Great. Good afternoon, everyone. I am Rayna Kumar, and I lead U.S. Payment Processors and IT Services. And today, I'm very fortunate to have, CFO of Jack Henry, Mimi. So, so Mimi, just to start out with, in the fourth fiscal quarter, Jack Henry booked 16 competitive core takeaways, making it 47 for the fiscal year. What's fueling the strength? Have the competitive dynamics changed, and, more importantly, are you seeing any residual effects from one of your competitors, which is currently struggling?
Thanks. So yeah, we just closed out a strong FY 2023. We are a June 30 filer, so we just finished our year-end and, and kicking off FY 2024. So historically, on average, we close about 50 new core wins. Now, when we core wins, we mean completely new logos to us. So this isn't a switcher, this is a completely new core win. So on average, we like to say it's like one per week. It's certainly not as even as that, but on average about 50-55 in a given year, and we've been doing that pace for a number of years. So I think the dynamics that have been driving demand are certainly still there, very much in force. And so, we support community and regional banks.
We intentionally don't aim to target the smallest institutions in America, and we don't target the ones, the Chases and the Wells and the super-high. So within that space, most of our customers have IT needs, and the demand is really robust. In fact, we've just even after a record Q4 and a record FY 2023, our pipeline going into FY 2024 is the lowest we've ever had. And one would expect you to kind of drain the pond, if you will, starting off the year, but we've actually walked into the new year with the strongest pipeline we've ever had. So I think that, you know, you mentioned competitors. I'm not going to talk about competitors specifically but, you know, the challenge you would think like, oh, gosh, there's other people struggling, can you go and do more?
The challenge is, in any given year, there's only so many people up for renewal on the core side. These are long-term contracts, on average, seven year length. It's an incredibly strenuous effort to change out your core system. You're talking about the heart and lungs of a financial organization. The ERP touches, like, every process, every employee in a bank or credit union. So they don't take this decision lightly, and even with that, we still get 50 new wins a year. But most, if you think about maybe 200-250 institutions across the U.S. thinking about a renewal or a change, only about half of those or even less actually make a decision. Most decisions is a no decision. They'll just keep with their current provider.
So of that, 100 did actually make a change in a given year, we win about 50-55. So we're winning a really nice margin percentage of those. But most still, you know, it's a really big undertaking. You know what drives most of them to make the change, and you mentioned competitors, is that either they're having really weak customer service where they're at, or they're not getting innovation. And so Jack Henry has one core system on the credit union side and one flagship on the bank side. We have two other for smaller institutions and kind of a legacy perspective, but our SilverLake product on our banking side and our Symitar product on our credit union side. But if you're at a. You may not.
You know, they have 10-20 sometimes core systems, and you're not clear what is the go forward core, and you may not be getting that innovation. And so while it's an incredibly strenuous effort from a bank or credit union to make that core decision, that sometimes that's the only way you're going to get innovation, and that's also the only way you're going to be able to get things like ancillary products that are so critical to their system, like digital banking.
Just to be clear, you're only running three core systems? Is that-
So we have one on the credit union side, and we have three on the banking side, but one is our flagship go forward core, which is SilverLake.
Got it. Okay, that makes a lot of sense. And then, I know you're not going after the Bank of America of the world, but are you trying to have conversations with larger banks, maybe more of the regional banks?
Yeah. The largest customer today is around a $30 billion institution. They have aspiration to be a $75 billion institution. And technologically, today, we can support up to a $100 billion institution. So we are getting inbound inquiries interestingly enough. We've been talking about our tech modernization strategy for a little over a year and a half now, and it's really interesting because we've been getting an incredible amount of inbound calls from these larger institutions that are really excited about technologically, where we're going and our approach. So part of our tech modernization strategy is around decoupling the core. So the core system has maybe 30 bits of functionality that a bank from kind of end-to-end, open accounts, take deposits, and record mortgages. That's kind of what's the heart of a core system.
By decoupling those elements, it de-risks that huge big bang conversion that would normally go in over a weekend. That's really appealing to a lot of large institutions.
Yeah. Just sticking with the tech modernization strategy, I feel like we get tons of questions on it because there's some confusion as to what Jack Henry is doing, there. But could you talk about, like, help us better understand how unbundling services can help the customer and generate a longer-term sustainable revenue stream for the company?
Yeah. So it's taking that, you know, let's call it that 30 core pieces of functionality and saying: yeah, most likely people are going to have a, a bundle of suite that kind of looks like a core does today. But if they want to, they can do it piecemeal and just say, you know, à la carte services, what do I want to do? Which allows, say, a larger size institution to say, "Oh, I'll do deposits first," or, "maybe I'll do commercial loans first, or just my account opening first." And so it allows them to step into, over time, that process of a core conversion. It also allows us to, what I call, write once, use often, which is how do we take parts of functionality and then add that innovation to Symitar or SilverLake today?
Over time, in the long term, I think you'll see what is a core for a credit union and what is a core system for a bank more similar, where there's going to be more of a commonality in the functionality and then maybe some modules of differences.
Got it, that makes sense. Are you starting to see interest from your customers for being in a public cloud environment?
Yeah. So we have today parts that are, you know, public cloud native today. So our payments through Payrailz, anything we're producing in the last three years has been completely cloud native. So our LoanVantage product, our Financial Crimes Defender that's coming out this year, all of our other work, our FedNow work. There's other work, Banno, for example, digital cloud native, and for Banno, our digital. It's just where PII sits. So even though people are very comfortable with Banno being in the public cloud, it's really the regulators who are not comfortable with the PII being in the public cloud. So there are very few banks in the U.S. today that have their core system in the public cloud.
Now, I think it's going that way, certainly, and we're doing our part to help the regulators on their education and figure out how to test in that environment. But I think what we've been thinking about from a development roadmap timeframe is somewhere probably three to five years, where you see a full end-to-end core in the public cloud.
Understood. Okay. Looking across your segments, core revenue growth has accelerated in the last few quarters. What's driving the trends, and which components do you expect to be durable into FY 2024?
Yeah. We report in three public segments, our core business, that is where you get new core sales wins. Now, that takes about 12-18 months for any new sale to come along from an implementation perspective, that revenue stream. Now that timing is less about us helping them on a readiness and more from the financial institution, because that core, they're changing its workflow, every training. It's a lot of work from the institution to get ready for that core migration. So any sales you see today might be 12-15 to even 18 months off on the, on the late side of that. But you're also getting organic growth from our clients growing. So even though the number of institutions in the U.S. is shrinking, the size of those institutions are growing.
As a reminder, we get paid mostly for our cloud-hosted business, that's on a per account or a per member basis on the core. And on hosted, on the on-premises, when they have the license on their premises, it is on a per guide. So as they grow, we're going to get that same core sales growth. And then we have sometimes implementation revenue. When they're doing an acquisition, we help them with that. So that's the drivers behind the core segment. And I would say in any one quarter, it's really about who's coming off the back wall and who's coming online. And so there might be fluctuations in a quarter, but we really don't have seasonality in our business. I would really recommend you look at it on an annual basis.
So that's our core segment.
Makes a lot of sense. Can you talk through your progress with FedNow?
Yeah.
I'm going to be one of the first testers of FedNow. What, what type of revenue model is that?
So we've been working with the Fed for a number of years, in writing. We've had a number of our clients into beta. We have 15 clients live today, probably about another 150, 160 signed. We're quite excited. We're hearing a lot of enthusiasm from our customers. A couple of reasons, they like the neutrality of it. Rather than having some of the other rails owned by a consortium of their factors, they like the neutrality of it being the Fed, and most have an account with the Fed already, so there's a trusted relationship there. You know, I think the adoption curve is going to take some time, as you saw with other RTPs. But I think it has the opportunity to accelerate from a slope perspective, that adoption relative to others.
If you think about the number of payments that the U.S. government and the Treasury control, now, the Fed can't mandate that, but they can certainly work with their partners at the Treasury. But if you think about it, they said, "The only way you're getting your IRS rebate is through FedNow, or your VA payment, or your Medicare payments." That's a lot of payments that the Fed controls through the Treasury. And so what we have on the ready to be turned on to receive. We think it'll take some time before you see sending volume large, but I think receiving volume will start it out clip.
As you talk to these banks about FedNow, what do you think are the main use cases?
Yeah. I think today it's a lot of commercial, but I think in talking with the governors and bank presidents, they're really excited about business. So it'll be interesting to see the ramification for B2B in the long run of does this become some of the rails that for B2B? For our clients, they're excited about all, not only the neutrality of it being the Fed, but they're excited about this being a revenue opportunity. Today, they don't make money on Zelle, for example, and yet they have Zelle's processing. And we don't make money because they don't make money on Zelle. But for FedNow, originally, the thought was it'd be somewhere between a wire and an ACH, and it looks like they're pricing it closer to an ACH.
So I think that'll be another thing that's going to spur adoption, and that's good for our customers to be able to make money on that, and then us, in turn, to be able to make money on this transaction.
So I've also heard the biggest use case for FedNow is P2P. Are you also hearing use cases for consumer P2P and P2P?
I think it's going to start to develop. I think you're going to see most in the government sending to consumer and in B2B before I think you see a P2P, but I think it's going to be there.
Got it. Okay. I just want to move on to operating margins. So, in your last earnings call, you guided for 25 basis points of non-GAAP operating margin expansion in FY 2024. Can you talk about the different inputs and takes of this target, including maybe unpacking some of the payroll mechanics in there?
Sure. So first, and foremost, margin expansion on a consistent basis is super important to us. We know it's a primary tenet in the investment thesis for Jack Henry, and we are determined to deliver it. So I am also personally gold on it, just FYI, in all transparency. So, we know that it is important, and we believe that the business model inherently is a margin expansion story. If you think about some of the tailwinds, we have the continuation from on-premise to private cloud, and that's where our clients host the software themselves to where Jack Henry hosts the software. And you may say, like, "Well, why is it different?" Well, when we host it, it's almost 2x the revenue.
And you may ask, "Well, why are they paying you 2x the revenue?" It's well, now the FI doesn't have to have a CPO and worry about disaster recovery and their own cyber insurance and hardware equipment can go, you know, several hundred thousand dollars to millions of dollars. And so that trend, we're about 70% hosted today on our private cloud. I think you're going to cap out somewhere in the 90s. So there's a nice seven year runway. We win about 50 of those conversion deals a year. I think you have a long runway for that, and then they'll go to the private, from private cloud to public cloud. I think that's another margin expansion opportunity between FinOps, the security environment, just lower dev cost environment. I think that's a margin expansion story. So I think those are some longer-term tenets.
Your question, specifically for FY 2024 and the guide of 20-25 basis points, I think there's three main drivers I would kind of point to. One, in FY 2023, we did not meet our internal financial goals. We have a very wide bonus program for our associates, and because we didn't meet our internal numbers in Q4 of FY 2024, you'll see that improving and hopefully, you know, we're going to meet all our goals, hitting at 100%. That's about a $6 million headwind year over year. The second thing I would point to is with over 7,000 employees, people are one of our big lines.
And while we've seen a tempering in the wage, hiring, and we've seen a more in addition, there's still people, other people related to costs, like medical benefits, for example, still in the teens, you know, year on year from an inflationary perspective, travel costs, et cetera, are still out there. So I think that is probably another year till that inflationary pressure kind of tempers itself. That's been a headwind to margin expansion. And the third one, is because of the amount of internal development we've done over the last three years, and this year having a roster of super exciting new products like Banno Business and Defender. Once those products go GA, we start to expense that amortization.
And so out the gate, typically you'll start to see revenue build, but that expense comes front and center day one of GA, as you start to have to amortize that. So that's the other third headwind that's creating for FY 2024 some pressure to keep the margin expansion a little lower than our longer multi-year trajectory.
Given the headwinds you just talked about, would you characterize your guidance as conservative?
I think there's probably a little bit of conservatism in there, for sure. But you know, it's really important to me. I'm about a year in the chair. Integrity is really important to me, and at Jack Henry, we talk about doing, you know, doing what you say you're going to do. And so it was really important that we could come up with a number that I can sleep at night comfort, knowing the model delivers. You know, short of a major macro event, we are going to hit that number, and as a management team, we are fully committed to focus on delivering that.
Makes sense. Okay. I know beyond 2024, you've highlighted normalized margin expansion, that 20-40 basis point range. Can you talk about, like, what, what would get you closer to the 20 versus the 40?
...Yeah, I mean, I think the 20 side is probably a little bit of conservatism there. You know, the 40, I feel good about the nature of the business model. You know, inherently, as we sign on more clients, particularly as we sign up larger tier clients, like, it's not a ton of extra cost in the model. So, you know, inherently, once we get over this rise from an amortization expense perspective, we're going to see the margins increase. Now, there's always. I call us, we're a SaaS business, but we're a fortified SaaS business. So we are, you know, there's other SaaS businesses with margins, like Salesforce or Adobe. Nobody is going in to hack Adobe system to get your demo or your document or your contract.
When you support over 8,000 of the U.S. financial institutions, you have a fortified data center, and so there are costs around cyber that we will always spend to make sure that our environment is secure. But over time, as we gain more and more efficiency, we're always looking to see how do we drive cost out of our business. We're going to see margin expansion.
Makes a lot of sense. Just going back to the tech transformation plan for a second, are you seeing any of your competitors do anything like Jack Henry is doing? In the sense of unbundling and shifting over to a public cloud environment.
Yeah. I mean, I think there's definitely a push for public cloud, and interest in that for all the benefits that you get, like DevOps tools. You know, typically in our space, you get innovation once a year, maybe at most, twice a year, in big drops of product refreshes. By having it in the public cloud, it's like your phone. I mean, Banno could do many, you know, updates a month. Just as soon as we have new code, that functionality, we can release that seamlessly. So that development philosophy of innovation in the cloud, there's bursting capabilities. So banks and credit unions, it's night, every night and every month, every quarter, every year-end from major capacity needs.
Well, in the public cloud, you know, capacity is limitless and cheaper than, you know, maintaining that, that peak level in a private cloud environment. Security, we, we offer an incredibly durable, secure environment. But Google, who's our major public cloud provider, we work with AWS, and we work with Microsoft, but Google is our go-forward strategic partner, has an even better security environment than ours to maintain. So, all of those, I think from a perspective, are part of our tech modernization and are reasons why people are excited about public cloud. I think part of the decoupling or the modularization, there's a couple startups that are in that direction. I think I would point to the differences from a Jack Henry perspective. Our clients still want 90%+ functionality out of the box.
When you're a regional or community bank, you don't have the army of tech talent to customize a complete front end. So there's a number of tech modern alternatives out there. Some are we would call headless, where there's no UI, there's no UX. Others still require some servers. If you look at the architecture, I would say that's not, you know, a public cloud-native architecture, and others are just really long to implement because it takes so much to do that customized development.
Makes a lot of sense.
So I think we're really at the forefront alone in terms of our approach to the development.
Got it. When we say it's a competitive environment outside of your two largest competitors, are you seeing any other new entries, be it startups or international competitors?
Yeah, I mean, there's a couple of startups up there. I would, you know, without going into too much names, I would say, you know, SoFi is the most acute from a technology approach to it. Now, I would say theirs requires more of that customization. But in general, the beauty of Jack Henry is you get the innovation, but you also get the operational know-how. So it's a lot different to solve a mathematical computing challenge than it is to actually operate in a highly regulated environment. And a lot of these startups don't know how to support their customers in that with the regulators. So, you know, for our customers, they're getting the best of both.
Understood. With all the moving pieces in macro right now, what's your view on bank IT spending for the next 6-12 months?
You know, what we're hearing from our customers is they don't have their head in the sand. They're watching delinquencies, they're watching real estate, they're watching, you know, auto prices, used auto prices and the like. But by and large, they're feeling pretty healthy. And the reality is there isn't a challenge that they face right now, that technology is not the solution or the primary of the solution. So if it's deposit gathering, if it's fraud mitigation, if it's driving efficiency business, it's compliance, technology is, is the solution for them. So I don't see where, in particular our clients, put off the gas and remain competitive. I think maybe in that super tier one space where more they're in development is more back-end loaded versus front-end client facing, they could maybe, you know, slow down if they chose to.
Our clients, it's really around a digital front door. It's around innovation that's going to help them remain competitive.
All right. Okay, I'll pause here. We can take any questions from the audience. We have a mic that will go around. Feel free to raise your hand if you have anything for me... And if not, I will continue with my questions. I have plenty. So for, for Mimi, so for FY 2024, you expect free cash flow to be 60%. How should we think about free cash flow conversion over the medium term as you transition from the license and maintenance business model more to that?
Yeah. So we're going to continue to target that 80%-100% free cash flow conversion as our target. There certainly were some things driving FY 2023 that are continuing to be headwinds in FY 2024. Most prominently, the change in Section 174, which is the legislation around the deductibility of development-related expenses, and that hit a lot of software vendors. For tax purposes, you used to be able to deduct all of your development-related expenses for tax purposes, and, and now you can't. And so it restarts that clock. If you're domestic, it restarts that clock for a five year amortization. And if you're international, it then restarts that clock for 15%. So last year on FY 2023, that led to an extra incremental $80 million in cash taxes. Well, that's a big hit to free cash flow.
And on top of that, we had roughly about another $14 million in COVID-related tax repayments. So, that certainly, the COVID-related stuff is certainly one year. But if you look at the free cash flow conversion and you neutralize that impact for the taxes, you're in the 70%-80% range. So you know, unclear if post-election you'll see a reversal of that legislation or not, but if not, it still mitigates each year the impact, with the largest impact being FY 2023 and FY 2024.
Without that, do we think of the medium term as a 70%-80% conversion?
Yeah, without that, for sure.
Okay, great. Just any update on your capital allocation priority area? You've been in the seat for roughly one year. And maybe what's your acquisition pipeline? What types of assets Jack Henry interested in, what criteria do you think to assess-
Yeah.
-acquisitions?
I think more will stay the same than change in terms of allocation philosophies. We're a very conservative company. We're really about shareholder value creation. So we first and foremost, we spent about 14%-15% of revenue on R&D. We believe in organic redevelopment and spending for, from that perspective, on organic growth, driving future organic growth. The second is we are longstanding to our dividend policy and growing that. We've grown our dividend over 35... I think this year is 35 years. Vance, correct me if I'm wrong. And certainly right now, in the current interest rate environment, paying down debt, we have a small amount of debt on our books. And then last is opportunistically repurchasing our shares should we not see any M&A that interests us. So we'll return any excess capital back to shareholders that way.
In terms of M&A, you know, I was really hoping that there'd be a better pipeline here, Irina, than we're seeing right now. You know, I think small companies have yet to capitulate on valuations, and larger companies are well capitalized still and, you know, think that they're going to bounce back from the current stock environment that they're in. So, there is not a lot of stuff out there. Now, the positive is we don't have a lot of gaps. So our 7%-8% revenue growth, not GAAP revenue growth targets, don't imply any need for external acquisitions. So we have the ability, as we've done the last number of years, to just head down and develop it ourselves if we're not seeing anything that interests us.
From an acquisition perspective, it would need to be digital cloud native. It would need to be a cultural fit. It would need to be clearly an additive, either a migration of an existing product or something that would be a need to our niche market. We like serving domestic financial institutions. So there aren't that many things out there that we're seeing right now, but we're always looking. We're an experienced acquirer, so we're always looking.
You only want to be a core processor, unlike your competitors?
Well, we specifically didn't get into merchant acquiring for a reason. And I think, even though people gave that, Dave a lot of grief on that when he chose not to go in that direction, I think today that decision's looking he's having some good things been going on. But, no, we like serving directly to the financial institutions. So we have a portfolio of over 200 solutions beyond core and a sales force that knows how to sell outside our core base. So if there is a good piece of technology that we think will serve our financial institutions, we certainly know, and have great experience in knowing how to integrate them and sell that.
I'm going to sneak a question about Gen AI-
Sure.
Because everyone wants to know the impact of Gen AI on all the companies I cover. So what do you think is the impact, potential impact on the cost side and maybe on the revenue side as well for Jack Henry?
Yeah. So as it relates to AI machine learning, not Gen AI, but machine learning, Jack Henry's been using it for quite some time. So, call center, thinking about what the next question might be, the QA doing our fraud solutions, using machine learning in our fraud solutions engines. So we've been using that for quite some time now. Gen AI, we, like a lot of folks, are trying to figure out like what to do. Obviously, it would need to be a walled garden experience. We have a lot of PII that we're not going to be putting up onto, you know, ChatGPT. And so we're trying to figure out where that fits within our organization, but we've already been doing a lot of work with machine learning.
Understood. How has the effort been trying to sell Banno to non-core customers, and do you think that could be material to your revenue and earnings?
Yeah. So we, we made the strategic decision last year. We had been ready to sell Banno outside the core base, and we were excited about it, and we actually temporarily paused that because what we were hearing from competitor salespeople is, "Please bring Banno to us." And then we said: We're not really in the, in the job to make other people's core systems better. And so right now, you can still only buy Banno if you're a Jack Henry core customer. Now, over time, we will cherry-pick and think very thoughtfully about which, other core systems, competitive core systems we will, we will work and sell, but we won't do, like, a mass opening for all. It's going to be a targeted approach, where we're winning and having the most traction from a sales perspective against those other weaker cores.
Today, any new core customer is buying Banno, as part of that, and we have over 10 million users on the Banno platform.
Got it. Okay, that's great. Can you talk a little bit about the progress you're making on your credit card processing business and when you think that'll become a larger piece? And maybe just help us better understand the dynamics you have with First Data and how long that contract is.
Yeah. So Jack Henry has long been a debit card issuer and processor on behalf of our FIs. Most banks, you open a bank account, they give you a debit card, and so, we have over a thousand customers using our debit platform. A couple of years ago, we entered into the credit space as a way to support our customers. Customers tend to want their debit and credit at the same place. And so we wanted to ensure that we were continuing to win in the debit space, but also as a way for our FIs to diversify their revenue sources and potentially enter into credit. So we have two ways for them to use credit. We have a traditional offering that we do, but we also have a partnership with TIB, where they can do a complete white glove.
So if someone doesn't have the resources within their financial institution to do credit, they can have an outsourced program. And a lot of the regional and community financial institutions, you know, they were leery about credit because of fraud. You know, while fraud, you know, JPM, you know, fraud costs are extremely expensive relative to their business, you know, it's not debilitating. For a small, or smaller, you know, institution, that can be big dollars relative to their books. So a lot of the re-entry into credit was really the modernization of the management tools around that program, around managing that risk, managing fraud. And so we're really excited about where that's going and from a direction of helping our customers in mitigating it.
But it'll be some time, and I don't think you'll ever see credit being, like, this huge, you know, portion of our business. In part, because whenever we win a credit customer, we're winning a debit customer, so from a ratio perspective, that's going to be a hard win to drive. But we have about 50 customers on credit and about 1,000 on debit.
Any comments on the First Data contract, how long that is?
Yeah.
And-
So we have a partnership. It's not direct with Fiserv.
Okay.
It's through PSCU. So that's where our relationship is.
Okay, understood. Okay, I know we're running out of time, so I just have one final question. Well, it's actually two parts. What are you most excited about for Jack Henry's future, and what keeps you up at night?
Well, what's exciting? So much is exciting. This year, I mean, FY 2024, just the amount of new products coming out, and we've been talking about them internally since I joined, but now to be able to see and talk to customers who are starting to use them is really exciting. You know, one of the things that brought me to Jack Henry is it's this really rare opportunity where you have a 46-year-old, now 47-year-old company of operational execution, maturity, and know-how, mixed with innovation and this, like, drive for growth. And so to me, that's a really, like, wonderful blend. I just, I'm really excited about our tech modernization.
I think where it can unlock and just the business models it can lock and how we can help support, you know, what will be the next ten-plus year approach to banking, I think is really an exciting time. So that, that excites me. What keeps me up at night? Not much. I have a fantastic team, the best IR guy in the world. You know, it, it's you know, I would say, if anything, what keeps me up is, there's a bit of... I mean, listen, there's always fraud, and there's always cyber risk in our industry, so, but I, I feel, you know, knock on some sort of wood, like we're pretty fortified in that, but that's a constant struggle.
I mean, there's bad actors out there, and that's a constant struggle to stay ahead, but I feel like we're doing a great job there. If anything, I think it's continuing to how we get our message out. I think there's some misnomers about us. There's misnomers that we only play in the itty-bitty banking space. You know, this year has been a challenge to be anything associated with banks. Our correlation with the CRE has, you know, hurt us, and it seems to be unidirectional. You know, and I think what people miss is we're a well-rounded technology firm. And so I'm, you know, quite excited about that. I think it's—I sleep pretty well at night.
Great. Well, Mimi, it was wonderful having you. Thank you so much for your time.
Thank you for having us.
This was great.
Thank you, everybody.