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HENRY JACK & ASSOCIATES INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

February 6, 2014

This discussion and analysis should be read in conjunction with the condensed consolidated financial statements and the accompanying notes to the condensed consolidated financial statements included in this Form 10-Q. RESULTS OF OPERATIONS Background and Overview Jack Henry & Associates, Inc. (JHA) is a leading provider of technology solutions and payment processing services primarily for financial services organizations. Our solutions are marketed and supported through three primary brands. Jack Henry Banking® supports banks ranging from community to mid-tier, multi-billion dollar institutions with information and transaction processing solutions. Symitar® is a leading provider of information and transaction processing solutions for credit unions of all sizes. ProfitStars® provides specialized products and services that enable financial institutions of every asset size and charter, and diverse corporate entities outside the financial services industry, to mitigate and control risks, optimize revenue and growth opportunities, and contain costs. JHA's integrated solutions are available for in-house installation and outsourced and hosted delivery. The majority of our revenue is derived from recurring outsourcing fees and transaction processing fees that predominantly have contract terms of five years or greater at inception. Support and service fees also include in-house maintenance fees on primarily annual contract terms. Less predictable software license fees and hardware sales complement our primary revenue sources. We continually seek opportunities to increase revenue while at the same time containing costs to expand margins. In the second quarter of fiscal 2014, revenues increased 9% or $23,831 compared to the same period in the prior year, with strong growth continuing in our support & service revenue component, particularly in our electronic payment services. In the six months ending December 31, 2013, revenues increased 9% or $48,489 compared to the same six months last year, with strong growth continuing in all components of our support & service revenues. The growth in revenue and the Company's continued focus on cost management continued to drive up gross margins for the year-to-date period. Operating expenses decreased 21% for the quarter and decreased 9% for the six month period ended December 31, 2013 mainly due to $13,686 of year-to-date expenses in the prior year related to the impact of Hurricane Sandy flooding on our Lyndhurst, New Jersey item processing center. Provision for income taxes increased over both the prior quarter and year-to-date periods. The prior year was low due to the tax impact of the Lyndhurst, New Jersey expenses and the release of previously unrecognized tax benefits. The result of increased revenue and the above changes resulted in a combined 33% increase in net income for the quarter and 25% for the six months ended December 31, 2013. We continue to focus on our objective of providing the best integrated solutions, products and customer service to our clients. We are cautiously optimistic regarding ongoing economic improvement and expect our clients to continue investing in our products and services to improve their operating efficiencies and performance. We anticipate that consolidation within the financial services industry will continue, including some reduced amount of bank failures and an increasing amount of merger and acquisition activity. Regulatory conditions and legislation such as the Dodd-Frank Wall Street Reform and Consumer Protection Act will continue to impact the financial services industry and could motivate some financial institutions to postpone discretionary spending. A detailed discussion of the major components of the results of operations for the three and six month periods ended December 31, 2013 follows. All amounts are in thousands and discussions compare the current three and six month periods ended December 31, 2013, to the prior year three and six month periods ended December 31, 2012. REVENUE License Revenue % Three Months Ended December 31, Change Six Months Ended December 31, % Change 2013 2012 2013 2012 License $ 12,893$ 13,210 (2



)% $ 24,671$ 26,074 (5 )% Percentage of total revenue

4 % 5 % 4 % 5 % License revenue decreased for the quarter and year-to-date periods due mainly to a decrease in license revenue from both core and complementary Credit Union products. While license fees will fluctuate, recent trends indicate that our customers are increasingly electing to contract for our products via outsourced delivery rather than a traditional license as our outsourced delivery does not require an up-front capital investment in license fees. We expect this trend to continue in the long term. 14



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Table of Contents Support and Service % % Revenue Three Months Ended December 31, Change



Six Months Ended December 31, Change

2013 2012 2013 2012 Support and service $ 274,276$ 250,310 10 % $ 543,820$ 494,895 10 % Percentage of total revenue 91 % 90 % 91 % 90 % Qtr over Qtr Year over Year $ Change % Change $ Change % Change In-House Support & Other Services $ 4,753 6 % $ 6,667 4 % Electronic Payment Services 11,734 12 % 26,056 13 % Outsourcing Services 5,738 11 % 12,620 12 % Implementation Services 1,741 8 % 3,582 9 % Total Increase $ 23,966$ 48,925 There was growth in all support and service revenue components for the current quarter and year-to-date. In-house support and other services revenue increased for the quarter and year-to-date due to annual maintenance fee increases for both core and complementary products as our customers' assets grow and due to the maintenance fees associated with new software implemented. Electronic payment services continue to experience the largest growth. The revenue increases are attributable to strong performance across debit/credit card transaction processing services, online bill payment services and ACH processing. Outsourcing services for banks and credit unions continue to drive revenue growth as customers continue to show a preference for outsourced delivery of our solutions. We expect the trend towards outsourced product delivery to benefit outsourcing services revenue for the foreseeable future. Revenues from outsourcing services are typically earned under multi-year service contracts and therefore provide a long-term stream of recurring revenues. Implementation services revenue increased for the quarter due mainly to increased implementations of our Credit Union core products. The year-to-date increase is due mainly to increased implementations of our Credit Union core and also our remote deposit capture products. Hardware Revenue % % Three Months Ended December 31, Change Six Months Ended December 31, Change 2013 2012 2013 2012 Hardware $ 15,356$ 15,174 1 % $ 29,694$ 28,727 3 % Percentage of total revenue 5 % 5 % 5 % 5 % Hardware revenue increased slightly for the quarter and year-to-date periods. Although there will be continuing quarterly fluctuations, we expect there to be an overall decreasing trend in hardware sales due to the change in sales mix towards outsourcing contracts, which typically do not include hardware, and the general deflationary trend of computer prices. BACKLOG Our backlog of $503,761 ($122,311 in-house and $381,450 outsourcing) at December 31, 2013 increased 11% from $452,239 ($89,796 in-house and $362,443 outsourcing) at December 31, 2012. The current quarter backlog remained consistent with September 30, 2013, when backlog was $503,103 ($116,852 in-house and $386,251 outsourcing). 15



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COST OF SALES AND GROSS PROFIT

% % Three Months Ended December 31, Change Six Months Ended December 31, Change 2013 2012 2013 2012 Cost of License $ 947 $ 1,251 (24 )% $ 2,359$ 2,329 1 % Percentage of total <1% <1% <1% <1% revenue License Gross Profit $ 11,946$ 11,959 - % $ 22,312$ 23,745 (6 )% Gross Profit Margin 93 % 91 % 90 % 91 % Cost of support and service $ 157,893$ 144,683 9 % $ 312,477$ 288,101 8 % Percentage of total 52 % 52 % 52 % 52 % revenue Support and Service Gross Profit $ 116,383$ 105,627 10 % $ 231,343$ 206,794 12 % Gross Profit Margin 42 % 42 % 43 % 42 % Cost of hardware $ 10,867$ 10,523 3 % $ 21,808$ 21,101 3 % Percentage of total 4 % 4 % 4 % 4 % revenue Hardware Gross Profit $ 4,489 $ 4,651 (3 )% $ 7,886$ 7,626 3 % Gross Profit Margin 29 % 31 % 27 % 27 % TOTAL COST OF SALES $ 169,707$ 156,457 8 % $ 336,644$ 311,531 8 % Percentage of total 56 % 56 % 56 % 57 % revenue TOTAL GROSS PROFIT $ 132,818$ 122,237 9 % $ 261,541$ 238,165 10 % Gross Profit Margin 44 % 44 % 44 % 43 % Cost of license consists of the direct costs of third party software. For the quarter, sales of third party software products decreased compared to last quarter, leading to higher gross profit margins. For the year-to-date, sales of third party software products increased, which has led to higher related costs and slightly decreased gross profit margins. Gross profit margins in support and service have remained consistent for the quarter and increased for the year-to-date period due to economies of scale realized from increased revenues, particularly in electronic payment services. In general, changes in cost of hardware trend consistently with hardware revenue. For the quarter, margins are lower due to decreased sales of higher margin hardware upgrade products. 16



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Table of Contents OPERATING EXPENSES Selling and Marketing % % Three Months Ended December 31, Change Six Months Ended December 31, Change 2013 2012 2013 2012



Selling and marketing $ 21,071$ 19,937 6 % $ 42,529$ 40,126 6 % Percentage of total revenue

7 % 7 % 7 % 7 % Selling and marketing expenses for the quarter and year-to-date increased mainly due to higher commission expenses and a general increase in sales headcount and related salaries. This is in line with increased sales volume of long term service contracts on which commissions are paid as a percentage of total revenue. Research and Development % % Three Months Ended December 31, Change Six Months Ended December 31, Change 2013 2012 2013 2012 Research and development $ 16,142$ 15,691 3 % $ 31,814$ 30,337 5 % Percentage of total revenue 5 % 6 % 5 % 6 %



Research and development expenses increased slightly for the quarter and year-to-date periods primarily due to increased headcount and related salaries. General and Administrative

% % Three Months Ended December 31, Change Six Months Ended December 31, Change 2013 2012 2013 2012 General and administrative $ 12,132$ 27,181 (55 )% $ 26,382$ 40,759 (35 )% Percentage of total revenue 4 % 10 % 4 % 7 % General and administrative expenses decreased compared to quarter and year-to-date periods last year due mainly to expenses in the prior year related to the impact of Hurricane Sandy flooding on our Lyndhurst, New Jersey item processing center. Excluding the Lyndhurst expenses from the prior year and the insurance recovery from the current year, non-GAAP general and administrative expenses would have been $15,032 and $29,282 for the quarter and year-to-date current year periods, respectively, and the non-GAAP increase would have been $1,537, or 11% for the quarter and $2,209, or 8%, for the year-to-date compared to the prior year. INTEREST INCOME AND EXPENSE % % Three Months Ended December 31, Change Six Months Ended December 31, Change 2013 2012 2013 2012 Interest Income $ 129 $ 190 (32 )% $ 260 $ 378 (31 )% Interest Expense $ (267 )$ (1,261 ) (79 )% $ (546 )$ (2,602 ) (79 )% Interest income fluctuated due to changes in invested balances and yields on invested balances. Interest expense decreased for the quarter and year-to-date due to full repayment of our term loan in the fourth quarter of fiscal 2013. PROVISION FOR INCOME TAXES The provision for income taxes was $29,353 and $56,760 for the three and six-month periods ended December 31, 2013 compared with $17,852 and $41,738 for the same periods last year. As of the end of the current quarter, the effective rate of income taxes is 35.2% and 35.4% of income before income taxes for the quarter and year-to-date respectively, compared to 30.6% and 33.5% as reported in fiscal 2013. The increase in the effective tax rate was primarily due to the recognition of previously unrecognized tax benefits during the prior year quarter following the close of an Internal Revenue Service audit of fiscal years 2010 and 2011. NET INCOME Net income increased 33% for the three months ended December 31, 2013. For the second quarter of fiscal 2014, it was $53,982 or $0.63 per diluted share compared to $40,505, or $0.47 per diluted share in the same period last year. Net income also increased 25% for the six month period ended December 31, 2013 to $103,770 or $1.21 per diluted share compared to $82,981 or $0.96 per diluted share, for the same six month period last year. 17



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Table of Contents Three Months Ended December 31, 2013 Lyndhurst, GAAP New Jersey Non-GAAP Gross Profit $ 132,818 $ - $ 132,818 Operating Expenses 49,345 2,900 52,245 Operating Income 83,473 (2,900 ) 80,573 Interest Income (Expense) (138 ) - (138 ) Income Before Income Taxes 83,335 (2,900 ) 80,435 Provision for Income Taxes 29,353 (1,021 ) 28,332 Net Income 53,982 (1,879 ) 52,103



Diluted weighted average shares outstanding 85,986 85,986

85,986 Diluted earnings per share $ 0.63 $ (0.02 )$ 0.61 Three Months Ended December 31, 2012 Lyndhurst, GAAP New Jersey Non-GAAP Gross Profit $ 122,237 $ - $ 122,237 Operating Expenses 62,809 (13,686 ) 49,123 Operating Income 59,428 13,686 73,114 Interest Income (Expense) (1,071 ) - (1,071 ) Income Before Income Taxes 58,357 13,686 72,043 Provision for Income Taxes 17,852 4,893 22,745 Net Income 40,505 8,793 49,298 Diluted weighted average shares outstanding 86,639 86,639 86,639 Diluted earnings per share $ 0.47 $ 0.10 $ 0.57 The Company reports its financial results in accordance with U.S. GAAP. The Company believes that the non-GAAP financial measures discussed above allows management and investors to understand and compare the Company's results in a more consistent manner. The non-GAAP measures should be considered supplemental and not a substitute for the Company's results that were recorded in accordance with GAAP for the periods presented. BUSINESS SEGMENT DISCUSSION The Company is a provider of integrated computer systems that perform data processing (available for in-house installations or outsourced services) for banks and credit unions. The Company's operations are classified into two reportable segments: bank systems and services ("Bank") and credit union systems and services ("Credit Union"). The Company evaluates the performance of its segments and allocates resources to them based on various factors, including prospects for growth, return on investment, and return on revenue. Bank Systems and Services % % Three Months Ended December 31, Change Six Months Ended December 31, Change 2013 2012 2013 2012 Revenue $ 229,875$ 208,134 10 % $ 450,882$ 410,560 10 % Gross profit $ 100,338$ 90,760 11 % $ 194,156$ 176,566 10 % Gross profit margin 44 % 44 % 43 % 43 % Revenue in the Bank segment increased 10% compared to the equivalent quarter last fiscal year. This was primarily due to growth in all areas of support and service revenue, particularly electronic payment transaction processing services revenue which grew 17% and outsourcing services revenue which increased 11%. 18



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Year-to-date revenue increased 10% for the six month period due mainly to increased support and service revenue. Within support and service revenue, the increase was driven by 17% year-over-year growth in electronic payment services revenues from transaction processing and a 13% increase in outsourcing services revenue. Gross profit margins remain consistent for both the quarter and year-to-date. Credit Union Systems and Services % % Three Months Ended December 31, Change Six Months Ended December 31, Change 2013 2012 2013 2012 Revenue $ 72,650 $ 70,560 3 % $ 147,303$ 139,136 6 % Gross profit $ 32,480 $ 31,477 3 % $ 67,385$ 61,599 9 % Gross profit margin 45 % 45 % 46 % 44 % Revenue in the Credit Union segment increased 3% from the same quarter last year mainly due to support & service revenue which increased 6% due to growth in all areas of support and service revenue. Gross profit margins for the Credit Union segment for the three month period have remained consistent with the prior year. Year-to-date revenue in the Credit Union segment increased 6% over the prior year, driven by all components of support & service revenue. In particular, electronic payment services increased due to the continuing growth of our transaction processing and debit/credit card processing services and increased implementation services. Gross profit margins for the Credit Union segment for the six month period increased mainly due to economies of scale realized from growing transaction volume in our payment processing services. FINANCIAL CONDITION Liquidity The Company's cash and cash equivalents increased to $155,501 at December 31, 2013 from $127,905 at June 30, 2013. The increase from June 30, 2013 is primarily due to continued receipts from our annual maintenance billings. The following table summarizes net cash from operating activities in the statement of cash flows: Six Months Ended December 31, 2013 2012 Net income $ 103,770$ 82,981 Non-cash expenses 60,479 56,202 Change in receivables 94,694 89,193 Change in deferred revenue (104,293 ) (99,881 )



Change in other assets and liabilities (23,334 ) (9,327 ) Net cash provided by operating activities $ 131,316$ 119,168

Cash provided by operating activities increased 10% compared to last year. Cash from operations is primarily used to repay debt, pay dividends, repurchase stock and other capital expenditures. Cash used in investing activities for the first six months of fiscal year 2014 totaled $55,052 and included capital expenditures on facilities and equipment of $21,866, which included spending on our outsourcing data center infrastructure, and purchase of an aircraft and computer equipment. Other uses of cash included $29,015 for the development of software and $6,980 for the purchase and development of internal use software. These expenditures have been partially offset by $2,809 proceeds received primarily from sale of an aircraft. Cash used in investing activities for the first six months of fiscal 2013 totaled $42,704. The largest uses of cash included $23,826 for the development of software and $18,957 capital expenditures on facilities and equipment, which includes spending on our online bill payment data center migration. These expenditures were partially offset by proceeds of $265 from the sale of property. Financing activities used cash of $48,668 during the first six months of the current fiscal year. Cash used was mainly dividends paid to stockholders of $34,146, repayments of capital leases of $13,630, and $892 related to stock-based compensation. Net cash used in the first six months of last year was $40,923, which included dividends paid to stockholders of $19,813, repayments of long and short term borrowings on our credit facilities of $17,336, and $9,297 for the purchase of treasury shares. Cash used last year was partially offset by $5,523 net proceeds from the issuance of stock and tax related to stock-based compensation. 19



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We have not experienced any significant issues with our current collection efforts. Furthermore, we believe that any future impact to our liquidity would be minimized by our access to available lines of credit. Capital Requirements and Resources The Company generally uses existing resources and funds generated from operations to meet its capital requirements. Capital expenditures totaling $21,866 and $18,957 for the six month periods ended December 31, 2013 and 2012, respectively, were made primarily for additional equipment and the improvement of existing facilities. These additions were funded from cash generated by operations. Total consolidated capital expenditures for the Company for fiscal year 2014 are not expected to exceed $50,000 and will be funded from cash generated by operations. The Board of Directors 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 short-term borrowings on its existing credit facilities. The share repurchase program does not include specific price targets or timetables and may be suspended at any time. At December 31, 2013, there were 16,754 shares in treasury stock and the Company had the remaining authority to repurchase up to 8,237 additional shares. The total cost of treasury shares at December 31, 2013 is $402,082. No treasury shares were purchased in the first six months of fiscal 2014. Capital leases The Company has entered into various capital lease obligations for the use of certain computer equipment. Long term capital lease obligations were entered into of which $9,102 remains outstanding at December 31, 2013 of which $3,413 will be maturing within the next twelve months. The Company also has short term capital lease obligations totaling $534 at December 31, 2013. Other lines of credit The long term revolving credit facility allows for borrowings of up to $150,000, which may be increased by the Company at any time until maturity to $250,000. Each of the above loans bear interest at a variable rate equal to (a) a rate based on LIBOR or (b) an alternate base rate (the greater of (a) the Federal Funds Rate plus 0.5%, (b) the Prime Rate or (c) LIBOR plus 1.0%), plus an applicable percentage in each case determined by the Company's leverage ratio. The credit facility is secured by pledges of capital stock of certain subsidiaries of the Company and also guaranteed by certain subsidiaries of the Company. The credit facility is subject to various financial covenants that require the Company to maintain certain financial ratios as defined in the agreement. As of December 31, 2013, the Company was in compliance with all such covenants. The revolving loan terminates June 4, 2015 and at December 31, 2013, there was no outstanding revolving loan balance. The Company renewed an unsecured bank credit line on April 29, 2012 which provides for funding of up to $5,000 and bears interest at the prime rate less 1% (2.25% at December 31, 2013). The credit line was renewed through April 29, 2014. At December 31, 2013, no amount was outstanding.


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