Jack Henry and Associates RCMP Recommendation James Falkoff 12/6/05.

Jack Henry and Jack Henry and AssociatesAssociates

RCMP RecommendationRCMP Recommendation

James FalkoffJames Falkoff

12/6/0512/6/05

RCMP PositionRCMP Position

Purchased 200 shares at $36/share on Purchased 200 shares at $36/share on December 10, 1999.December 10, 1999.

After two stock splits, RCMP now owns 800 After two stock splits, RCMP now owns 800 shares at a cost basis of $9/share.shares at a cost basis of $9/share.

Current share price: $19.13Current share price: $19.13 13.3% CAGR, vs. 12.0% for the S&P MidCap 13.3% CAGR, vs. 12.0% for the S&P MidCap

400 and -0.7% for the S&P 500.400 and -0.7% for the S&P 500. Constitutes 5.7% of the RCMP portfolio (after Constitutes 5.7% of the RCMP portfolio (after

AEOS & DELL sales). AEOS & DELL sales).

Company OverviewCompany Overview

Corporate HistoryCorporate History 1976.1976. Jack Henry and Jerry Hall found Jack Henry & Jack Henry and Jerry Hall found Jack Henry &

Associates. The company develops software systems for Associates. The company develops software systems for small banks.small banks.

1985.1985. JKHY is listed on the NASDAQ. JKHY is listed on the NASDAQ. 1992.1992. JKHY sets out on a mission to become a one-stop JKHY sets out on a mission to become a one-stop

shop for all the technology needs of small banks. The shop for all the technology needs of small banks. The company begins making acquisitions of complementary company begins making acquisitions of complementary technology solutions.technology solutions.

2005. 2005. One third of the nation’s small- and mid-size banks One third of the nation’s small- and mid-size banks rely on Jack Henry solutions. Jack Henry and Jerry Hall still rely on Jack Henry solutions. Jack Henry and Jerry Hall still sit on the Board of Directors, as does Mike Henry, Jack’s sit on the Board of Directors, as does Mike Henry, Jack’s son.son.

Company OverviewCompany Overview

Business Description:Business Description: Provides data processing solutions to small banks Provides data processing solutions to small banks

and credit unions (assets under $30 billion). and credit unions (assets under $30 billion). Customers either install systems in-house or Customers either install systems in-house or

outsource their operations to Jack Henry.outsource their operations to Jack Henry. 3 sources of revenue:3 sources of revenue:

Software licensingSoftware licensing Support and ServiceSupport and Service HardwareHardware

Macroeconomic ReviewMacroeconomic Review

GICS Sector: Information TechnologyGICS Sector: Information Technology Sub-industry: Application SoftwareSub-industry: Application Software

Neutral industry outlook. Spending expected to accelerate in a few Neutral industry outlook. Spending expected to accelerate in a few key areas such as security while others experience slower growth. key areas such as security while others experience slower growth.

Commoditization of software industry. Competition from Commoditization of software industry. Competition from international (Indian, Eastern European) developers.international (Indian, Eastern European) developers.

Peer Group: Accounting and Financial SoftwarePeer Group: Accounting and Financial Software Consolidation: Number of commercial banks has declined by 3% Consolidation: Number of commercial banks has declined by 3%

annually over past five years. Credit unions have consolidated at annually over past five years. Credit unions have consolidated at the same rate.the same rate.

Sarbanes-Oxley compliance a major information technology hurdle Sarbanes-Oxley compliance a major information technology hurdle and source of IT spending.and source of IT spending.

Macroeconomic ReviewMacroeconomic Review

Competition:Competition: Major competitors: Major competitors:

Fiserv Inc.: Closest competitor. Focuses on financial Fiserv Inc.: Closest competitor. Focuses on financial data processing services. (Mkt. Cap $8.5B)data processing services. (Mkt. Cap $8.5B)

Marshall & Ilsley Corp.: A multibank holding company Marshall & Ilsley Corp.: A multibank holding company that offers financial technology services through its that offers financial technology services through its Metavante unit. ($10.2B)Metavante unit. ($10.2B)

Automatic Data Processing Inc. ($27.1B) Automatic Data Processing Inc. ($27.1B) First Data Corp. ($31.8B).First Data Corp. ($31.8B).

Stock FactsStock Facts

Price: $19.13Price: $19.13 52wk Range: $15.35 - $21.9652wk Range: $15.35 - $21.96 Mkt. Cap: $1.75BMkt. Cap: $1.75B P/E (ttm): 22.89P/E (ttm): 22.89 Div & Yield: $0.18 (0.90%) Div & Yield: $0.18 (0.90%)

Stock Market PerformanceStock Market Performance

Five-Year Share Price History

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Stock Market PerformanceStock Market Performance

Business DescriptionBusiness Description

Core SystemsCore Systems Can be used in-house or outsourced.Can be used in-house or outsourced. Provide core processing functionality: deposits, loans, etc.Provide core processing functionality: deposits, loans, etc. 5 core systems:5 core systems:

Silverlake System: for banks with $500 million to $30 Silverlake System: for banks with $500 million to $30 billion in assetsbillion in assets

CIF 20/20: for banks with less than $1 billion in assetsCIF 20/20: for banks with less than $1 billion in assets Core Director: for banks with less than $1 billion in Core Director: for banks with less than $1 billion in

assets (Windows-based)assets (Windows-based) Episys: for credit unions with greater than $50 million in Episys: for credit unions with greater than $50 million in

assetsassets Cruise: for credit unions with less than $50 million in Cruise: for credit unions with less than $50 million in

assetsassets


Complementary Products (around 100)Complementary Products (around 100) Allow the company to offer custom-tailored, Allow the company to offer custom-tailored,

integrated suites of software solutions.integrated suites of software solutions. Expose the company to high-growth areas, like Expose the company to high-growth areas, like

security, risk management, online bill pay, and security, risk management, online bill pay, and electronic funds transfer.electronic funds transfer.

Product offering expanded through acquisitions of Product offering expanded through acquisitions of small companies providing specialized technology small companies providing specialized technology solutions. 17 Acquisitions since the start of FY02.solutions. 17 Acquisitions since the start of FY02.


Examples of complementary productsExamples of complementary products Synapsis: Relationship management (customer profiling, Synapsis: Relationship management (customer profiling,

referral tracking, etc.)referral tracking, etc.) NetTeller: Online home banking system with real-time NetTeller: Online home banking system with real-time

account information and transaction capabilities.account information and transaction capabilities. Remote Deposit Capture: Peforms image capture, storage, Remote Deposit Capture: Peforms image capture, storage,

and processing for paper checks.and processing for paper checks. PassPort: Drives and monitors ATM networks.PassPort: Drives and monitors ATM networks. Biodentify: Biometric fingerprint security.Biodentify: Biometric fingerprint security. Centurion Disaster Recovery: Disaster recovery protection.Centurion Disaster Recovery: Disaster recovery protection.


StrategyStrategy Expand existing customer relationships to garner Expand existing customer relationships to garner

more revenue with little marketing expense.more revenue with little marketing expense. Expand customer base.Expand customer base. Increase sales outside core customer base.Increase sales outside core customer base. Build recurring revenue through service and Build recurring revenue through service and

outsourcing contracts.outsourcing contracts. Maximize economies of scale to increase margins.Maximize economies of scale to increase margins.

Recent TrendsRecent Trends

Revenue by Segment FY03-FY05

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

2003 2004 2005

License

Support and Service

Hardware


Gross Margins by Segment FY03-FY05

93.3%92.4%91.9%

33.0%33.3%31.6%27.9% 28.4% 28.7%

0.0%10.0%20.0%30.0%40.0%50.0%60.0%70.0%80.0%90.0%

100.0%

2003 2004 2005

License Margin

Support and ServiceMargin

Hardware Margin


Q1 FY06 Results:Q1 FY06 Results: License revenue License revenue down 13.5%down 13.5% Support and Service revenue Support and Service revenue up 18.8%up 18.8% Hardware revenue Hardware revenue down 1.1%down 1.1% License margin License margin up to 95.0%up to 95.0% from 91.8% from 91.8% Support and Service margin Support and Service margin up to 35.4%up to 35.4% from from

33.0%33.0% Hardware margin Hardware margin up to 25.8%up to 25.8% from 23.9% from 23.9%

Forecasting Assumptions Forecasting Assumptions

Support and Service: Support and Service: Fairly constant sales growth on Fairly constant sales growth on stable margins.stable margins.Rationale:Rationale: Historical stability of performance in this segment.Historical stability of performance in this segment. Management’s emphasis on this segment in conference Management’s emphasis on this segment in conference

calls and the 10K’s description of business strategy.calls and the 10K’s description of business strategy.

Hardware: Hardware: Flat sales on declining margins.Flat sales on declining margins.Rationale:Rationale: Falling P and rising Q should offset one another.Falling P and rising Q should offset one another. Macro trend toward lower margins on computer hardware.Macro trend toward lower margins on computer hardware.

Forecasting AssumptionsForecasting Assumptions

License: License: ?????? Historically volatile segment.Historically volatile segment. Unexpected dropoff in Q1 license revenue.Unexpected dropoff in Q1 license revenue. Management anticipates a ramp-up as the Management anticipates a ramp-up as the

year progresses. Estimates 20% yoy year progresses. Estimates 20% yoy revenue growth. revenue growth.

Unbroken upward trend in license margins.Unbroken upward trend in license margins.

Volatility of License SegmentVolatility of License Segment

License Revenue - Historical

010,00020,00030,00040,00050,00060,00070,00080,00090,000

2000 2001 2002 2003 2004 2005

Volatility of License SegmentVolatility of License Segment

20012001 Q1 Q1 107.6%107.6% Q2 Q2 192.9%192.9% Q3 Q3 77.8%77.8% Q4 Q4 21.7%21.7%

20042004 Q1 Q1 7.4%7.4% Q2 Q2 -10.2%-10.2% Q3 Q3 46.9%46.9%Q4 Q4 83.0%83.0%

20022002 Q1 Q1 -9.3%-9.3% Q2 Q2 -6.0%-6.0% Q3 Q3 -3.9%-3.9% Q4 Q4 -1.7%-1.7%

20052005 Q1 Q1 50.9%50.9% Q2 Q2 78.6%78.6% Q3 Q3 36.7%36.7% Q4 Q4 -9.9%-9.9%

20032003 Q1 Q1 -18.3%-18.3% Q2 Q2 -13.8%-13.8% Q3 Q3 -40.8%-40.8% Q4 Q4 -34.0%-34.0%

20062006 Q1 Q1 -13.5%-13.5%

Scenario AnalysisScenario Analysis

License Revenue Scenario - Bad 2006, 2007

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

2005 2006 2007 2008 2009 2010 2011 2012 2013


License Revenue Scenario - Recession 2007-2008

020,00040,00060,00080,000

100,000120,000140,000160,000180,000200,000

2005 2006 2007 2008 2009 2010 2011 2012 2013


License Revenue Scenario - Tapered Growth, No Setbacks

0

50,000

100,000

150,000

200,000

250,000

2005 2006 2007 2008 2009 2010 2011 2012 2013

ValuationValuation Given the established Given the established

forecasting assumptions for forecasting assumptions for the service and hardware the service and hardware segments, and assuming segments, and assuming license margins remain strong license margins remain strong for the next few years before for the next few years before slowly tapering off, here are slowly tapering off, here are the DCF valuations for three the DCF valuations for three license revenue scenarios.license revenue scenarios.

Bad FY06 Bad FY06 and FY07and FY07

$17.17$17.17

Recession Recession 2007-20082007-2008

$18.99$18.99

Tapered Tapered GrowthGrowth

$21.53$21.53

SWOT AnalysisSWOT Analysis

StrengthsStrengths Industry knowledge.Industry knowledge. Customer relationships.Customer relationships. Provides custom-tailored, Provides custom-tailored,

integrated solutions.integrated solutions.

WeaknessesWeaknesses Little control over when customers Little control over when customers

purchase licenses.purchase licenses.

OpportunitiesOpportunities Potential to increase market Potential to increase market

share.share. Shifting product mix.Shifting product mix. Market for complementary Market for complementary

products outside base of core products outside base of core

systems customers.systems customers.

ThreatsThreats Integration of acquisitions may fail.Integration of acquisitions may fail. Bank consolidation could lead to Bank consolidation could lead to

cancelled contracts.cancelled contracts. New competitors always a threat.New competitors always a threat.

RecommendationRecommendation

Recommendation: Recommendation: HoldHold Management is following through on its Management is following through on its

strategy.strategy. Stock’s price reflects uncertainty in the Stock’s price reflects uncertainty in the

license segment.license segment. Potential for positive surprises to lift the Potential for positive surprises to lift the

stock price.stock price.

Jack Henry and Associates RCMP Recommendation James Falkoff 12/6/05.

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Transcript of Jack Henry and Associates RCMP Recommendation James Falkoff 12/6/05.