product, Banno Conversations with AI Assist that can really help back office efficiency of the customer service center.
There is a lot of other products there within that digital suite. Today, Banno has over 13 million active users. I think once we add Moov in there, there is just a great opportunity to take advantage of that platform to be able to, that is also where we integrate a ton of third-party fintechs, or the bank has a choice to integrate third-party fintechs. It is a great medium for addressing client needs.
Got it. Another product question, and we have just a few minutes left here. You mentioned that some of your customers may eventually want to jump directly to public cloud-type solutions. What have you been hearing about regulators' willingness to allow kind of that PII to be hosted and stored fully in the public cloud? How has that changed your pace of conversation with customers?
Yeah. I don't think it's really changed our pace, James. We've always been trying to build to where we think the demand will be. We, rather, are a very, very small handful of institutions today that are doing things in the public cloud for their core. It tends to not be a full core. It may be deposits only. The reality is the regulators are in their office. I mean, they have a permanent fixture there alongside. I think most institutions expect within three to five years the regulators to be up to speed in how to do supervision and oversight in the public cloud. The great thing is compliance as code is inherent in the way we're building that. The ability for the regulators to see, access, audit is going to be much easier in the public cloud. We think we get there.
I think that's in that three to five years is when we'll have a full product offering of a full complete core in the cloud ready. Kind of building for what we think is the demand. If all of a sudden we think regulators get there sooner, customer demand can get there sooner, we have the opportunity to accelerate. Right now, we're kind of targeting right on time.
Got it. Just last couple of things, capital, capital allocation. Right now, your trailing 12-month free cash flow of just over $300 million. It's about a 71% conversion rate. You've got plans to return to your 80%-100% free cash flow conversion levels. Where are we in that process, and how is that going to impact your allocation decision-making once you get back to those levels?
Yeah. Spot on that we're kind of making our way back to the journey here. We're hopeful still that Congress addresses the tax expense nature of the R&D credits. If they do that, that's going to be kind of like a boost to that kind of runway back to 90%-100%. Even if they do not, we're almost two years left into that five-year amortization. We're like three years into that journey of repooling that R&D credits. Even if they do not address it, we think we're on a healthy back to that 90%-100%.
Got it. M&A has always been a key fixture within Jack Henry. We had high valuations, and then valuations come down, but maybe the capital environment was harder. Where are you at right now, and what kind of opportunities are you seeing? How much potential is there for that to return to be back to a meaningful contributor and part of what Jack Henry is doing?
Yeah. It is always part of our DNA. The company has a long history of being an experienced acquirer. It is something we are always opportunistically looking at. I would maybe argue with you that I do not think valuations came down that much, or certainly not as much as we were hoping.
Rationality.
Those two things could be different, right?
We thought maybe more rationality would come back to the market. That has not quite gone back yet. If it is digital cloud native, API first, if it is an accelerant to our roadmap, if it is in our adjacency of serving banks and credit unions, we will take a look at it for sure. We are always open. The reality is we do not have a lot of strategic gaps at the moment. If something makes a product more robust or, again, accelerates our tech roadmap, we will certainly look towards it. In the long run, I suspect M&A will come back at some point in time. That is the beauty of Jack Henry. We can partner. We can build. We can buy. We are not reliant on anyone. As I said, we do not have a lot of gaps.
I think overall, from a capital allocation, we're nearing back close to zero again on the debt pretty soon here. We have a healthy dividend policy that has had modest increases over time. That's a possibility to increase. Share buyback is always on the table. I know current tax has potential more onerous look at it, but that's always something we look at. Again, we'll always explore M&A.
Got it. Mimi, per usual, we blew through our time. I appreciate you being here today.
Thank you, James. Thank you.