Focusing exclusively on dividend metrics is a flawed method by which to determine which companies are worthwhile investments. However, investors who do pay particularly close attention to dividend metrics might be interested in Jack Henry & Associates, Inc. (JKHY).

On February 13, 2023, it announced a 6% increase in its quarterly dividend to $0.52/share. This increase marks the company’s 34th consecutive year of dividend increases, making the company a Dividend Champion. Furthermore, JKHY has paid consecutive quarterly dividends since 1991.

Overview

JKHY was founded in 1976 as a provider of core information processing solutions for banks. Over the years it has evolved and currently provides an extensive array of products and services for over 7,800 financial institutions and diverse corporate entities.

It provides products and services primarily to financial institutions that include transaction processing, transactions, automated business processes, and information management.

1. JKHY provides core bank-integrated data processing systems to over 950 banks. Some of its clients are multi-billion-dollar institutions with assets of up to $50B. The number of banks JKHY serves has decreased in the recent year due to acquisitions and mergers within the banking industry. The banking solutions JKHY provides support on-premise and private cloud operating environments with three functionally distinct core processing platforms and more than 140 integrated complementary solutions.
2. Core credit union data processing solutions are provided to credit unions of all sizes, with a growing client base of ~720 credit union customers. There is one flagship core processing platform and more than 100 integrated complementary solutions that support on-premise and private cloud operating environments.
3. Non-core highly specialized core-agnostic products and services are also provided to financial institutions. There are more than 100 complementary solutions that offer highly specialized financial performance, imaging and payments processing, information security and risk management, retail delivery, and online and mobile solutions. These products and services enhance the performance of traditional financial services organizations of all asset sizes and charters, and non-traditional diverse corporate entities with over 7,800 customers, comprised of nearly 1,650 (950 banks and ~720 credit unions) of JKHY’s core customers as well as over 6,150 other non-core customers.

Revenue Sources

The majority of JKHY’s revenue is derived from support and services provided by the company’s private cloud services for hosted customers that are typically on a 7+ year contract, recurring electronic payment solutions that are generally on a 7+ year contract term, and to on-premise customers that are typically on a one-year contract.

Less predictable software license fees, paid by customers implementing JKHY’s software solutions on-premise, and hardware sales, including all non-software products that JKHY re-markets in
order to support its software systems, complement JKHY’s primary revenue sources.

JKHY’s operations are classified into four reportable segments:

• Core
• Payments
• Complementary
• Corporate and Other

JKHY’s 2 primary revenue streams are ‘services and support’ and ‘processing.’

Services and support includes:

• ‘private and public cloud’ fees that predominantly have contract terms of 7+ years at inception;
• ‘product delivery and services’ revenue which includes revenue from the sales of licenses, implementation services, deconversion fees, consulting, and hardware; and
• ‘on-premise support’ revenue, composed of maintenance fees which primarily contain annual contract terms.

Processing revenue includes:

• ‘remittance’ revenue from payment processing, remote capture, and ACH transactions;
• ‘card’ fees, including card transaction processing and monthly fees; and
• ‘transaction and digital’ revenue, which includes transaction and mobile processing fees.

Part 1 of JKHY’s Form 10-K provides an industry background, an overview of the business, and risk factors.

Jack Henry & Associates’ Financial Results

Q2 and YTD2023 Financial Results

JKHY’s Form 8-K released February 7, 2023 reflects Q2 and YTD2023 financial results. Form 10-Q provides investors with more comprehensive information.

Operating Cash Flow (OCF) and Free Cash Flow (FCF)

JKHY’s OCF (in billions of $ rounded) in FY2013 – FY2022 is $0.309, $0.342, $0.374, $0.366, $0.357, $0.412, $0.431, $0.511, $0.462, and $0.505. In the first half of FY2023, it generated ~$0.191B.

JKHY’s FCF (in billions of $ rounded) in FY2013 – FY2022 is $0.211, $0.230, $0.228, $0.202, $0.209, $0.262, $0.260, $0.333, $0.304, and $0.313. In the first half of FY2023, it generated ~$0.119B.

Source: JKHY – Q2 2023 Form 8-K – February 7, 2023

FY2023 Guidance

When JKHY released its FY2022 results on August 16, 2022, it provided the following FY2023 guidance:

• GAAP revenue $2.080B – $2.087B;
• GAAP EPS $5.05 – $5.09; and
• Non-GAAP revenue $2.045B – $2.052B

On November 8, 2022 when Q1 2023 results were released, FY2023 guidance was amended as follows:

• GAAP revenue $2.092B – $2.099B;
• GAAP operating margin 23.2% – 23.3%;
• GAAP EPS $4.90 – $4.94;
• Non-GAAP revenue $2.045B – $2.052B; and
• Non-GAAP operating margin 22.5% – 22.6%

FY2023 guidance has now been amended to reflect:

• GAAP revenue $2.048B – $2.055B;
• GAAP operating margin 22.8% to 22.9%;
• GAAP EPS $4.79 – $4.83;
• Non-GAAP revenue $2.021B – $2.028; and
• Non-GAAP operating margin 22.8%- 22.9%

The reduction in guidance is partially attributed to the impact of unpredictable deconversion revenue. This revenue is generated when a customer is acquired and they essentially buy their way out of their existing contract.

Recurring Revenue and Guidance

When preparing its guidance, JKHY typically knows what customers have already been acquired and can determine how much deconversion revenue will be generated.

If a substantial number of JKHY’s customers are acquired, JKHY will generate a surge in deconversion revenue. This will bolster short-term results. However, the downside is that JKHY needs to replace this stream of lost recurring revenue. As a result, investors should hope that mergers and acquisitions in the space in which JKHY operates do not spike regularly.

In Q2 2023, JKHY’s results were significantly impacted by a recent rapid slowdown of merger and acquisition activity in the financial institution industry. This caused decreases in deconversion fee revenue and conversion/merger services revenue.

A significant portion of JKHY’s business, however, continues to be derived from recurring revenues. In addition, management states there is an encouraging sales pipeline. Its customers continue to face regulatory and operational challenges which JKHY’s products and services address, and JKHY believes these customers and prospects have a great need for its solutions to directly address institutional profitability, efficiency, and security.

Credit Ratings

JKHY’s debt is not rated by any major rating agency. We see from its Q2 2023 Form 10-Q, however, that JKHY is conservatively capitalized.

Long-term debt has risen from $0.115B at the June 30, 2022 FYE to $0.275B at the end of Q2 (December 31, 2022). This increase is attributed to the acquisition of Payrailz, LLC which was announced on August 9, 2022 and closed on September 1, 2022; details of this acquisition are found in Note 10 – Business Acquisition in the Q2 2023 Form 10-Q starting on page 17. Payment for this acquisition (net of cash acquired) was ~$0.23B.

At the end of Q2, JKHY had ~$0.469B in total current assets. Although total current liabilities amount to ~$0.408B, ~0.215B is deferred revenue. This deferred revenue is to be recognized over the next 12-month period and represents the receipt of customer funds before the rendering of services. Once the services are provided, the liability is reduced and JKHY reports the appropriate revenue and related expenses on its Income Statement.

Investors need to account for this when looking at JKHY’s current ratio (current assets/current liabilities). If we deduct ~$0.215B in deferred revenue from ~$0.408B in total current liabilities, JKHY has to lay out ~$0.193B over the next 12 months. JKHY, however, has ~$0.272B in cash and cash equivalents and accounts receivable.

JKHY also has ample credit availability under its credit facilities for which details are provided in Note 6 – Debt that commences on page 13 in the Q2 2023 Form 10-Q. Information about JKHY’s liquidity and capital resources commences on page 27 in the same document.

Dividend, Stock Split, and Share Repurchase Metrics

Dividends

As noted at the outset of this post, JKHY has an enviable track record of annual dividend increases which will appeal to some investors (see dividend history).

The next quarterly dividend will be $0.52/share and it will be payable on March 24, 2023, to stockholders of record as of March 8, 2023. With share trading at ~$166, the dividend yield is ~1.25%.

Source: Portfolio Insight*

Looking at JKHY’s financial strength, I see no reason why JKHY will be unable to prolong its track record of dividend increases nor should it experiences challenges in servicing its dividend.

Source: Portfolio Insight*

While the low dividend yield will likely dissuade some investors from investing in JKHY, it would be wise to look beyond dividend metrics. Rather, gauge JKHY’s potential to generate an attractive total investment return.

Stock Splits

While JKHY has split its stock 6 times, the last was in 2001. I do not envision a stock split at any time in the foreseeable future.

Source: Split History.com

Share Repurchases

JKHY’s Board has authorized the company to repurchase shares of its common stock. Under this authorization, the Company may finance its share repurchases with available cash reserves or borrowings on its existing line of credit. The share repurchase program does not include specific price targets or timetables and may be suspended at any time.

On August 16, 2022, the Inflation Reduction Act of 2022 (‘IRA’) was signed into law. The IRA made several changes to the U.S. tax code including, but not limited to, a 1% excise tax on net stock repurchases and tax incentives to promote clean energy. JKHY does not expect the IRA to have a material impact on its financial statements.

JKHY’s weighted average number of diluted outstanding shares (in millions rounded) in FY2013 – FY2022 is 87, 85, 82, 80, 78, 78, 77, 77, 76, and 73. In Q2 2023, there were 73.141 million outstanding compared to 73.486 at FYE2022 (June 30).

In FY2020 – FY2022, JKHY purchased treasury stock totalling $71.549, $431.529, and $193.916 (in millions). This was partially offset by stock-based compensation expenses of $16.883, $20,746, and $24,780 (in millions).

In the first half of FY2023, JKHY has repurchased no shares versus ~$193.916 in the first half of FY2022. It has, however, incurred ~$14.544 of stock-based compensation expense during the first half of FY2023 ($13.027 in the first half of FY2022).

Jack Henry’s Valuation

JKHY’s PE ratio in FY2013 – FY2022 is 27.80, 24.86, 29.24, 27.15, 36.90, 24.95, 40.46, 41.64, 38.74, and 34.97.

Shares currently trade at ~$166 and management’s current GAAP EPS guidance is $4.79 – $4.83. Using the $4.81 mid-point, the forward diluted PE is ~34.5.

The forward adjusted diluted PE levels using current broker estimates are:

• FY2023 – 12 brokers – mean of $4.81 and low/high of $4.79 – $4.84. Using the mean estimate, the forward adjusted diluted PE is ~34.5 and ~34.3 if I use $4.84.
• FY2024 – 13 brokers – mean of $5.33 and low/high of $5.16 – $5.50. Using the mean estimate, the forward adjusted diluted PE is ~31.1 and ~30.2 if I use $5.50.
• FY2025 – 5 brokers – mean of $5.84 and low/high of $5.66 – $6.08. Using the mean estimate, the forward adjusted diluted PE is ~28.4 and ~27.3 if I use $6.08.

Final Thoughts on Jack Henry & Associates (JKHY)

I do not have exposure to JKHY. While it is an attractive company, I think its valuation is too high.

Secondly, I do not care about a company’s track record of dividend increases. Using such a track record is tantamount to driving while looking in the rearview mirror.

Thirdly, I am not looking to initiate a new position. I recently completed my January 2023 Investment Holdings Review and am focused on increasing my exposure to existing high-quality holdings.

Fourthly, many executives on earnings calls to which I listen express caution. In some cases, expectations are for the first half of 2023 to be weak with an improvement in the second half. I am not so sure we will see much of a recovery in the second half.

Interest Rates

In the past 12 months, the Fed has hiked rates seven times to combat rising inflation. As of January 2023, the federal funds rate is 4.43%. However, the FOMC predicts that it could continue to rise and peak at around 4.9% in 2023. Policymakers, however, could raise rates to 5% – 5.25% and some Fed officials see a scenario where rates could rise even higher, with the most aggressive forecasts in a 5.5% – 5.75% target range; this would be the highest since 2000.

Naturally, where rates end up depends on inflation and the labour market.

Changes in interest rates typically take time to filter through the economy with the job market often one of the last places impacted. It is entirely possible that it could take several months for the full effect of the rate hikes to translate into slower job growth and fewer job openings.

In early 2022, interest rates were near-zero percent. Now that economic growth is no longer being stimulated by low interest rates, it is entirely likely that further interest rate increases could have an increasingly detrimental impact on the US economy.

Current Price and Valuation

Although JKHY’s share price has pulled back from its ~$213 intra-day high set in early July 2022, the share price decline is no justification to acquire shares. I view a company’s share price merely as what investors are prepared to pay. Sometimes what investors are prepared to pay has no bearing on the underlying fundamentals of the company or the business outlook.

If JKHY is of interest to you, I think you may wish to consider it when its forward-adjusted diluted PE ratio based on FY2023 earnings estimates approaches ~30X versus the current ~34.5X.

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