United States


Securities and Exchange Commission

Washington, D.C.  20549

FORM 10-Q

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
for the Period Ended April 30,July 31, 2006.

o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
for the Transition Period from                        to                           .

Commission file number  0-24201

Carreker Corporation

(Exact name of registrant as specified in its charter)

Delaware

Delaware

75-1622836

(State or other jurisdiction of

(IRS Employer Identification No.)

incorporation or organization)

 

 

 

4055 Valley View Lane, #1000

Dallas, Texas

75244

(Address of principal executive office)

(Zip Code)

(972) 458-1981

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one)

Large Accelerated Filer o                  Accelerated Filer x            Non-Accelerated Filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes oNo x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.

Common Stock, $.01 par value — 25,425,70325,592,690 shares as of MayAugust 31, 2006.

 








PART I:  FINANCIAL INFORMATION

Item 1.  Financial Statements

CARREKER CORPORATION

Condensed Consolidated Balance Sheets

(Unaudited)

(In thousands, except per share amounts)

ASSETS

 

 

April 30,

 

January 31,

 

 

 

2006

 

2006

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

Cash and cash equivalents

 

$

34,822

 

$

29,684

 

Marketable securities

 

5,900

 

4,700

 

Accounts receivable, net of allowance of $571 and $601 at April 30, 2006 and January 31, 2006, respectively

 

9,957

 

12,225

 

Prepaid expenses and other current assets

 

2,491

 

2,940

 

Total current assets

 

53,170

 

49,549

 

 

 

 

 

 

 

Property and equipment, net of accumulated depreciation of $23,643 and $23,050 at April 30, 2006 and January 31, 2006, respectively

 

6,217

 

5,947

 

Capitalized software costs, net of accumulated amortization of $14,009 and $13,686 at April 30, 2006 and January 31, 2006, respectively

 

2,965

 

2,761

 

Acquired developed technology, net of accumulated amortization of $21,548 and $20,393 at April 30, 2006 and January 31, 2006, respectively

 

4,152

 

5,307

 

Goodwill, net of accumulated amortization of $3,405 at April 30, 2006 and January 31, 2006

 

20,765

 

20,765

 

Customer relationships, net of accumulated amortization of $6,883 and $6,533 at April 30, 2006 and January 31, 2006, respectively

 

1,517

 

1,867

 

Deferred loan costs, net of accumulated amortization of $1,639 and $1,571 at April 30, 2006 and January 31, 2006, respectively

 

68

 

136

 

Other assets

 

795

 

793

 

Total assets

 

$

89,649

 

$

87,125

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

Accounts payable

 

$

1,103

 

$

1,168

 

Accrued compensation and benefits

 

5,302

 

6,153

 

Other accrued expenses

 

3,635

 

4,608

 

Income tax payable

 

110

 

220

 

Deferred revenue

 

23,218

 

19,151

 

Accrued merger and restructuring costs

 

247

 

334

 

Total current liabilities

 

33,615

 

31,634

 

 

 

 

 

 

 

Commitments and Contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

Preferred stock, $.01 par value:
2,000 shares authorized; no shares issued or outstanding

 

 

 

Common stock, $.01 par value:
100,000 shares authorized; 25,367 and 25,319 shares issued at April 30, 2006 and January 31, 2006, respectively

 

254

 

254

 

Additional paid-in capital

 

112,938

 

112,316

 

Accumulated deficit

 

(53,882

)

(53,848

)

Less treasury stock, at cost: 648 and 641 common shares at April 30, 2006 and January 31, 2006, respectively

 

(3,276

)

(3,231

)

Total stockholders’ equity

 

56,034

 

55,491

 

Total liabilities and stockholders’ equity

 

$

89,649

 

$

87,125

 

 

 

 

   July 31,   

 

   January 31,   

 

 

 

2006

 

2006

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

Cash and cash equivalents

 

$

27,614

 

$

29,684

 

Marketable securities

 

5,900

 

4,700

 

Accounts receivable, net of allowance of $610 and $601 at July 31, 2006 and January 31, 2006, respectively

 

17,266

 

12,225

 

Prepaid expenses and other current assets

 

2,343

 

2,940

 

Total current assets

 

53,123

 

49,549

 

 

 

 

 

 

 

Property and equipment, net of accumulated depreciation of $24,265 and $23,050 at July 31, 2006 and January 31, 2006, respectively

 

6,593

 

5,947

 

Capitalized software costs, net of accumulated amortization of $14,333 and $13,686 at July 31, 2006 and January 31, 2006, respectively

 

3,359

 

2,761

 

Acquired developed technology, net of accumulated amortization of $22,617 and $20,393 at July 31, 2006 and January 31, 2006, respectively

 

3,083

 

5,307

 

Goodwill, net of accumulated amortization of $3,405 at July 31, 2006 and January 31, 2006

 

20,765

 

20,765

 

Customer relationships, net of accumulated amortization of $7,233 and $6,533 at July 31, 2006 and January 31, 2006, respectively

 

1,167

 

1,867

 

Deferred loan costs, net of accumulated amortization of $1,571 at January 31, 2006

 

 

136

 

Other assets

 

797

 

793

 

Total assets

 

$

88,887

 

$

87,125

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

Accounts payable

 

$

1,086

 

$

1,168

 

Accrued compensation and benefits

 

6,190

 

6,153

 

Other accrued expenses

 

4,114

 

4,608

 

Income tax payable

 

77

 

220

 

Deferred revenue

 

19,366

 

19,151

 

Accrued merger and restructuring costs

 

247

 

334

 

Total current liabilities

 

31,080

 

31,634

 

 

 

 

 

 

 

Commitments and Contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

Preferred stock, $.01 par value: 2,000 shares authorized; no shares issued or outstanding

 

 

 

Common stock, $.01 par value: 100,000 shares authorized; 25,589 and 25,329 shares issued at July 31, 2006 and January 31, 2006, respectively

 

256

 

254

 

Additional paid-in capital

 

113,847

 

112,316

 

Accumulated deficit

 

(52,921

)

(53,848

)

Less treasury stock, at cost: 663 and 641 common shares at July 31, 2006 and January 31, 2006, respectively

 

(3,375

)

(3,231

)

Total stockholders’ equity

 

57,807

 

55,491

 

Total liabilities and stockholders’ equity

 

$

88,887

 

$

87,125

 

See accompanying notes.


CARREKER CORPORATION

Condensed Consolidated Statements of Operations

(Unaudited)

(In thousands, except per share amounts)

 

 

Three Months Ended
April 30,

 

 

 

2006

 

2005

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

Consulting

 

$

8,558

 

$

8,318

 

Software license

 

2,557

 

3,359

 

Software maintenance

 

10,752

 

11,312

 

Software implementation and other services

 

4,135

 

4,134

 

Outsourcing service

 

510

 

257

 

Out-of-pocket expense reimbursements

 

733

 

818

 

Total revenues

 

27,245

 

28,198

 

 

 

 

 

 

 

Cost of revenues:

 

 

 

 

 

Consulting

 

4,872

 

4,241

 

Software license

 

1,840

 

1,536

 

Software maintenance

 

3,172

 

3,975

 

Software implementation and other services

 

3,076

 

2,973

 

Outsourcing service

 

476

 

579

 

Out-of-pocket expenses

 

774

 

790

 

Total cost of revenues

 

14,210

 

14,094

 

Gross profit

 

13,035

 

14,104

 

 

 

 

 

 

 

Operating costs and expenses:

 

 

 

 

 

Selling, general and administrative

 

10,780

 

10,904

 

Research and development

 

2,205

 

2,521

 

Amortization of customer relationships

 

350

 

350

 

Restructuring and other charges

 

 

95

 

Total operating costs and expenses

 

13,335

 

13,870

 

Income (loss) from operations

 

(300

)

234

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

Interest income

 

271

 

144

 

Interest expense

 

(105

)

(105

)

Other income

 

200

 

306

 

Total other income, net

 

366

 

345

 

Income before provision for income taxes

 

66

 

579

 

Provision for income taxes

 

100

 

81

 

Net income (loss)

 

$

(34

)

$

498

 

Basic earnings (loss) per share

 

$

0.00

 

$

0.02

 

Diluted earnings (loss) per share

 

$

0.00

 

$

0.02

 

Shares used in computing basic earnings (loss) per share

 

23,916

 

24,425

 

Shares used in computing diluted earnings (loss) per share

 

23,916

 

24,867

 

 

 

Three Months Ended
July 31,

 

Six Months Ended
July 31,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

Consulting

 

$

6,839

 

$

9,502

 

$

15,397

 

$

17,820

 

Software license

 

5,493

 

3,782

 

8,050

 

7,141

 

Software maintenance

 

10,899

 

10,576

 

21,651

 

21,888

 

Software implementation and other services

 

4,249

 

4,892

 

8,384

 

9,026

 

Outsourcing services

 

530

 

241

 

1,040

 

498

 

Out-of-pocket expense reimbursements

 

793

 

927

 

1,526

 

1,745

 

Total revenues

 

28,803

 

29,920

 

56,048

 

58,118

 

 

 

 

 

 

 

 

 

 

 

Cost of revenues:

 

 

 

 

 

 

 

 

 

Consulting

 

4,798

 

4,277

 

9,670

 

8,518

 

Software license

 

1,885

 

1,828

 

3,725

 

3,364

 

Software maintenance

 

3,189

 

3,436

 

6,361

 

7,411

 

Software implementation and other services

 

2,938

 

3,682

 

6,014

 

6,655

 

Outsourcing services

 

514

 

434

 

990

 

1,013

 

Out-of-pocket expenses

 

774

 

808

 

1,548

 

1,598

 

Total cost of revenues

 

14,098

 

14,465

 

28,308

 

28,559

 

Gross profit

 

14,705

 

15,455

 

27,740

 

29,559

 

 

 

 

 

 

 

 

 

 

 

Operating costs and expenses:

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

11,423

 

11,593

 

22,203

 

22,497

 

Research and development

 

2,453

 

2,516

 

4,658

 

5,037

 

Amortization of customer relationships

 

350

 

350

 

700

 

700

 

Restructuring and other charges

 

 

28

 

 

123

 

Total operating costs and expenses

 

14,226

 

14,487

 

27,561

 

28,357

 

Income from operations

 

479

 

968

 

179

 

1,202

 

 

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

407

 

166

 

678

 

310

 

Interest expense

 

(106

)

(107

)

(211

)

(212

)

Other income

 

315

 

129

 

515

 

435

 

Total other income, net

 

616

 

188

 

982

 

533

 

Income before provision for income taxes

 

1,095

 

1,156

 

1,161

 

1,735

 

Provision for income taxes

 

134

 

102

 

234

 

183

 

Net income

 

$

961

 

$

1,054

 

$

927

 

$

1,552

 

Basic earnings per share

 

$

0.04

 

$

0.04

 

$

0.04

 

$

0.06

 

Diluted earnings per share

 

$

0.04

 

$

0.04

 

$

0.04

 

$

0.06

 

Shares used in computing basic earnings per share

 

24,041

 

24,127

 

23,986

 

24,326

 

Shares used in computing diluted earnings per share

 

24,461

 

24,421

 

24,407

 

24,703

 

See accompanying notes.


CARREKER CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

Condensed Consolidated Statements Of Stockholders’ Equity

(Unaudited)

(In thousands, except per share amounts)

 

 

Common Stock

 

Additional

 

 

 

Treasury Stock

 

Total

 

 

 

Unrestricted
Shares

 

Restricted
Shares

 

Amount

 

Paid-In
Capital

 

Accumulated
Deficit

 

Shares

 

Amount

 

Stockholders’
Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at January 31, 2006

 

24,587

 

732

 

$

254

 

$

112,316

 

$

(53,848

)

641

 

$

(3,231

)

$

55,491

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cancellation of restricted stock

 

 

(7

)

 

 

 

 

 

 

Compensation expense related to issuance of restricted stock

 

 

 

 

240

 

 

 

 

240

 

Compensation expense related to issuance of stock options

 

 

 

 

382

 

 

 

 

382

 

Issuance of restricted stock

 

 

46

 

 

 

 

 

 

 

Restricted shares withheld for payroll taxes

 

 

(7

)

 

 

 

7

 

(45

)

(45

)

Conversion of restricted common stock to unrestricted

 

15

 

(15

)

 

 

 

 

 

 

Net loss

 

 

 

 

 

(34

)

 

 

(34

)

Balance at April 30, 2006 

 

24,602

 

749

 

$

254

 

$

112,938

 

$

(53,882

)

648

 

$

(3,276

)

$

56,034

 

 

 

Common Stock

 

Additional

 

 

 

Treasury Stock

 

Total

 

 

 

Unrestricted

 

Restricted

 

 

 

Paid-In

 

Accumulated

 

 

 

Stockholders’

 

 

 

Shares

 

Shares

 

Amount

 

Capital

 

Deficit

 

Shares

 

Amount

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at January 31, 2006

 

24,596

 

732

 

$

254

 

$

112,316

 

$

(53,848

)

641

 

$

(3,231

)

$

55,491

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cancellation of restricted stock

 

 

(7

)

 

 

 

 

 

 

Compensation expense related to issuance of restricted stock

 

 

 

 

240

 

 

 

 

240

 

Compensation expense related to issuance of stock options

 

 

 

 

382

 

 

 

 

382

 

Issuance of restricted stock

 

 

46

 

 

 

 

 

 

 

Restricted shares withheld for payroll taxes

 

 

 

 

 

 

7

 

(45

)

(45

)

Conversion of restricted common stock to unrestricted

 

22

 

(22

)

 

 

 

 

 

 

Net loss

 

 

 

 

 

(34

)

 

 

(34

)

Balance at April 30, 2006

 

24,618

 

749

 

254

 

112,938

 

(53,882

)

648

 

(3,276

)

56,034

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cancellation of restricted stock

 

 

(5

)

 

 

 

 

 

 

Compensation expense related to issuance of restricted stock

 

 

 

1

 

286

 

 

 

 

287

 

Compensation expense related to issuance of stock options

 

 

 

 

340

 

 

 

 

340

 

Issuance of restricted stock

 

 

164

 

 

 

 

 

 

 

Restricted shares withheld for payroll taxes

 

 

 

 

 

 

15

 

(99

)

(99

)

Conversion of restricted common stock to unrestricted

 

124

 

(124

)

 

 

 

 

 

 

Issuance of shares of common stock upon exercises of stock options

 

63

 

 

1

 

283

 

 

 

 

284

 

Net income

 

 

 

 

 

961

 

 

 

961

 

Balance at July 31, 2006

 

24,805

 

784

 

$

256

 

$

113,847

 

$

(52,921

)

663

 

$

(3,375

)

$

57,807

 

See accompanying notes.


CARREKER CORPORATION

Condensed Consolidated Statements of Cash Flows

(Unaudited)
(In thousands)

 

 

Three Months Ended
April 30,

 

 

 

2006

 

2005

 

Operating Activities:

 

 

 

 

 

Net income (loss)

 

$

(34

)

$

498

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization of property and equipment

 

779

 

793

 

Amortization of capitalized software costs

 

322

 

266

 

Amortization of acquired developed technology

 

1,155

 

1,155

 

Amortization of customer relationships

 

350

 

350

 

Amortization of deferred loan costs

 

68

 

68

 

Stock based compensation

 

622

 

128

 

Minority share of loss in Carretek LLC

 

(133

)

(318

)

Non-cash charge for merger costs

 

 

(32

)

Allowance for doubtful accounts

 

(48

)

7

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

2,316

 

401

 

Prepaid expenses and other assets

 

447

 

(324

)

Accounts payable and accrued expenses

 

(1,888

)

(2,692

)

Income taxes payable/receivable

 

(110

)

10

 

Deferred revenue

 

4,067

 

1,800

 

Net cash provided by operating activities

 

7,913

 

2,110

 

 

 

 

 

 

 

Investing Activities:

 

 

 

 

 

Purchases of property and equipment

 

(1,049

)

(698

)

Purchases of marketable securities

 

(3,500

)

 

Sales of marketable securities

 

2,300

 

 

Computer software costs capitalized

 

(526

)

(437

)

Net cash used in investing activities

 

(2,775

)

(1,135

)

 

 

 

 

 

 

Financing Activities:

 

 

 

 

 

Proceeds from exercises of stock options

 

 

52

 

Purchase of treasury stock

 

 

(349

)

Proceeds from minority shareholder equity contributions to Carretek LLC

 

 

551

 

Net cash provided by financing activities

 

 

254

 

Net increase in cash and cash equivalents

 

5,138

 

1,229

 

Cash and cash equivalents at beginning of period

 

29,684

 

34,516

 

Cash and cash equivalents at end of period

 

$

34,822

 

$

35,745

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

Cash paid for interest

 

$

38

 

$

38

 

Cash paid for income taxes, net

 

$

198

 

$

76

 

 

 

Three Months Ended
July 31,

 

Six Months Ended
July 31,

 

 

 

2006

 

2005

 

2006

 

2005

 

Operating Activities:

 

 

 

 

 

 

 

 

 

Net income

 

$

961

 

$

1,054

 

$

927

 

$

1,552

 

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

 

 

 

 

 

 

 

 

 

Depreciation and amortization of property and equipment

 

707

 

805

 

1,486

 

1,598

 

Amortization of capitalized software costs

 

324

 

201

 

646

 

467

 

Amortization of acquired developed technology

 

1,069

 

1,155

 

2,224

 

2,310

 

Amortization of customer relationships

 

350

 

350

 

700

 

700

 

Amortization of deferred loan costs

 

68

 

68

 

136

 

135

 

Stock based compensation

 

627

 

130

 

1,249

 

258

 

Minority share of loss in Carretek LLC

 

(194

)

(213

)

(327

)

(531

)

Non-cash charge for merger costs

 

 

 

 

(32

)

Allowance for doubtful accounts

 

76

 

(48

)

28

 

(41

)

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

Accounts receivable

 

(7,385

)

(5,606

)

(5,069

)

(5,205

)

Prepaid expenses and other assets

 

200

 

363

 

647

 

(289

)

Accounts payable and accrued expenses

 

1,244

 

(242

)

(644

)

(2,606

)

Income taxes payable

 

(33

)

(275

)

(143

)

(264

)

Deferred revenue

 

(3,852

)

(3,620

)

215

 

(1,820

)

Net cash provided by (used in) operating activities

 

(5,838

)

(5,878

)

2,075

 

(3,768

)

 

 

 

 

 

 

 

 

 

 

Investing Activities:

 

 

 

 

 

 

 

 

 

Purchases of property and equipment

 

(1,136

)

(588

)

(2,185

)

(1,286

)

Purchases of marketable securities

 

 

(4,600

)

(3,500

)

(4,600

)

Sales of marketable securities

 

 

 

2,300

 

 

Software development costs capitalized

 

(718

)

(271

)

(1,244

)

(708

)

Net cash used in investing activities

 

(1,854

)

(5,459

)

(4,629

)

(6,594

)

 

 

 

 

 

 

 

 

 

 

Financing Activities:

 

 

 

 

 

 

 

 

 

Proceeds from exercises of stock options

 

284

 

214

 

284

 

266

 

Purchase of treasury stock

 

 

(2,873

)

 

(3,222

)

Proceeds from minority shareholder equity contributions to Carretek LLC

 

200

 

 

200

 

551

 

Net cash provided by (used in) financing activities

 

484

 

(2,659

)

484

 

(2,405

)

Net decrease in cash and cash equivalents

 

(7,208

)

(13,996

)

(2,070

)

(12,767

)

Cash and cash equivalents at beginning of period

 

34,822

 

35,745

 

29,684

 

34,516

 

Cash and cash equivalents at end of period

 

$

27,614

 

$

21,749

 

$

27,614

 

$

21,749

 

 

 

 

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

 

 

 

Cash paid for interest

 

$

38

 

$

38

 

$

76

 

$

76

 

Cash paid for income taxes, net

 

$

166

 

$

351

 

$

364

 

$

427

 

See accompanying notes.

6




Carreker Corporation

Notes to Condensed Consolidated Unaudited Financial Statements

For the Three and Six Months Ended April 30,July 31, 2006

1.           Description of Business

For the last 28 years, Carreker Corporation (“the Company,” “Carreker,” “our,” “we”) has designed, developed, sold and delivered payments-related software and consulting solutions to financial institutions and financial service providers.  More recently, we have introduced a business process outsourcing solution to our customers.  Our products and services address a broad spectrum of payment activities and are designed to help our clients enhance the performance of their payments businesses; improve operational efficiency in payments processing; enhance revenue and profitability from payments-oriented products and services; reduce losses associated with fraudulent payment transactions; facilitate compliance with risk-related laws and regulations; and/or maximize clients’ customer income streams by aligning their customer interactions and products with customer needs.  See Note 9 for a description of our business segments.

2.           Summary of Significant Accounting Procedures

Principles of Consolidation

The condensed consolidated unaudited financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

The condensed consolidated unaudited financial statements also reflect the operations of Carretek LLC, which is a 51% owned subsidiary.  The minority interest and minority share of net loss of Carretek LLC represent the 49% minority stockholder’s investment and share of the loss of this consolidated subsidiary.  The minority interest is currently classified in other accrued expenses in the accompanying condensed consolidated unaudited balance sheet and the minority share of net loss of Carretek LLC is recorded in other income in the accompanying condensed consolidated unaudited statements of operations.

The accompanying condensed consolidated unaudited financial statements and notes have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission for Form 10-Q and include all of the information and disclosures required by generally accepted accounting principles for interim financial reporting.  The accompanying financial statements reflect all adjustments (consisting of normal recurring entries) which in the opinion of management are necessary for a fair presentation of the results for the interim periods presented.  The results of operations for the three and six months ended April 30,July 31, 2006 are not necessarily indicative of full-year results.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires the use of estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.  As discussed below, the Company makes significant estimates and assumptions in the areas of accounts receivable, impairment of intangibles and revenue recognition.  Although the Company believes that the estimates and assumptions are reasonable, actual results may differ, and such differences could be significant to the Company’s financial results.

Cash and Cash Equivalents

The Company considers all highly liquid investments with maturities of three months or less when purchased to be cash equivalents.  Cash and cash equivalents consist primarily of demand deposit accounts and demand money market accounts with nationally recognized financial institutions, along with domestic commercial paper.  The Company utilizes a sweep service from a financial institution to invest daily in overnight repurchase agreements, typically in U.S. Treasury or agency issues.


Marketable Securities

We classify our investments in marketable securities as “available-for-sale” in accordance with the provisions of Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”).  We currently have no investments that we intend to hold for more than one year and therefore all investments are classified as short term investments.

Available-for-sale securities are carried at fair value with the unrealized gain or loss, net of tax, reported in other comprehensive income.  Held-to-maturity securities are recorded at amortized cost.  Unrealized losses considered to be “other-than-temporary” are recognized currently in earnings.  The cost of securities sold is based on the specific identification method.  The fair value of most investment securities is determined by currently available market prices.  Where quoted market prices are not available, we use the market price of similar types of securities that are traded in the market to estimate fair value.

Marketable securities at April 30,July 31, 2006 consist of insured municipal bonds and guaranteed student loan backed debt securities with a cost of $5.9 million, which approximates fair value.

All original maturities of debt securities classified as available for sale at April 30,July 31, 2006 were due after 10 years.  All the debt securities are auction rate securities and the interest rates for these investments will adjust to current market rates at each interest reset date, which is typically on at least a monthly basis.

Comprehensive Income

The Company has no other comprehensive income; accordingly, comprehensive income is the same as net income for all periods presented.

Foreign Currency Translation

The Company considers the U.S. Dollar to be the functional currency for its international subsidiaries.  All remeasurement adjustments are recorded in the consolidated statements of operations.

Accounts Receivable and Concentration of Credit Risk

Financial instruments which potentially subject the Company to concentration of credit risk consist principally of temporary cash investments such as short term commercial paper and marketable debt securities along with accounts receivable.  The Company places temporary cash investments with major banks and limits its exposure with any one financial institution, commercial issuer, municipal issuer or government agency issuer.  The Company has not experienced any material credit losses on these investments.

A significant portion of the Company’s business consists of providing consulting services and licensing software to major domestic and international banks, which gives rise to a concentration of credit risk in receivables.  Because the Company’s accounts receivable are typically unsecured, the Company periodically evaluates the collectibility of its accounts based on a combination of factors, including a particular customer’s ability to pay as well as the age of receivables.  In cases where the evidence suggests a customer may not be able to satisfy its obligation to the Company or if the collection of the receivable becomes doubtful due to a dispute that arises subsequent to the delivery of the Company’s products and services, the Company sets up a reserve in an amount determined appropriate for the perceived risk.  Most of the Company’s contracts include multiple payment milestones, some of which occur in advance of revenue recognition, which mitigates the risk both in terms of collectibility and adjustments to recorded revenue.  During the three months ended April 30,July 31, 2006 recoveries of receivables were $18,000 and during the three months ended April 30, 2005, write-offs of receivables were $32,000.$37,000 and $9,000, respectively.  During the six months ended July 31, 2006 and 2005, write-offs of receivables, net of recoveries, were $19,000 and $42,000, respectively.

The fair value of accounts receivable approximates the carrying amount of accounts receivable.


Property and Equipment

Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives of the respective assets, generally from two to five years. Leasehold improvements are amortized using the straight-line method over the shorter of the terms of the related leases or the respective useful lives of the assets.

The Company accounts for the costs of computer software developed or obtained for internal use in accordance with Statement of Position 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use”.The Company capitalizes software costs incurred after the preliminary project stage is complete, the Company has committed to the project and it is probable that the software will be used to perform the function intended.  Capitalized software costs are amortized on an individual basis using the estimated economic life of the product on a straight-line basis, generally three to five years.  These capitalized software costs are included in “Equipment and Software”.  Costs incurred during preliminary project and post-implementation stages are charged to expense.

The components of property and equipment are as follows (in thousands):

 

April 30,

 

January 31,

 

 

 

2006

 

2006

 

 

 

 

 

 

 

Furniture

 

$

5,043

 

$

5,070

 

Equipment and software

 

23,549

 

22,643

 

Leasehold improvements

 

1,268

 

1,284

 

Total cost

 

29,860

 

28,997

 

 

 

 

 

 

 

Less accumulated depreciation and amortization

 

(23,643

)

(23,050

)

Net property and equipment

 

$

6,217

 

$

5,947

 

 

July 31,

 

January 31,

 

 

 

2006

 

2006

 

 

 

 

 

 

 

Furniture

 

$

5,049

 

$

5,070

 

Equipment and software

 

24,412

 

22,643

 

Leasehold improvements

 

1,397

 

1,284

 

Total cost

 

30,858

 

28,997

 

 

 

 

 

 

 

Less accumulated depreciation and amortization

 

(24,265

)

(23,050

)

Net property and equipment

 

$

6,593

 

$

5,947

 

Long Lived Assets

The Company accounts for goodwill and other intangible assets in accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”).  Under the provisions of SFAS 142, an annual assessment of goodwill impairment is performed.  This assessment involves the use of estimates related to fair market values of the Company’s reporting units with which the goodwill is associated.  The assessment of goodwill impairment in the future will be impacted if future operating cash flows of the Company’s reporting units decline significantly, which could result in decreases in the related estimate of fair market value.  The Company performs its annual impairment analysis as of November 1st of each year and whenever facts and circumstances indicate impairment may exist.

The Company accounts for long lived assets in accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”).  Under the provisions of SFAS 144, long-lived assets, such as property, plant and equipment and purchased intangibles subject to amortization are tested for recoverability whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset.  If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the estimated fair value of the asset.

Deferred Loan Costs

Deferred loan costs consist of loan closing costs associated with the Revolving Credit Agreement.Company’s revolving credit agreement.  The Company chose not to renew the revolving credit agreement which expired by its terms on July 31, 2006.  These costs are beingwere amortized to interest expense over the 36 month life of the Revolving Credit Agreementrevolving credit agreement and are to bewere fully amortized byat July 31, 2006.


Capitalized Software Costs and Acquired Developed Technology

The Company capitalizes the development costs of software, other than internal-use software, in accordance with Statement of Financial Accounting Standards No. 86, “Accounting for Costs of Computer Software to be Sold, Leased or Otherwise Marketed” (“SFAS 86”).  The Company’s policy is to capitalize software development costs incurred in developing a product once technological feasibility of the product has been established. Technological feasibility of the product is determined after completion of a detailed program design and a determination has been made that any uncertainties related to high-risk development issues have been resolved. If the process of developing the product does not include a detail program design, technological feasibility is determined only after completion of a working model. All capitalized software development costs are amortized using an amount determined as the greater of: (1) the ratio that current gross revenues for a capitalized software project bears to the total of current and estimated future gross revenues for that project or (2) the straight-line method over the estimated remaining economic life of the product (generally three to five years). The Company capitalized $526,000$718,000 and $437,000$271,000 in the three months ended April 30,July 31, 2006 and 2005, respectively.  The Company capitalized $1.2 million and $708,000 in the six months ended July 31, 2006 and 2005, respectively.  The software development efforts in both periods were related to several new Cash and Risk solutions within the Global Payments Technologies business segment.

The Company recorded amortization relating to software development costs capitalized of $322,000$324,000 and $266,000$201,000 in the three months ended April 30,July 31, 2006 and 2005, respectively.  The Company recorded amortization relating to software development costs capitalized of $646,000 and $467,000 in the six months ended July 31, 2006 and 2005, respectively.  Amortization expense is recorded as a component of cost of software license fees in the accompanying consolidated statements of operations.

Acquired developed technology includes purchased technology intangible assets associated with acquisitions.  These purchased technology intangibles are initially recorded based on the fair value ascribed at the time of acquisition.

Acquired developed technology with a useful life of 3-6 years is amortized on a straight-line basis, resulting in amortization expense of $1.1 million and $1.2 million for the three months ended April 30,July 31, 2006 and 2005, respectively, and $2.2 million and $2.3 million for the six months ended July 31, 2006 and 2005.  Amortization expense is recorded as a component of cost of software license fees in the accompanying consolidated statements of operations.

The following table sets forth the estimated amortization expense of capitalized software costs and acquired developed technology for the indicated fiscal years ending January 31 (in thousands):

Year

 

Capitalized
Software
Costs

 

Acquired
Developed
Technology

 

 

 

 

 

 

 

Remainder of 2007

 

$

902

 

$

2,952

 

2008

 

830

 

1,200

 

2009

 

331

 

 

 

 

 

 

 

 

Year

 

Capitalized
Software
Costs

 

Acquired
Developed
Technology

 

 

 

 

 

 

 

Remainder of 2007

 

$

577

 

$

1,883

 

2008

 

830

 

1,200

 

2009

 

331

 

 

The table does not include the estimated amortization expense for $902,000$1.6 million of capitalized software products that are currently being developed, and for which amortization has not commenced.

The Company continually monitors the net realizable value of software capitalized and acquired developed technology for factors that would indicate impairment such as a decline in demand or a loss of a significant customer.  During the quarterly period ended January 31, 2006, the Company performed its annual formal evaluation for impairment and determined that the carrying amount of these assets was not impaired and has subsequently noted no factors in the threesix months ended April 30,July 31, 2006 that would indicate impairment.


Revenue Recognition

The Company’s revenue recognition policies are in accordance with Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” as amended by SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions,” Staff Accounting Bulletin (“SAB”) No. 104,Revenue Recognition,” and Emerging Issues Task Force (“EITF”) No. 00-21, “Revenue Arrangements with Multiple Deliverables.”  In the case of software arrangements that require significant production, modification, or customization of software, or the license agreement requires the Company to provide implementation services that are determined to be essential to other elements of the arrangement, the Company follows the guidance in SOP 81-1, “Accounting for Performance of Construction—Construction–Type and Certain Production—Production–Type Contracts.”

In the case of non-software arrangements, we apply EITF No. 00-21 and revenues related to arrangements with multiple elements are allocated to each element based on the element’s relative fair value.  Revenue allocated to separate elements is recognized for each element in accordance with our accounting policies described below.  If we cannot account for items included in a multiple-element arrangement as separate units of accounting, they are combined and accounted for as a single unit of accounting and generally recognized as the undelivered items or services are provided to the customer.

Consulting.The Company employs three primary pricing methods in connection with its delivery of consulting services. First, the Company may price its delivery of consulting services on the basis of time and materials, in which case the customer is charged agreed-upon daily rates for services performed and out-of-pocket expenses. In this case, the Company is generally paid fees and related amounts usually on a monthly basis, and the Company recognizes revenues as the services are performed. Second, the Company may deliver consulting services on a fixed-price basis. In this case, the Company is paid on a monthly basis or pursuant to an agreed upon payment schedule, and the Company recognizes revenues on a proportionate performance basis.  The Company believes that this method is appropriate because of its ability to determine performance milestones and determine dependable estimates of its costs applicable to each phase of a contract.  Because financial reporting of these contracts depends on estimates, which are assessed continually during the term of the contract, costs are subject to revisions as the contract progresses.  Anticipated losses on fixed-price contracts are recognized when estimable.  Third, the Company may deliver consulting services pursuant to a value-priced contract with the customer. In this case, the Company is paid, on an agreed upon basis with the customer, either a specified percentage of (1) the projected increased revenues and/or decreased costs that are expected to be derived by the customer generally over a period of up to twelve months following implementation of its solution or (2) the actual increased revenues and/or decreased costs experienced by the customer generally over a period of up to twelve months following implementation of its solution, subject in either case to a maximum, if any is agreed to, on the total amount of payments to be made to the Company.  The Company must first commit time and resources to develop projections associated with value-pricing contracts before a customer will commit to purchase its solutions, and the Company therefore assumes the risk of making these commitments with no assurance that the customer will purchase the solution.  Costs associated with these value-pricing contracts are expensed as incurred.  These contracts typically include payments to be made to the Company pursuant to an agreed upon schedule ranging from one to twelve months in length.  The Company recognizes revenues generated from consulting services in connection with value-priced contracts once customer acknowledgement is obtained that confirms fees have become fixed and determinable.  In some cases, these acknowledgements contain future deliverables or services, in which case the revenue from these engagements is recognized on a proportionate performance basis based on efforts to be incurred following the customer acknowledgement.  In an effort to allow customers to more closely match expected benefits from services with payments to the Company, the Company on occasion, may offer payment terms which extend beyond 12 months.  When the Company enters into an agreement which has a significant component of the total amount payable under the agreement due beyond 12 months or if it is determined payments are not fixed and determinable at the date the agreement was entered into, revenue under the arrangement will be recognized as payments become due and payable.  When fees are to be paid based on a percentage of actual revenues and/or savings to customers, the Company recognizes revenues only upon completion of all services and as the amounts of actual revenues or savings are confirmed by the customer with a fixed payment date.

Costs associated with time and materials, fixed-priced and value-priced consulting fee arrangements are expensed as incurred and are included as a component of the cost of consulting fees.

The Company expects that value-pricing contracts will continue to account for a significant portion of its revenues in the future. As a consequence of the use of value-pricing contracts and due to the revenue recognition policy associated with those contracts, the Company’s results of operations will likely fluctuate significantly from period to period.

Regardless of the pricing method employed by the Company in a given contract, the Company is typically reimbursed on a monthly basis for out-of-pocket expenses incurred on behalf of its customers.


Software License.A perpetual software license is sold either together with implementation services or on a stand-alone basis.  The Company is usually paid software license fees in one or more installments, as provided in the customer’s contract


but not to exceed twelve months.  The Company recognizes software license revenue upon execution of a contract and delivery of the software, provided that the license fee is fixed and determinable, no significant production, modification or customization of the software is required and collection is considered probable by management.  When the software license arrangement requires the Company to provide implementation services that are essential to the functionality of the software or significant production, customization or modification of the software is required, both the product license revenue and implementation fees are recognized as services are performed.  A term software license is sold either together with implementation services and/or with maintenance services.  These term licenses are usually paid in annual installments over the term of the license.  If the term software license is sold without essential implementation services, the revenue is recognized ratably over the non-cancelable license term.  If the term license is sold with essential implementation services, the license revenue is recognized as the lesser of the amount of license revenue recognized as services are performed or on a ratable basis.

In certain instances, especially with recently developed software, the Company defers software license revenue recognition until the earlier of the product being determined to be generally available and subject to revenue recognition or when the services are completed and the project is accepted by the customer.  This practice is followed for the first two installations of a recently developed software product.  After two successful implementations, the product is considered generally available (“GA”).

Software licenses are often sold as part of a multiple element arrangement that may include maintenance, implementation or consulting.  The Company determines whether there is vendor specific objective evidence of fair value (“VSOEFV”) for each element identified in the arrangement to determine whether the total arrangement fees can be allocated to each element.  If VSOEFV exists for each element, the total arrangement fee is allocated based on the relative fair value of each element.  In cases where there is not VSOEFV for each element, or if it is determined services are essential to the functionality of the software being delivered, or if significant production, modification or customization of the software is required, the Company initially defers revenue recognition of the software license fees until VSOEFV is established or the services are performed.  However, if VSOEFV is determinable for all of the undelivered elements, and assuming the undelivered elements are not essential to the delivered elements, the Company will defer recognition of the full fair value related to the undelivered elements and recognize the remaining portion of the arrangement value through application of the residual method.  Where VSOEFV has not been established for certain undelivered elements, revenue for all elements is deferred until those elements have been delivered or their fair values have been determined.  Evidence of VSOEFV is determined for software products based on actual sales prices for the product sold to a similar class of customer and based on pricing strategies set forth in the Company’s price book.  Evidence of VSOEFV for services (implementation and consulting) is based upon standard billing rates and the estimated level of effort for individuals expected to perform the related services.  The Company establishes VSOEFV for maintenance agreements using the percentage method such that VSOEFV for maintenance is a percentage of the license fee charged annually for a specific software product, which in most instances is 20% of the portion of arrangement fees allocated to the software license element.

Although substantially all of the Company’s current software licenses provide for a fixed price license fee, some licenses instead provide for the customer to pay a monthly license fee based on actual use of the software product.  The level of license fees earned by the Company under these arrangements will vary based on the actual amount of use by the customer.  Revenue under these arrangements is recognized on a monthly basis as the usage becomes determinable.

Software Maintenance.In connection with the sale of a software license, a customer may elect to purchase software maintenance services. Most of the customers that purchase software licenses from the Company also purchase software maintenance services, which typically are renewed annually.  The Company charges an annual maintenance fee, which is typically a percentage of the initial software license fee. The annual maintenance fee generally is paid to the Company at the beginning of the maintenance period, and the Company recognizes these revenues ratably over the term of the related contract.  If the annual maintenance fee is not paid at the beginning of the maintenance period, the Company defers revenue recognition until the time that the maintenance fee is paid by the customer.  The Company normally continues to provide maintenance service while awaiting payment from customers.  When the payment is received, revenue is recognized for the period that revenue was previously deferred.  This may result in volatility in software maintenance revenue from period to period.

Software Implementation and Other Services.In connection with the sale of a software license, a customer may elect to purchase software implementation services, including software enhancements and other software services. Most of the customers that purchase software licenses from the Company also purchase software implementation services.  The Company prices its implementation services on a time-and-materials or on a fixed-price basis, and the Company recognizes the related revenues as services are performed.  Costs associated with these engagements are expensed as incurred.


Outsourcing Services.We currently recognize revenue based on the number of items processed.  These services are billed currently on a monthly basis.


Return Provisions.The Company’s contracts typically do not include right of return clauses, and as a result, the Company does not record a provision for returns.

Royalties

The Company is required to pay royalties in connection with software license, maintenance, and consulting agreements entered into with certain customers under which the Company acquired third party software technology or other intellectual property used in products and services sold to its customers.  Under these arrangements, the Company recognizes royalty expense when the associated revenue is recognized.  For current product offerings, the royalty percentages generally range from 20% to 50% of the associated revenues.  Approximately $439,000$543,000 and $214,000$535,000 of royalty expense was recorded under these agreements in the three months ended April 30,July 31, 2006 and 2005, respectively.respectively, and $982,000 and $749,000 of royalty expense was recorded under these agreements in the six months ended July 31, 2006 and 2005.  Royalty expense is primarily included as a component of the cost of software license revenues; however, certain amounts are also included in cost of consulting revenues and cost of software maintenance revenues in the accompanying consolidated statements of operations.

Deferred Revenue

Deferred revenue represents amounts paid by customers under terms specified in consulting, software licensing, and maintenance contracts for which completion of contractual terms or delivery of the software has not occurred.

Deferred revenue consists of the following (in thousands):

 

April 30,

 

January 31,

 

 

 

2006

 

2006

 

 

 

 

 

 

 

Deferred software maintenance fees

 

$

31,378

 

$

39,343

 

Deferred software implementation and license fees

 

14,511

 

15,769

 

 

 

45,889

 

55,112

 

Less amounts not yet collected

 

(22,671

)

(35,961

)

Net deferred revenue

 

$

23,218

 

$

19,151

 

 

July 31,

 

January 31,

 

 

 

2006

 

2006

 

 

 

 

 

 

 

Deferred software maintenance fees

 

$

24,596

 

$

39,343

 

Deferred software implementation and license fees

 

15,533

 

15,769

 

 

 

40,129

 

55,112

 

Less amounts not yet collected

 

(20,763

)

(35,961

)

Net deferred revenue

 

$

19,366

 

$

19,151

 

Research and Development Costs

Research and development costs which are not subject to capitalization under Statement of Financial Accounting Standards No. 86, “Accounting for the Cost of Computer Software to be Sold, Leased, or Otherwise Marketed” (“SFAS 86”), are expensed as incurred and relate mainly to the development of new products, new applications, new features or enhancements for existing products or applications.  Sustaining maintenance activities are expensed as incurred and charged to cost of revenues software maintenance fees.


Other income (expense)

Other income (expense) is comprised of the following (in thousands):

 

Three Months Ended
April 30,

 

 

 

2006

 

2005

 

 

 

 

 

 

 

Minority share of net loss of Carretek LLC

 

$

133

 

$

318

 

Foreign exchange (losses) / gains

 

70

 

(17

)

Other

 

(3

)

5

 

Total

 

$

200

 

$

306

 

The Company owns a 51% interest in Carretek LLC (“Carretek”), which offers financial institutions offshore-centric outsourcing of their business processes. The minority interest in this loss was recorded in other income (expense) and was $133,000 and $318,000 for the three months ended April 30, 2006 and 2005, respectively.

13




 

Three Months Ended
July 31,

 

Six Months Ended
July 31,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

 

Minority share of net loss of Carretek LLC

 

$

194

 

$

213

 

$

327

 

$

531

 

Foreign exchange gains (losses)

 

123

 

(84

)

193

 

(101

)

Other

 

(2

)

 

(5

)

5

 

Total

 

$

315

 

$

129

 

$

515

 

$

435

 

Income Taxes

The Company accounts for income taxes using the liability method, whereby deferred tax assets and liabilities are determined based on differences between financial reporting and the tax basis of assets and liabilities measured using enacted tax rates and laws that will be in effect when the differences are expected to reverse.  The measurement of deferred tax assets is adjusted by a valuation allowance, if necessary, to recognize the extent to which, based on available evidence, it is more likely than not that the future tax benefits will not be realized.

Earnings Per Share

Basic earnings per share is computed, in accordance with the provisions of SFAS No. 128, “Earnings per Share,” (“SFAS 128”) using the weighted average number of shares of common stock outstanding during each period. Diluted earnings per share is computed using the weighted average number of shares of common stock outstanding during each period and common equivalent shares consisting of stock options and unvested restricted stock (using the treasury stock method), if such stock options and unvested restricted stock have a dilutive effect.

Stock-Based Compensation

The Company has two stock-based employee compensation plans which are more fully described in the Company’s 2005 Annual Report on Form 10-K for the year ended January 31, 2006.

On February 1, 2006, the Company adopted, on a modified prospective basis, SFAS 123(R), “Share Based Payment” (“SFAS 123(R)”).  SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options and shares purchased under an employee stock purchase plan (if certain parameters are not met), to be recognized in the financial statements based on their fair value.

Upon the adoption of SFAS 123(R), the Company began recording compensation cost related to the continued vesting of stock options that remained unvested as of February 1, 2006, as well as for all new stock option grants after our adoption date.  The compensation cost to be recorded is based on the fair value at the grant date.  The adoption of SFAS 123(R) did not have an effect on our recognition of compensation expense relating to the vesting of restricted stock grants.

Prior to the adoption of SFAS 123(R), any cash flows resulting from the tax benefit related to equity-based compensation was presented in operating cash flows, along with other tax cash flows, in accordance with the provisions of EITF 00-15, “Classification in the Statement of Cash Flows of the Income Tax Benefit Received by a Company upon Exercise of a Nonqualified Employee Stock Option” (“EITF 00-15”).  SFAS 123(R) superseded EITF 00-15, amended SFAS 95, “Statement of Cash Flows,” and requires tax benefits relating to excess equity-based compensation deductions to be prospectively presented in the statement of cash flows as financing cash inflows.


Prior to the adoption of SFAS 123(R), we accounted for equity-based compensation under the provisions and related interpretations of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”).  Accordingly, we were not required to record compensation expense when stock options were granted to our employees as long as the exercise price was not less than the fair market value of the stock at the grant date.

The following table presents the impactAs a result of adopting SFAS 123(R) on selected line items for our condensed consolidated financial statementsFebruary 1, 2006, the Company’s net income for the three and six months ended April 30,July 31, 2006 (in thousands, exceptis $340,000 and $722,000 lower, respectively, than if it had continued to account for share-based compensation under APB 25.  Basic earnings per share amounts):

 

Three Months Ended
April 30, 2006

 

 

 

As reported
following
SFAS 123(R)

 

If reported
following
APB No. 25

 

Income (loss) from operations

 

$

(300

)

$

82

 

Income before provision for income taxes

 

66

 

448

 

Net income (loss)

 

(34

)

348

 

Net income per share:

 

 

 

 

 

Basic

 

0.00

 

0.01

 

Diluted

 

0.00

 

0.01

 

Cash flow from operating activities

 

7,913

 

7,913

 

Cash flow from financing activities

 

$

 

$

 


for the three and six months ended July 31, 2006 are $0.01 and $0.03 lower, respectively, and diluted earnings per share for the three and six months ended July 31, 2006 are $0.01 and $0.03 lower, respectively, than if the Company had continued to account for share-based compensation under APB 25.

Determining Fair Value Under SFAS No. 123(R)

Valuation and Amortization Method.The Company estimates the fair value of share-based awards granted using the Black-Scholes option evaluationvaluation model.  The Company amortizes the fair value of all awards on a straight-line basis over the requisite service periods, which are generally the vesting periods.

Expected Life.The expected life of awards granted represents the period of time that they are expected to be outstanding.  The Company determines the expected life using the “simplified method” in accordance with Staff Accounting Bulletin No. 107.

Expected Volatility.Using the Black-Scholes option valuation model, the Company estimates the volatility of its common stock at the date of grant based on the historical volatility of our common stock.

Risk-Free Interest Rate.The Company bases the risk-free interest rate used in the Black-Scholes option valuation model on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term equal to the expected life of the award.

Expected Dividend Yield.The Company has not paid any cash dividends on its common stock in the last ten years and does not anticipate paying any cash dividends in the foreseeable future.  Consequently, the Company uses an expected dividend yield of zero in the Black-Scholes option valuation model.

Expected Forfeitures.The Company uses historical data to estimate pre-vesting option forfeitures and recordedrecords stock-based compensation only for those awards that are expected to vest.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model.  A summary of the weighted average assumptions and results for options granted during the three and six months ended April 30,July 31, 2006 are as follows:

 

Three Months Ended
July 31,

 

Six Months Ended
July 31,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

 

Volatility

 

0.745

 

0.835

 

0.744

 

0.837

 

Weighted-average expected lives (years)

 

4.500

 

4.000

 

4.400

 

4.000

 

Expected dividend yields

 

 

 

 

 

Weighted-average risk-free interest rates

 

5.06

%

3.91

%

5.02

%

3.91

%

Weighted-average fair value of options granted

 

$

4.02

 

$

3.61

 

$

3.93

 

$

3.63

 

 

Three Months Ended
April 30,

 

 

 

2006

 

Volatility

 

.741

 

Weighted-average expected lives

 

4.21 years

 

Expected dividend yields

 

 

Weighted-average risk-free interest rates

 

4.90

%

Weighted-average fair value of options granted

 

$

3.62

 


Share-Based Compensation Under SFAS No. 123(R)

The following table summarizes share-based compensation expense related to share-based awards under SFAS No. 123(R) for the three and six months ended April 30,July 31, 2006 and 2005 which is recorded in the statement of operations as follows (in thousands):

 

Three Months Ended
July 31, 2006

 

Six Months Ended
July 31, 2006

 

 

Three Months Ended
April 30, 2006

 

 

Unvested
Stock
Options

 

Unvested
Restricted
Common
Stock

 

Total

 

Unvested
Stock
Options

 

Unvested
Restricted
Common
Stock

 

Total

 

 

Unvested
Stock Options

 

Unvested Restricted
Common Stock

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenues

 

$

70

 

$

86

 

$

156

 

 

$

63

 

$

98

 

$

161

 

$

133

 

$

184

 

$

317

 

Selling, general and administrative expense

 

303

 

141

 

444

 

 

274

 

175

 

449

 

578

 

316

 

894

 

Research and development expense

 

9

 

13

 

22

 

 

3

 

14

 

17

 

11

 

27

 

38

 

Total share-based compensation

 

$

382

 

$

240

 

$

622

 

 

$

340

 

$

287

 

$

627

 

$

722

 

$

527

 

$

1,249

 

 

 

 

Three Months Ended
July 31, 2005

 

Six Months Ended
July 31, 2005

 

 

 

Unvested
Stock
Options

 

Unvested
Restricted
Common
Stock

 

Total

 

Unvested
Stock
Options

 

Unvested
Restricted
Common
Stock

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenues

 

$

 

$

71

 

$

71

 

$

 

$

126

 

$

126

 

Selling, general and administrative expense

 

 

50

 

50

 

 

118

 

118

 

Research and development expense

 

 

9

 

9

 

 

14

 

14

 

Total share-based compensation

 

$

 

$

130

 

$

130

 

$

 

$

258

 

$

258

 

At April 30,July 31, 2006, the Company had unvested options to purchase 666,825645,721 shares with a weighted average grant date fair value of $3.75.$3.88.  Additionally, the Company had 748,820783,949 shares of unvested restricted common stock with a weighted average fair value on the datedates the award wasawards were granted of $6.11.


$6.22.

The unrecognized compensation costs are expected to be amortized over the following indicated fiscal years ending January 31 (in thousands):

 

Unvested Stock
Options

 

Unvested
Restricted
Common Stock

 

Total

 

 

 

 

 

 

 

 

 

Remainder of 2007

 

$

417

 

$

610

 

$

1,027

 

2008

 

756

 

1,219

 

1,975

 

2009

 

509

 

1,129

 

1,638

 

2010

 

123

 

853

 

976

 

2011

 

 

454

 

454

 

2012

 

 

75

 

75

 

Total

 

$

1,805

 

$

4,340

 

$

6,145

 

 

Unvested Stock
Options

 

Unvested Restricted
Common Stock

 


Total

 

Remainder of 2007

 

$

657

 

$

741

 

$

1,398

 

2008

 

498

 

988

 

1,486

 

2009

 

244

 

898

 

1,142

 

2010

 

22

 

617

 

639

 

2011

 

 

232

 

232

 

2012

 

 

9

 

9

 

Total

 

$

1,421

 

$

3,485

 

$

4,906

 


Stock Option Activity

In the quarter ended January 31, 2006, the Company accelerated the vesting of all unvested stock options, except those options granted to the CEO, with a grant price in excess of $7.50.  This acceleration was accomplished to reduce the stock option expense in future years.  This acceleration will resultresults in approximately $1.9 million of expense savings in future years.over the four year period from February 1, 2006 through January 31, 2010.

On March 10, 2006, the Compensation Committee of the Board of Directors of the Company (the “Committee”) voted to provide for the automatic accelerated vesting of all outstanding stock options and restricted stock of the Company upon the occurrence of certain specified triggering events deemed to constitute a change in control of the Company.  This provision will require the Company to accelerate unrecognized stock-based compensation expense if a change in control event occurs prior to the original vesting schedule of the stock options or restricted stock.

Pursuant to the Director Stock Option Plan, each outside director on August 1st is granted a number of options with a Black-Scholes fair value of $60,000.  Therefore, on August 1, 2006 each outside director received 11,976 options or 107,784 options in the aggregate.

Stock option transactions during the threesix months ended April 30,July 31, 2006 were as follows (dollars and share data in thousands):

 

 

April 30, 2006

 

 

 

Number of
Shares

 

Weighted
Average
Exercise Price

 

Weighted
Average
Remaining
Contractual
Life (Years)

 

Aggregate
Intrinsic Value

 

Stock options outstanding at the beginning of the period

 

3,781

 

$

8.44

 

 

 

Granted

 

62

 

6.13

 

 

 

Exercised

 

 

 

 

 

Forfeited

 

(10

)

7.44

 

 

 

Stock options outstanding at the end of the period

 

3,833

 

$

8.41

 

4.50

 

$

1,948

 

 

 

 

 

 

 

 

 

 

 

Stock options vested and exercisable at the end of the period 

 

3,166

 

$

9.04

 

4.50

 

$

1,291

 

 

Six Months Ended July 31, 2006

 

 

 

Number of
Shares

 

Weighted
Average
Exercise Price

 

Weighted
Average
Remaining
Contractual
Life (Years)

 

Aggregate
Intrinsic Value

 

 

 

 

 

 

 

 

 

 

 

Stock options outstanding at the beginning of the period

 

3,781

 

$

8.44

 

 

 

Granted

 

279

 

6.42

 

 

 

Exercised

 

(63

)

4.52

 

 

 

Forfeited

 

(72

)

8.74

 

 

 

Stock options outstanding at the end of the period

 

3,925

 

$

8.36

 

4.33

 

$

2,436

 

 

 

 

 

 

 

 

 

 

 

Stock options vested and exercisable at the end of the period

 

3,279

 

$

8.85

 

4.24

 

$

1,842

 

Other information pertaining to option activity during the threesix months ended April 30,July 31, 2006 was as follows (dollars in thousands, except per share data):

Weighted average grant-date fair value of options granted

 

$

3.62

 

Total fair value of stock options vested

 

$

637

 

Total intrinsic value of stock options exercised

 

$

 


Weighted average grant-date fair value of options granted

 

$

3.93

 

Total fair value of stock options vested

 

$

 1,371

 

Total intrinsic value of stock options exercised

 

$

145

 

Information related to options outstanding at April 30,July 31, 2006 is summarized below (option amounts in thousands):

Range of Exercise Price

 

Options
Outstanding at
April 30, 2006

 

Weighted Average
Remaining 
Contractual Life

 

Weighted
Average
Exercise Price

 

Options
Vested and
Exercisable at
April 30, 2006

 

Weighted
Average
Exercise Price

 

$2.97 to $4.97

 

1,085

 

4.54

 

$

4.62

 

773

 

$

4.72

 

$5.06 to $8.90

 

1,225

 

4.92

 

7.28

 

888

 

7.72

 

$9.19 to $11.00

 

943

 

3.60

 

9.97

 

925

 

9.97

 

$11.05 to $25.44

 

580

 

5.04

 

15.33

 

580

 

15.33

 

 

 

3,833

 

4.50

 

$

8.41

 

3,166

 

$

9.04

 

Range of Exercise
Price

 

Options
Outstanding at
July 31, 2006

 

Weighted
Average
Exercise Price

 

Weighted
Average
Remaining
Contractual Life

 

Options Vested
and Exercisable
at
July 31, 2006

 

Weighted Average
Exercise Price of
Vested and
Exercisable
Options

 

$3.00 to $4.97

 

1,020

 

$

4.63

 

4.28

 

838

 

$

4.68

 

$5.00 to $7.79

 

830

 

6.32

 

5.45

 

384

 

6.35

 

$8.00 to $9.88

 

795

 

8.62

 

4.07

 

795

 

8.62

 

$10.00 to $25.44

 

1,280

 

12.48

 

3.79

 

1,262

 

12.51

 

 

 

3,925

 

$

8.36

 

4.33

 

3,279

 

$

8.85

 


As of April 30,July 31, 2006, the Company has reserved for issuance under the Plans 5,412,7565,190,995 shares of common stock, of which 3,832,5873,925,062 shares are subject to currently outstanding options to employees and directors, and 1,580,1691,265,933 shares are reserved for future awards.

Restricted Common Stock Activity

For the stock compensation expense related to the restricted common stock issued to employees and officers, the Company is amortizing the compensation expense on a straight line basis over the period that the restrictions on the common stock lapse.  The Company recorded $240,000$287,000 and $128,000$130,000 of compensation expense related to the restricted common stock during the three months ended April 30,July 31, 2006 and 2005, respectively, and $528,000 and $258,000 for the six months ended July 31, 2006 and 2005, respectively.  Restricted common stock transactions during the threesix months ended April 30,July 31, 2006 were as follows (number of shares in thousands):

 

April 30, 2006

 

 

 

Number
of Shares

 

Weighted
Average
Grant Date
Fair Value

 

Restricted common stock unvested at the beginning of the period

 

732

 

$

6.14

 

Granted

 

46

 

6.15

 

Vested and released

 

(22

)

7.22

 

Forfeited

 

(7

)

6.43

 

Restricted common stock unvested at the end of the period

 

749

 

$

6.11

 


 

Six Months Ended
July 31, 2006

 

 

 

Number of
Shares

 

Weighted
Average Grant
Date Fair Value

 

 

 

 

 

 

 

Restricted common stock unvested at the beginning of the period

 

732

 

$

6.14

 

Granted

 

210

 

6.34

 

Vested and released

 

(146

)

5.98

 

Forfeited

 

(12

)

6.41

 

Restricted common stock unvested at the end of the period

 

784

 

$

6.22

 

Prior Period Proforma Presentations

Had compensation cost for stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans in accordance with the provisions of SFAS 123(R), net income and net income per share would have been as follows (in thousands, except per share data):

 

 

Three Months Ended

 

 

 

April 30, 2005

 

Net income, as reported

 

$

498

 

Stock compensation expense recorded under the intrinsic value method

 

128

 

Pro forma stock compensation expense computed under the fair value method

 

(767

)

Pro forma net loss

 

$

(141

)

 

 

 

 

Basic earnings per common share, as reported

 

$

0.02

 

Diluted earnings per common share, as reported

 

$

0.02

 

Pro forma basic loss per common share

 

$

(0.01

)

Pro forma diluted loss per common share

 

$

(0.01

)

Risks and Uncertainties

The Company’s future results of operations and financial condition could be impacted by the following factors, among others: dependence on the banking industry, decline in check volumes, fluctuations in operating results, relatively fixed costs, product and service mix, lack of long-term agreements, dependence on key personnel, rapid technological change and dependence on new products, strategic alliances or acquisitions, focus on providing business process outsourcing with a significant offshore component, ability to attract and retain qualified personnel, customer concentration, competition, proprietary rights, infringement claims, dependence on third parties for technology licenses, liability claims, defects in our software and solutions, our ability to protect our information technology infrastructure, international operations, changing government and tax regulations, stock price fluctuations, impairment of goodwill or intangible assets, realization of revenue from contracted sales, potential sales, backlog and deferred revenue, the resolution of a pending class action lawsuit, anti-takeover provisions and the restatement of prior period financial statements.

 

Three Months
Ended

 

Six Months
Ended

 

 

 

July 31, 2005

 

July 31, 2005

 

 

 

 

 

 

 

Net income, as reported

 

$

1,054

 

$

1,552

 

Stock compensation expense recorded under the intrinsic value method

 

130

 

258

 

Pro forma stock compensation expense computed under the fair value method

 

(989

)

(1,743

)

Pro forma net income

 

$

195

 

$

67

 

 

 

 

 

 

 

Basic earnings per common share, as reported

 

$

0.04

 

$

0.06

 

Diluted earnings per common share, as reported

 

$

0.04

 

$

0.06

 

Pro forma basic loss per common share

 

$

0.01

 

$

0.00

 

Pro forma diluted loss per common share

 

$

0.01

 

$

0.00

 


Financial Guarantees

In November 2002, the FASB issued Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.”  FIN 45 requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee or indemnification.  FIN 45 also requires additional disclosure by a guarantor in its interim and annual consolidated financial statements about its obligations under certain guarantees and indemnifications.  The following is a summary of the agreements that the Company has determined are within the scope of FIN 45:

Under the terms of the majority of the Company’s software license agreements with its customers, the Company agrees that in the event the software sold infringes upon any patent, copyright, trademark, or any other proprietary right of a third party, it will indemnify its customer licensee against any loss, expense, or liability from any damages that may be awarded against its customer.  The Company includes this infringement indemnification in most of its software license agreements.  In the event the customer cannot use the software or service due to infringement and the Company cannot obtain the right to use, replace or modify the license or service in a commercially feasible manner so that it no longer infringes, then the Company may generally terminate the license and provide the customer a pro-rata refund of the fees paid by the customer for the infringing license or service.  The Company has recorded no liability associated with this indemnification, as it is not aware of any pending or threatened infringement actions that are probable losses. The Company believes the estimated fair value of these intellectual property indemnification clauses is minimal.

The Company has agreed to indemnify members of the board of directors, officers and certain key employees of the Company if they are made a party or are threatened to be made a party to any proceeding by reason of the fact that they are acting in their capacities on behalf of the Company, or by reason of anything done or not done by them in any such capacities.  The indemnity is for any and all expenses and liabilities of any type whatsoever (including but not limited to, judgments, fines and amounts paid in settlement) actually and reasonably incurred by the directors, officers and key employees in connection with the investigation, defense, settlement or appeal of such proceeding, provided they acted in good faith.  The Company maintains insurance coverage for directors and officers liability (“D&O insurance”).  No maximum liability is stipulated in these agreements that include indemnifications of members of the board of directors, officers and certain key employees of the Company.  The Company has recorded no liability associated with these indemnifications as it is not aware of any pending or threatened actions or claims against the members of its board of directors or officers that are probable losses in excess of amounts covered by its D&O insurance. As

Recently Issued Accounting Standards

In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” – an interpretation of FAS 109, “Accounting for Income Taxes” (“FIN 48”) to create a resultsingle model to address accounting for uncertainty in tax positions.  FIN 48 clarifies the accounting for income taxes, by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements.  FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition.  FIN 48 is effective for fiscal years beginning after December 15, 2006.  The Company will adopt FIN 48 as of February 1, 2007, as required.  The cumulative effect of adopting FIN 48 will be recorded in retained earnings and other accounts as applicable.  The Company has not determined the insurance policy coverage,effect, if any, that the Company believesadoption of FIN 48 will have on the estimated fair valueCompany’s financial position and results of these indemnification agreements is minimal.operations.


3.           Goodwill and Intangible Assets

Goodwill and intangible assets deemed to have indefinite lives are not amortized but are subject to annual impairment tests.  Other intangible assets, which include acquired developed technology and customer relationships, are amortized over their estimated useful lives.

Customer relationships, obtained in the acquisition of Check Solutions in June 2001, with finite useful lives are amortized on a straight-line basis, which resulted in amortization expense of $350,000 during the three months ended April 30,July 31, 2006 and 2005, respectively.respectively, and $700,000 during the six months ended July 31, 2006 and 2005.

The following table sets forth the estimated amortization expense of customer relationships for the indicated fiscal years ending January 31 (in thousands):

Year

 

 

 

Amount

 

Remainder of 2007

 

$

1,050

 

2008

 

467

 

Year

 

Amount

 

 

 

 

 

Remainder of 2007

 

$

700

 

2008

 

467

 

During the fourth quarter of the year ended January 31, 2006, the Company performed its annual evaluation for goodwill impairment and determined that the carrying amount of goodwill was not impaired and subsequently havehas noted no factors that would indicate impairment.


4.           Revolving Credit Agreement

The Company ishas been a party to a revolving credit agreement with a group of banks providing for a commitment amount of $30.0 million and a maturity date of July 31, 2006.  The Company didchose not have any borrowings outstanding under the revolving credit agreement at April 30, 2006. Borrowings underto renew the credit agreement bear interest equalfacility, which expired by its terms on July 31, 2006, as current cash on hand, marketable securities and cash generated from operations are believed to either the greater of prime or federal funds rate plus a margin ranging from 1.25%be sufficient to 2.25% depending onmeet the Company’s ratio of funded debt to Earnings before Interest, Taxes, Depreciation and Amortization (“EBITDA”), or LIBOR plus a margin equal to 2.75% to 3.75% depending oncash requirements for the Company’s ratio of funded debt to EBITDA. Interest payments are due quarterly. The Company is required to pay an annual commitment fee equal to 0.50% onforeseeable future.  By not renewing the unused amount of the revolving credit agreement. The revolving credit agreement contains customary affirmative and negative covenants, including financial covenants requiring the maintenance of specified interest coverage, ratio of EBITDA to funded debt, and ratio of 80% of accounts receivable, cash and short term investments to funded debt. Additionally, the payment of dividends and the purchase of treasury stock is precluded and subject to the approval of the banks. Substantially all of the Company’s assets collateralize the revolving credit agreement. As of April 30, 2006,facility, the Company is in compliancewill be able to avoid certain fees and expenses associated with the covenantsrenewing and maintaining a line of the revolving credit agreement as amended.credit.

Interest expense, including the commitment fee and exclusive of the amortization of deferred loan costs on the credit agreement, was $37,000$38,000 for the three months ended April 30,July 31, 2006 and 2005, and $76,000 for the six months ended July 31, 2006 and 2005.

5.           Provision for Income Taxes

The Company has established a valuation allowance to reserve its net deferred tax assets at April 30,July 31, 2006 because of the Company’s inconsistent history of generating profitable operations and taxable income.  The tax provision was computed based on actual results by jurisdiction which resulted in a foreign tax provision of $100,000$134,000 and $81,000$102,000 for the three months ended April 30,July 31, 2006 and 2005, respectively, and $234,000 and $183,000 for the six months ended July 31, 2006 and 2005, respectively.  In addition to the provision for foreign taxes, the Company recorded $20,000 and $15,000 of U.S. Federal and State tax expense in the three and six months ended July 31, 2006 and 2005, respectively, for alternative minimum tax purposes.


6.    Benefit Plans

401(k) Plan

The Company has adopted a plan pursuant to Section 401(k) of the Internal Revenue Code (“the Code”) whereby participants may contribute a percentage of compensation not in excess of the maximum allowed under the Code. Employer matching contributions amounted to $286,000$256,000 and $338,000$267,000 for the three months ended April 30,July 31, 2006 and 2005, respectively, and $542,000 and $605,000 for the six months ended July 31, 2006 and 2005, respectively. The Company may make additional contributions at the discretion of the Board of Directors.  No discretionary contributions were made during the three and six months ended April 30,July 31, 2006 and 2005.

Incentive Compensation Plans

The Carreker Incentive Bonus Plan (“CIBP”) awards employees bonuses based on the Company’s or the applicable business unit’s operating results.  Substantially all employees are eligible to receive cash awards under the CIBP.  Awards from this plan are paid to employees subsequent to the end of the fiscal year.  The Company’s Compensation Committee of the Board of Directors has the authority to determine the final amount of the bonus that is ultimately paid to the officers of the Company.  In the three months ended April 30,July 31, 2006 and 2005, the Company recorded expense under this plan of approximately $0$504,000 and $244,000,$19,000, respectively.  In the six months ended July 31, 2006 and 2005, the Company recorded expense under this plan of approximately $504,000 and $263,000, respectively.

The Company pays discretionary bonuses to key employees based primarily on the extent to which individuals meet agreed-upon objectives for the year. The Company recorded discretionary bonus expense of approximately $0 and $265,000$459,000 for the three months ended April 30,July 31, 2006 and 2005, respectively, and $0 and $724,000 for the six months ended July 31, 2006 and 2005, respectively.


7.    Earnings Per Share

The following table sets forth the computation of basic and diluted earnings (loss) per share (in thousands, except per share amounts):

 

Three Months Ended
April 30,

 

 

 

2006

 

2005

 

Basic earnings (loss) per share:

 

 

 

 

 

Net income (loss)

 

$

(34

)

$

498

 

 

 

 

 

 

 

Weighted average shares outstanding

 

23,916

 

24,425

 

 

 

 

 

 

 

Basic earnings (loss) per share

 

$

0.00

 

$

0.02

 

 

 

 

 

 

 

Diluted earnings (loss) per share:

 

 

 

 

 

Net income (loss)

 

$

(34

)

$

498

 

 

 

 

 

 

 

Weighted average shares outstanding

 

23,916

 

24,425

 

Assumed conversion of employee stock options and unvested restricted stock

 

 

442

 

Shares used in diluted earnings per share calculation

 

23,916

 

24,867

 

 

 

 

 

 

 

Diluted earnings (loss) per share

 

$

0.00

 

$

0.02

 

 

 

Three Months Ended
July 31,

 

Six Months Ended
July 31,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share:

 

 

 

 

 

 

 

 

 

Net income

 

$

961

 

$

1,054

 

$

927

 

$

1,552

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding

 

24,041

 

24,127

 

23,986

 

24,326

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

0.04

 

$

0.04

 

$

0.04

 

$

0.06

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share:

 

 

 

 

 

 

 

 

 

Net income

 

$

961

 

$

1,054

 

$

927

 

$

1,552

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding

 

24,041

 

24,127

 

23,986

 

24,326

 

Assumed conversion of employee stock options and unvested restricted stock

 

420

 

294

 

421

 

377

 

Shares used in diluted earnings per share calculation

 

24,461

 

24,421

 

24,407

 

24,703

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share

 

$

0.04

 

$

0.04

 

$

0.04

 

$

0.06

 

Options for 3,832,5872,439,901 shares and 2,614,5952,609,894 shares for the three months ended April 30,July 31, 2006 and 2005, respectively, and 2,439,901 shares and 2,666,520 shares for the six months ended July 31, 2006 and 2005, respectively, have been excluded from the diluted earnings per share computation as the options were anti-dilutive.

21





8.           Commitments and Contingencies

Shareholder Derivative Suit.

On June 15, 2004, by mutual agreement between the parties, Smith v. Carreker Corporation, et. al, Civil Action No. 303CV1211-M was reinstated in the United States District Court for the Northern District of Texas, Dallas Division. This action was originally filed on May 29, 2003, in the United States District Court for the Northern District of Texas, Dallas Division as Civil Action no. 303CV1211-D. On January 15, 2004, the Court, acting upon the joint motion of the parties, dismissed the action without prejudice. This action was brought as a shareholders’ derivative action pursuant to Rule 23.1, Fed.R.Civ.P. for the benefit of Nominal Defendant Carreker Corporation against certain of its current and former officers and directors, i.e., John D. Carreker, Jr., James D. Carreker, Richard R. Lee, Jr., James L. Fischer, Donald L. House, David K. Sias, Terry L. Gage, James R. Erwin, Ronald G. Steinhart and Ronald Antinori, seeking to remedy their individual breaches of fiduciary duty, including their knowing violations of Generally Accepted Accounting Principles (“GAAP”), knowing violations of federal and state securities laws, acts of bad faith and other breaches of fiduciary duty. The plaintiff sought redress (the form of which includes, among others, unspecified amounts of compensatory damages, interest and costs, including legal fees) for injuries to the Company and its shareholders caused by Defendants’ misfeasance and/or malfeasance during the period from May 20, 1998 through December 10, 2002. In May 2006, the District Court approved the final settlement of the derivative claims brought in this action, pursuant to which the Company agreed to adopt certain corporate governance enhancements and cover plaintiffs’ attorney’s fees and litigation expenses up to $300,000 and the litigation was terminated. Neither the Company nor any of its current or former officers and directors made any admission of wrongdoing.

Shareholder Class Action.

On April 16, 2003 the United States District Court for the Northern District of Texas, Dallas Division, issued an order consolidating a number of purported class action lawsuits into a Consolidated Action styled In re Carreker Corporation Securities Litigation, Civil Action No. 303CV0250-M. On October 14, 2003 the plaintiffs filed their Consolidated Class Action Complaint. The complaint, filed on behalf of purchasers of the Company’s common stock between May 20, 1998 and December 10, 2002, inclusive, alleged violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 against all defendants (the Company, John D. Carreker Jr., Ronald Antinori, Terry L. Gage and Ernst & Young, the Company’s auditors), violations of Section 20(a) of the Exchange Act against the individual defendants, and violation of Section 20A of the Securities Exchange Act against defendants John D. Carreker, Jr. and Ronald Antinori.  The complaint also alleges, among other things, that defendants artificially inflated the value of Carreker stock by knowingly or recklessly misrepresenting the Company’s financial results during the purported class period.  On March 22, 2005 the Court dismissed the action without prejudice and allowed the plaintiffs 60 days in which to file an amended complaint. Also the Court dismissed, with prejudice, all claims by shareholders relating to periods prior to July 31, 1999.

On May 31, 2005, the plaintiffs filed an Amended Consolidated Class Action Complaint on behalf of purchasers of the Company’s common stock between July 30, 1999 and December 10, 2002, inclusive, which reiterates the allegations in the first complaint, and alleges violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 against all defendants (the Company, John D. Carreker Jr., Ronald Antinori and Terry L. Gage) except Ernst & Young LLP, violations of Section 20(a) of the Exchange Act against the individual defendants, and violations of Section 20A of the Securities Exchange Act against defendants John D. Carreker, Jr. and Ronald Antinori.  The plaintiffs are seekingsought unspecified amounts of compensatory damages, interest and costs, including legal fees.

On April 21, 2006, counsel for the plaintiffs and defendants executed and submitted to the Court a stipulation of settlement whereby they have agreed to settle the class action litigation for a payment of $5,250,000.  The proposed settlement was preliminarily approved by the District Court entered a Final Judgment and Order of Dismissal with Prejudice on May 5,August 17, 2006 but remains subject to final court approval. At this time, there can be no assurance thatconcluding the settlement will receive final court approval.

litigation.  The settlement paymentspayment in both the shareholder derivative suit and the class action arewas fully covered by the Company’s directors and officer’s insurance policies.

The Company is periodically involved in various other legal actions and claims which arise in the normal course of business.  In the opinion of management, the final disposition of these matters is not expected to have a material adverse effect on the Company’s financial position or results of operations.

22





9.              Business Segments and Revenue Concentration

The tables below show revenues and income (loss) from operations for the periods indicated for our four reportable business segments: Revenue Enhancement, Global Payments Technologies, Global Payments Consulting and Business Process Outsourcing.  Certain prior year amounts have been reclassified to conform with the current year business segment presentation.  Our customer projects are sold on a solution basis, so it is necessary to break them down by segment and allocate accordingly.  Included in “Corporate Unallocated” are costs related to selling and marketing, and certain unallocated corporate overhead expense such as executive management, finance, accounting, human resources, legal and certain IT and facility functions.  Business segment results, which include costs for research and development as well as product royalty expense, the amortization and impairment of goodwill and intangible assets, the write-off of capitalized software costs and restructuring and other charges, were as follows (in thousands):

 

Three months ended April 30, 2006

 

 

Three months ended July 31, 2006

 

 

Revenue
Enhancement

 

Global
Payments
Technologies

 

Global
Payments
Consulting

 

Business
Process
Outsourcing

 

Corporate
Unallocated

 

Total

 

 

Revenue
Enhancement

 

Global
Payments
Technologies

 

Global
Payments
Consulting

 

Business
Process
Outsourcing

 

Corporate
Unallocated

 

Total

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consulting

 

$

7,517

 

$

142

 

$

899

 

$

 

$

 

$

8,558

 

 

$

6,251

 

$

121

 

$

467

 

$

 

$

 

$

6,839

 

Software license

 

179

 

2,135

 

243

 

 

 

2,557

 

 

69

 

5,396

 

28

 

 

 

5,493

 

Software maintenance

 

96

 

10,425

 

231

 

 

 

10,752

 

 

69

 

10,599

 

231

 

 

 

10,899

 

Software implementation and other services

 

535

 

3,205

 

395

 

 

 

4,135

 

 

641

 

3,399

 

209

 

 

 

4,249

 

Outsourcing services

 

 

 

 

510

 

 

510

 

 

 

 

 

530

 

 

530

 

Out-of-pocket expense reimbursements

 

271

 

311

 

151

 

 

 

733

 

 

323

 

387

 

83

 

 

 

793

 

Total revenues

 

$

8,598

 

$

16,218

 

$

1,919

 

$

510

 

$

 

$

27,245

 

 

$

7,353

 

$

19,902

 

$

1,018

 

$

530

 

$

 

$

28,803

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

$

3,393

 

$

1,655

 

$

453

 

$

(291

)

$

(5,510

)

$

(300

)

 

$

1,740

 

$

4,528

 

$

(176

)

$

(360

)

$

(5,253

)

$

479

 

 

 

Three months ended April 30, 2005

 

 

Three months ended July 31, 2005

 

 

Revenue
Enhancement

 

Global
Payments
Technologies

 

Global
Payments
Consulting

 

Business
Process
Outsourcing

 

Corporate
Unallocated

 

Total

 

 

Revenue
Enhancement

 

Global
Payments
Technologies

 

Global
Payments
Consulting

 

Business
Process
Outsourcing

 

Corporate
Unallocated

 

Total

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consulting

 

$

7,722

 

$

50

 

$

546

 

$

 

$

 

$

8,318

 

 

$

8,832

 

$

2

 

$

668

 

$

 

$

 

$

9,502

 

Software license

 

301

 

3,058

 

 

 

 

3,359

 

 

252

 

3,415

 

115

 

 

 

3,782

 

Software maintenance

 

114

 

10,970

 

228

 

 

 

11,312

 

 

152

 

10,210

 

214

 

 

 

10,576

 

Software implementation and other services

 

475

 

3,550

 

109

 

 

 

4,134

 

 

1,176

 

3,523

 

193

 

 

 

4,892

 

Outsourcing services

 

 

 

 

257

 

 

257

 

 

 

 

 

241

 

 

241

 

Out-of-pocket expense reimbursements

 

387

 

340

 

91

 

 

 

818

 

 

485

 

331

 

111

 

 

 

927

 

Total revenues

 

$

8,999

 

$

17,968

 

$

974

 

$

257

 

$

 

$

28,198

 

 

$

10,897

 

$

17,481

 

$

1,301

 

$

241

 

$

 

$

29,920

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

$

3,938

 

$

2,073

 

$

(300

)

$

(626

)

$

(4,851

)

$

234

 

 

$

5,470

 

$

1,690

 

$

8

 

$

(430

)

$

(5,770

)

$

968

 


 

 

Six months ended July 31, 2006

 

 

 

Revenue
Enhancement

 

Global
Payments
Technologies

 

Global
Payments
Consulting

 

Business
Process
Outsourcing

 

Corporate
Unallocated

 

Total

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

Consulting

 

$

13,769

 

$

262

 

$

1,366

 

$

 

$

 

$

15,397

 

Software license

 

248

 

7,531

 

271

 

 

 

8,050

 

Software maintenance

 

164

 

21,025

 

462

 

 

 

21,651

 

Software implementation and other services

 

1,176

 

6,604

 

604

 

 

 

8,384

 

Outsourcing services

 

 

 

 

1,040

 

 

1,040

 

Out-of-pocket expense reimbursements

 

594

 

698

 

234

 

 

 

1,526

 

Total revenues

 

$

15,951

 

$

36,120

 

$

2,937

 

$

1,040

 

$

 

$

56,048

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

$

5,133

 

$

6,183

 

$

277

 

$

(651

)

$

(10,763

)

$

179

 

 

 

Six months ended July 31, 2005

 

 

 

Revenue
Enhancement

 

Global
Payments
Technologies

 

Global
Payments
Consulting

 

Business
Process
Outsourcing

 

Corporate
Unallocated

 

Total

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

Consulting

 

$

16,554

 

$

52

 

$

1,214

 

$

 

$

 

$

17,820

 

Software license

 

553

 

6,473

 

115

 

 

 

7,141

 

Software maintenance

 

265

 

21,180

 

443

 

 

 

21,888

 

Software implementation and other services

 

1,652

 

7,072

 

302

 

 

 

9,026

 

Outsourcing services

 

 

 

 

498

 

 

498

 

Out-of-pocket expense reimbursements

 

872

 

672

 

201

 

 

 

1,745

 

Total revenues

 

$

19,896

 

$

35,449

 

$

2,275

 

$

498

 

$

 

$

58,118

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

$

9,408

 

$

3,763

 

$

(292

)

$

(1,056

)

$

(10,621

)

$

1,202

 

 

During the three monthsyear ended JulyJanuary 31, 2003,2004, the Company formed Carretek LLC (Carretek), in which it owns a 51% interest, to offer financial institutions offshore-centric outsourcing of their business processes and IT services needs.  During July 2004, Carretek signed its first contract to perform outsourced services with a customer.

The 49% share relating to the minority interest in the Carretek losses, which was $133,000$194,000 and $318,000$213,000 for the three months ended April 30,July 31, 2006 and 2005, respectively, and $327,000 and $531,000 for the six months ended July 31, 2006, respectively, was recorded in other income in the accompanying consolidated statements of operations.  The Company and its partner have funded Carretek to date in the aggregate amount of $4.5$4.9 million of equity.  Carretek’s operations are included in our business process outsourcing segment.


The following table summarizes revenues, exclusive of out-of-pocket expense reimbursements, derived from the Company’s largest customer and top five customers during the periods indicated.

 

Three Months Ended

 

Six Months Ended

 

 

July 31,

 

July 31, 

 

 

Three Months Ended
April 30,

 

 

2006

 

2005

 

2006

 

2005

 

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

Single customer

 

21

%

14

%

 

12.1

%

15.0

%

16.6

%

12.2

%

Top five customers

 

47

%

44

%

 

42.4

%

39.0

%

42.6

%

38.3

%

 

U.S. Bank accounted for approximately 21% and Wells Fargo accounted for approximately 10%12.1% of total revenues during the three months ended April 30,July 31, 2006 and Wells FargoNational City Corporation accounted for approximately 14%15.0% of total revenues during the three months ended April 30,July 31, 2005. U.S. Bank accounted for approximately 16.6% of total revenues during the six months ended July 31, 2006 and Wells Fargo accounted for approximately 12.2% of total revenues during the six months ended July 31, 2005.

The Company markets its solutions in several foreign countries.  Revenues, exclusive of out-of-pocket expense reimbursements, attributed to countries based on the location of the customers were as follows (in thousands):

 

Three Months Ended

 

 

July 31,

 

July 31,

 

 

Three Months Ended

 

Three Months Ended

 

 

2006

 

2005

 

 

April 30,
2006

 

April 30,
2005

 

 

Amount

 

Percent of
total
revenues

 

Amount

 

Percent of
total
revenues

 

 


Amount

 

Percent of 
total revenues

 


Amount

 

Percent of 
total revenues

 

 

 

 

 

 

 

 

 

 

United States

 

$

21,507

 

81

%

$

20,043

 

73

%

 

$

23,148

 

83

%

$

20,890

 

72

%

Europe

 

1,099

 

4

 

2,334

 

9

 

 

1,269

 

4

 

1,548

 

5

 

Canada

 

1,972

 

8

 

1,861

 

7

 

 

1,871

 

7

 

1,562

 

6

 

Asia Pacific

 

1,101

 

4

 

1,062

 

4

 

 

1,282

 

4

 

1,769

 

6

 

South Africa

 

211

 

1

 

2,010

 

7

 

 

188

 

1

 

2,410

 

8

 

Other

 

622

 

2

 

70

 

 

 

252

 

1

 

814

 

3

 

Total revenues

 

$

26,512

 

100

%

$

27,380

 

100

%

 

$

28,010

 

100

%

$

28,993

 

100

%

 

 

Six Months Ended

 

 

 

July 31,

 

July 31,

 

 

 

2006

 

2005

 

 

 

Amount

 

Percent of
total
revenues

 

Amount

 

Percent of
total
revenues

 

 

 

 

 

 

 

 

 

 

 

United States

 

$

44,686

 

82

%

$

40,962

 

73

%

Europe

 

2,367

 

4

 

3,319

 

6

 

Canada

 

3,831

 

7

 

3,422

 

6

 

Asia Pacific

 

2,376

 

4

 

2,831

 

5

 

South Africa

 

402

 

1

 

4,420

 

8

 

Other

 

860

 

2

 

1,419

 

2

 

Total revenues

 

$

54,522

 

100

%

$

56,373

 

100

%

 


10.    Restructuring and Other Charges

There were no restructuring and other charges recorded during the three months ended April 30,Q1 2006.  However, the Company recorded $127,000 in restructuring and other charges during the three month period ended April 30,Q1 2005, principally associated with the separation of 6 employees.  The Company also lowered its estimate by $32,000 for the costs associated with the discontinuance of one of its software offerings originally recorded in January 2004.

There were no restructuring and other charges recorded during Q2 2006.  However, the Company recorded $28,000 in restructuring and other charges during Q2 2005, principally associated with the separation of 2 employees

The activity related to the accrued merger and restructuring costs during the three and six months ended April 30,July 31, 2006 is as follows (in thousands):

 

 

Workforce
Reductions

 

Check Flow
Suite

 

Other

 

Total

 

Reserve balance at January 31, 2006

 

$

87

 

$

200

 

$

47

 

$

334

 

Additions to reserve balance:

 

 

 

 

 

 

 

 

 

Severance charges

 

 

 

 

 

Reductions to reserve balances:

 

 

 

 

 

 

 

 

 

Change in estimate

 

 

 

 

 

Cash paid

 

(87

)

 

 

(87

)

Reserve balance at April 30, 2006

 

$

 

$

200

 

$

47

 

$

247

 

 

Workforce
Reductions

 

CheckFlow
Suite

 

Other

 

Total

 

 

 

 

 

 

 

 

 

 

 

Reserve balance at January 31, 2006

 

$

87

 

$

200

 

$

47

 

$

334

 

Cash paid

 

(87

)

 

 

(87

)

Reserve balance at April 30, 2006 and July 31, 2006

 

$

 

$

200

 

$

47

 

$

247

 

 

The Company anticipatesexpects to complete these existing obligations by the remaining reserve accruals at April 30, 2006 will be paid or remaining customer obligations completed withinend of the next 3 months.fiscal year ending January 31, 2007.


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

All statements other than statements of historical fact contained in this report, including statements in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” concerning our financial position and liquidity, results of operations, prospects for future growth, and other matters, are forward-looking statements.  Although we believe that the expectations reflected in such forward-looking statements are reasonable, no assurance can be given that such expectations will prove correct.  Factors that could cause our results to differ materially from the results discussed in, or contemplated by, such forward-looking statements include the risks described under “Risk Factors” contained in our Form 10-K for the year ended January 31, 2006, as filed with the Securities and Exchange Commission (“SEC”).  Such risks include, without limitation: dependence on the banking industry, decline in check volumes, fluctuations in operating results, relatively fixed costs, product and service mix, lack of long-term agreements, dependence on key personnel, rapid technological change and dependence on new products, strategic alliances or acquisitions, focus on providing business process outsourcing with a significant offshore component, ability to attract and retain qualified personnel, customer concentration, competition, proprietary rights, infringement claims, dependence on third parties for technology licenses, liability claims, defects in our software and solutions, our ability to protect our information technology infrastructure, international operations, changing government and tax regulations, stock price fluctuations, impairment of goodwill or intangible assets, realization of revenue from contracted sales, potential sales, backlog and deferred revenue, the resolution of a pending class action lawsuit, anti-takeover provisions, and the restatement of prior period financial statements.statements and our exploration of strategic alternatives.  All forward-looking statements in this report are expressly qualified in their entirety by the cautionary statements in this paragraph, in the “Risk Factors” included in our SEC filings and elsewhere in this report.

Overview

Since 1978, Carreker Corporation has designed, developed, sold and delivered payments-related software and consulting solutions to financial institutions and financial service providers.  More recently, we have introduced a business process outsourcing solution to our customers.  Our products and services address a broad spectrum of payment activities and are designed to help our clients enhance the performance of their payments businesses; improve operational efficiency in payments processing; enhance revenue and profitability from payments-oriented products and services; reduce losses associated with fraudulent payment transactions; facilitate compliance with risk-related laws and regulations; and/or maximize clients’ customer income streams by aligning their customer interactions and products with customer needs.  Carreker employed a total of 491492 employees at April 30,July 31, 2006.


We are organized into four business unit operating divisions: Global Payments Technologies (“GPT”), Revenue Enhancement (“RevE”), Global Payments Consulting (“GPC”) and a Business Process Outsourcing business which is delivered through a majority-owned subsidiary named Carretek LLC (“Carretek”) to address the payments outsourcing arena.  These operating divisions are operated in distinct yet increasingly synergistic ways to bring value to our clients.

Global Payments Technologies.  This division is responsible for design, development, sales, and support of our technology solutions.  The division has three lines of business with distinct solution offerings:  Risk solutions, Payments solutions and Cash & Logistics solutions.  Revenue is primarily derived from license fees, implementation fees and maintenance fees.  As of April 30,July 31, 2006, GPT had 285282 employees.

Revenue Enhancement.  This highly specialized division provides consulting and software solutions focused on increasing clients’ revenue streams.  Areas of expertise include fee income, market segmentation, management of customer price structures, account retention, account acquisitions and profitability.  A majority of the revenue generated by this division is through benefit-sharing agreements with our customers, recorded as consulting revenue along with license fees, maintenance fees and implementation fees from our CVE software offering.  As of April 30,July 31, 2006, RevE had 8385 employees.

Global Payments Consulting.  The objective of this professional services division is to provide our clients with “applied thought leadership” related to the business of payments.  Revenue in the GPC division is primarily derived through the delivery of consulting services offered primarily on a time and materials basis to our clients, along with the license fees, maintenance fees and services fees associated with our Float Pricing System software offering and Payments Clearing Model product offering.  As of April 30,July 31, 2006, GPC had 23 employees.

Business Process Outsourcing.In fiscal 2003 we formed Carretek.  Carretek is a transformational business outsourcer for information technology and payment and transaction processing jointly owned by Carreker Corporation and Majesco Software, Inc., the U.S. subsidiary of Mastek Limited, a leading Indian outsourcing company with global operations.  As of April 30,July 31, 2006, 2 of the Company’s U.S. based employees and 131119 offshore personnel of Mastek Limited were seconded to Carretek on a contract basis.


Cost of Revenues and Gross Margins.We strive to control our cost of revenues and thereby maintain or improve our gross margins.  The major items impacting cost of consulting, cost of software maintenance and cost of software implementation are personnel, overhead and related expenses.  The major items impacting cost of software licenses are amortization of both capitalized and acquired software and also software royalties for software from third parties.  While the amortization expense is relatively fixed, the third party royalty expense can vary significantly based on the relative product mix.

Operating Expenses.Operating expenses, including selling, general and administrative and research and development, are substantially driven by personnel and overhead expenses.  Other significant operating expenses that we monitor include professional fees, use of contractors, travel, insurance and office services expenses.  As of April 30,July 31, 2006, the Corporate Account Relationship Management and Marketing staff had 1820 employees, and the Corporate staff which includes Executive Management, Legal, Finance and Accounting, Human Resources, Facilities and IT had 80 employees.

Liquidity and Cash Flows.Cash and cash equivalents at April 30,July 31, 2006 and January 31, 2006 totaled $34.8$27.6 million and $29.7 million, respectively.  In addition, we had $5.9$5.9 million of marketable debt securities at April 30,July 31, 2006, as compared to $4.7 million at January 31, 2006.  At April 30,July 31, 2006 and January 31, 2006, there were no borrowings outstanding under our revolving credit agreement.  Additionally, we did not renew our revolving credit agreement which expired by its terms on July 31, 2006 as current cash on hand, marketable securities and our cash projected to be generated from operations are believed to be sufficient to meet our cash requirements for the foreseeable future.

Products and Services

The products and services of our primary operating divisions are described below in this sequence: Global Payments Technologies (“GPT”), Revenue Enhancement (“RevE”), Global Payments Consulting (“GPC”) and Business Process Outsourcing.

Global Payments Technologies.Carreker’s technology solutions help financial institutions address the needs of some critical payment services and delivery functions that impact overall operating revenues and costs and risk management.  These functions include presentment of checks in paper and electronic form, identification and mitigation of fraudulent payments, handling irregular items such as checks returned unpaid (exceptions), maintaining a record of past transactions (archiving), responding to related customer inquiries (research), and correcting any errors that are discovered (adjustments).  Global Payments Technologies (“GPT”) solutions address these and other key functions in the context of improving operational efficiency and a gradual transition from paper to electronic-based payment systems.  GPT offers risk management solutions that mitigate depository account risk through profiling and advanced analytics technology.  GPT risk management solutions leverage transaction monitoring and filtering capabilities for AML and OFAC compliance.  Finally, we offer technology solutions that optimize the inventory management of a bank’s cash stock levels and logistical service requirements, including managing how much is needed, when it is needed and where it is needed.  Our solutions reduce the


amount of cash banks need to hold in reserve accounts and as cash-on-hand while ensuring a high level of customer service through timely replenishment of ATM cash supplies at minimal logistical services cost.


Specific solutions in the GPT group include:

Solution

 

Description

 

Products Offered

 

 

 

 

 

Risk Solutions:

 

 

 

 

 

 

 

 

 

Fraud Mitigation and Anti-Money Laundering Compliance

 

Automated fraud detection and prevention solutions that reduce incidents of check fraud, deposit fraud, check kiting, and electronic fraud. Anti-money laundering solutions screen names and related data against industry blacklists, local high-risk lists and other customized databases. Information management solution aggregates fraud source information and serves as a risk management dashboard. Multi-payment transaction monitoring solution uses advanced analytics and rules to detect suspicious activity.

 

FraudLink On-Us, FraudLink Deposit, FraudLink Deposit Branch Access Option, Kite, FraudLink Positive Pay, FraudLink eTracker, FraudLink ACHeCK, FraudLink PC, Workflow Manager, AML Filter, Information Manager, Fraud Manager On-Us, Deposit, Wires, AML, and Fraud Solutions Consulting

 

 

 

 

 

Payment Solutions:

 

 

 

 

 

 

 

 

 

Exception Management

 

Products that bring new efficiencies to back-office operations through leading-edge image, workflow, and RECO (character recognition) technologies.

 

Adjustments/Express, Exceptions/Express, Express Capture, Express Decision, Input/Express, Inbound Returns/Express, and All Transactions File

 

 

 

 

 

Remittance and Payments Processing

 

Both host and client/server-based platforms for improved productivity in processing retail and wholesale remittance transactions for financial institutions and payments processing for a wide variety of cross-industry applications.

 

NeXGen Remittance

 

 

 

 

 

Conventional Check Capture

 

An extensive array of enhancement products that add flexibility and usability to IBM’s Check Processing Control System (CPCS) and the IBM 3890/XP series of Document Processors.

 

Conventional Capture Products, CPCS Enhancements Products, XP/Productivity Tools, Platform Emulation, NeXGen Settlement, NeXGen Balancing, and LTA (Large Table Access)

 

 

 

 

 

Check Image Capture

 

Products and services related to the centralized and distributed capture, quality and inspection assurance, storage and delivery of check images. Distributed capture solutions come in web-based thin client and thick client. Distributed capture branch solution serves as a core component to full bank branch image enablement.

 

ALS & CIMS Products (MVS, AIX, Windows), NeXGen Image Processor, Image Enhancement Products, Reject Repair, RECO Technology, Image POD, Image Delivery Products, Delivery Express QAS Image Inspector, NeXGen Capture, Source Capture Suite

 

 

 

 

 

Check Image Archive Management

 

Comprehensive array of check image archive management products that may be tailored to a bank’s unique requirements based on their operational environments and volumes. Carreker offers archive technology for both in-house solutions and shared outsource providers.

 

Check Image Archive-AIX, Check Image Archive-MVS, Check Image Archive Load

 

 

 

 

 

Other Check Image Applications

 

An array of solutions that address revenue enhancement, risk reduction, and expense reduction issues through the application of image, workflow and RECO technologies.

 

Image Statements, CDRom Delivery, Input/Express, Express Capture, Payee Name Verification, and Amount Encoding Verification

 


 

Solution

 

Description

 

Products Offered

Electronic Check Presentment and Image Exchange

 

Enables banks to transition from paper-based to electronic payment systems by automating key elements of the processing stream, creation of image replacement documents (“IRD”) and image quality and usability checking.

ExchgLink , IRD Create, IRD Author, Image Inspector, CheckLink, CheckLink PC, Deposit Manager, Branch Truncation Manager and Cnotes

Aided by Check 21 legislation, these solutions are designed to reduce and eventually eliminate the movement of paper payments through the system, improving productivity, reducing errors, increasing customer satisfaction and reducing fraud.

 

ExchgLink , IRD Create, IRD Author, Image Inspector, CheckLink, CheckLink PC, Deposit Manager, Branch Truncation Manager and Cnotes

 

 

 

 

Cash & Logistics Solutions:

 

 

 

 

 

 

 

 

 

ATM Solutions

 

Advanced ATM monitoring and management, improving ATM availability and ensuring service levels are met. These solutions include an automated ATM monitoring and dispatching system for maximizing network availability; and a real-time Internet-based system for efficient handling of ATM service requests and responses.

 

eiManager, ATM Logix

 

 

 

 

 

Cash Solutions

 

A product suite, now optimized through Web-based software solutions, that dramatically reduces the amount of cash banks, financial institutions and companies need to hold as cash-on-hand throughout vault, branch and ATM networks. These solutions also enable automation and standardization of the cash ordering process, including the matching and reconciliation of invoices and the optimization of transportation. Consulting solutions can drive further efficiency and automation in vault, branch and ATM operations.

 

iCom, ReserveLink, Matchpoint and Currency Supply Chain Consulting

 

 

 

 

 

Enterprise Tracking

 

An enterprise tracking solution designed to track any object or virtual item from origination to final destination. Ability to track accountable mail, branch bags, item volumes, ATM work, currency bags, incoming domestic and international deposits, customer tapes and much more. Web-based application with distributed deployment capabilities.

 

Receive Sentry, and Trackpoint

 

 

 

 

 

eMetrics

 

Performance-measurement software suite that uses historical data to generate key performance indicators, item processing volume data, productivity statistics and quality control benchmarks.

 

Lumen, ProModel, eiMICR, eiStats, eiQuality, eiPerform

 

28





Revenue Enhancement.Revenue Enhancement (“RevE”) is a highly specialized division that provides consulting services focused on tactical methods of increasing banks’ fee income. The scope and depth of this practice has expanded throughout its 1415 year history and now includes retail, small business, and commercial deposits, treasury management, consumer and commercial lending, credit card lending and trust and investment services. Our solutions involve developing strategies that enable our clients to take advantage of electronification trends, often gaining first mover advantages for our clients. In addition to developing strategies, our business model ensures that we continue to translate those strategies into tactical implementations with measurable revenue streams. Our client base has continued to expand with very high penetration rates in the markets in which we operate. Thus, we have experienced a trend of becoming longer term strategic partners with our clients.

Another component of our RevE offering is our CVE solutions that include software, proprietary sales management methodologies and sales training programs. Our CVE solutions assist financial institutions in leveraging central intelligence with local insight, translating strategy into specific actions to achieve sustained organizational performance. This enables our clients to improve their identification of those customers and prospects representing the greatest value or potential, while aligning internal processes and behaviors with management’s focus. Our approach is unique and complementary to many CRM investments that banks have made in recent years and is designed to focus their activities such that they can attain increased returns on these CRM investments.

Global Payments Consulting.Our Global Payments Consulting (“GPC”) division helps financial institutions proactively plan, prepare and optimize for the regulatory, competitive and technological impacts affecting the financial payments environment.  The division provides strategic planning, program management, specialized tools, business applications and implementation advisory services for financial institutions and specialized payments clients.  The focus areas for these services include:

·               Enterprise payment rationalization (strategy through performance optimization)

·               Transaction/payment transformation services (research, planning, process design, implementation support, etc.)

·               Predictive financial and operational modeling of the implications of payment trends and strategies

·               Transaction clearing optimization solutions (transportation, float, clearing form,type, clearing partners and funds availability optimization)

·               Consolidation and merger/integration planning

·               Payment channel risk mitigation

·               Image exchange planning

·               Strategic Sourcing evaluation

·               Issue Recovery Services

The GPC division also contains the license, maintenance and services revenue for twothe following product areas:

·                    Float Management software products Float AnalysisPricing System, Payments Clearing Model and Float Management System —and Pricing Profitability application– for managing and reporting a bank’s float profitability through float analysis and pricing to improve profitability, reporting,of  workflow, and check clearing operations.operations and customer allocation methodologies.  These products also provide critical activity summaries, aid in creating multiple availability and pricing schedules, and pinpoint the cost/profitability of transactions or relationships.

·                    Payments Modeling product PaymentsLink is an application that allows a bank to create an enterprise virtual profit and loss statement for the payments business as well as model business scenarios around product and service pricing and transactional volume trends.

Business Process Outsourcing.  Carretek LLC is a transformational business outsourcer for information technology, payment and transaction processing for financial institutions jointly owned by Carreker Corporation (51%) and Majesco Software Inc. (49%), the U.S. subsidiary of Mastek Limited, a leading Indian outsourcing company with global operations.  Carretek was formed in fiscal 2003.

Carretek’s mission is to enable financial institutions and their processors to realize the benefits of transformational offshore-centric outsourcing (“offshoring”) of their information technology and business processes.  The benefits to clients could include reduction in operating costs, improvements in productivity, and enhancement of quality.


Initially, Carretek is focused on offshoring payments-related business processes.  Through Carretek, financial institutions can leverage the global work force at this critical period when Check 21 and other payment electronification trends are pressuring financial institutions to reduce their payment per item costs beyond the power of traditional cost management practices.  Carretek has designed and built specific product offerings targeted at payment and transaction processing functions for this express purpose.  Within this area of expertise, the Carretek offering includes a flexible array of offshore outsourcing services to financial institutions.

Executive Summary

Comparison of Three Months Ended April 30,July 31, 2006 (“Q1Q2 2006”) to Three Months Ended April 30,July 31, 2005 (“Q1Q2 2005”) and Six Months Ended July 31, 2006 (“YTD 2006”) to Six Months Ended July 31, 2005 (“YTD 2005”)

Our consolidated revenues declined 3.4%$1.1 million, or 3.7%, to $27.2$28.8 million in the three months ended April 30, 2006. We generated a net loss of $34,000 in the three months ended April 30,Q2 2006 as compared to $29.9 million in Q2 2005, and our revenues declined $2.1 million, or 3.6%, to $56.0 million in YTD 2006 as compared to $58.1 million in YTD 2005.  Our net income of $498,000declined $93,000, or 8.8%, to $961,000 in the three months ended April 30, 2005. The decreaseQ2 2006 as compared to $1.1 million in Q2 2005 and our net income was primarily the result of a declinedeclined $625,000, or 40.3%, to $927,000 in revenue within both our RevE and GPT business segments, offset by increased revenue within our GPC business segment and by a slight declineYTD 2006 as compared to $1.6 million in operating costs and expenses. Our cash balance increased $5.1 million and our marketable securities increased $1.2 million during the three months ended April 30, 2006. This increase in cash and marketable securities is primarily the result of the collection of our calendar year maintenance renewals.YTD 2005.

The decline in our revenue was primarily associated with our RevE business segment.  Both the Q2 2006 and YTD 2006 declines in revenue within RevE were centered in its traditional contingent fee based consulting revenues, particularly within its international markets.  The decline in RevE revenues was partially offset by an increase in GPT business segment. Revenue within this segment declined $1.7 million, or 9.7%, forrevenues.  GPT’s increase in revenues in Q2 2006 and YTD 2006 was primarily the three months ended April 30, 2006. The decline is primarilyresult of an increase in software license revenue within the Payments group.

The Payments group includes such products as Image Archive and Exception Management applications as well as Source Capture, ExchgLink and Image Replacement Document (“IRD”) solutions.  During Q2 2006, a single GPT customer expanded its licenses for both the Image Archive and IRD Author solutions.  This expansion resulted in approximately $2.3 million of software license revenue in Q2 2006, and accounted for 41.4% and 28.2% of software license revenue in Q2 2006 and YTD 2006, respectively.

Our cost of revenues declined on an absolute dollar basis $367,000, or 2.5%, to $14.1 million in Q2 2006 as compared to $14.5 million in Q2 2005 and our cost of revenues on an absolute dollar basis was relatively flat in YTD 2006 as compared to YTD 2005.  The decline in revenues, discussed above, lowered our gross profit to 51.1% in Q2 2006 as compared to 51.7% in Q2 2005 and 49.5% in YTD 2006 as compared to 50.9% in YTD 2005.

Total operating expenses declined $261,000, or 1.8%, to $14.2 million in Q2 2006 as compared to $14.5 million in Q2 2005, and operating expenses declined $796,000, or 2.8%, to $27.6 million in YTD 2006 as compared to $28.4 million in YTD 2005.  There were slight declines in both selling, general and administrative expenses and research and development expenses and there have been no restructuring and other charges recorded to date in fiscal 2006, which compares to $28,000 in Q2 2005 and $123,000 in YTD 2005.

Cash and cash equivalents decreased to $27.6 million at July 31, 2006, reflecting a decrease of $7.2 million from the end of Q1 2006 but only a decrease of $2.1 million on a YTD basis.  This decrease was primarily the result of continued technology investment delays by our customers andincreased accounts receivable, particularly within the intensification of competition in this particular market space. However, some traction has been gained in recent months as GPT’s initial Source Capture Branch installation was accepted by our customer in the three months ended January 31, 2006 and two smaller Source Capture installations were in progress during the three months ended April 30, 2006. Additionally, one large customer did not pay their fiscal 2006 maintenance renewal by April 30, 2006, which resulted in the deferral of approximately $374,000 of revenue from Q1 2006 to future periods. Finally, we signed an agreement with IBM on May 15, 2006 under which IBM will serve as a key channel to the larger North American financial institutions.

In absolute dollars, our cost of revenues increased $116,000 to $14.2 million for the three months ended April 30, 2006 as compared to $14.1 million for the three months ended April 30, 2005. This slight increase in costs, along with the decline in revenue discussed above, lowered our gross margin to 48.0% for the three months ended April 30, 2006 as compared to 50.0% for the three months ended April 30, 2005.

Operating expenses includes selling, general and administrative, research and development, amortization of customer relationships and restructuring and other charges. Overall, operating expenses declined $535,000 for the three months ended April 30, 2006 as compared to the three months ended April 30, 2005. Selling, general and administrative expenses have declined $124,000 for the three months ended April 30, 2006 as compared to the three months ended April 30, 2005. This reduction was primarily related to reductions in expenses in both corporate andRevE business segment sales and marketing functions. These reductions have been partially offset by increased legal fees in lawsuits in which we are the plaintiff along with increased professional fees. Additionally, the three months ended April 30, 2006 was the first period that contains stock option expense which totaled $382,000, of which $303,000 is contained in selling, general and administrative expense.

During the three months ended April 30, 2006, we did not record any restructuring and other charges, which compares to $95,000several large contracts recorded in the threefirst six months ended April 30, 2005.of fiscal 2006 contain payment terms which extend into the latter half of fiscal 2006.

We continue to focus on increasing research and development, particularly within GPT, to enhance our existing product offerings and develop new product offerings, and incurred research and development expenses of $2.2 million in the three months ended April 30, 2006 compared with $2.5 million in the three months ended April 30, 2005. In the three months ended April 30, 2006, we continued to focus on enhancing our Payments offerings and introducing several new Cash and Risk solutions within GPT.


We anticipate revenue growth during the second half of the 2006 fiscal year duerelative to the availability and anticipated acceptance of several new products and service offerings, which were developed during 2005, as well as new products and services expected to be introduced in 2006. Overall annual revenue growth is anticipated to be in the latterfirst half of the year due to various factors including the timing of revenue realization in our RevE business segment as well as a lengthened decision cycle and longer timelines for implementation and customer acceptance associated with certain new products.fiscal 2006.  We expect that revenue and net income (loss) for the secondthird quarter of fiscal 2006 will be down fromroughly in line with the correspondingsecond quarter in fiscal 2005 but believeof 2006 and that we will achieve improved revenue and net income in fiscal 2006 as compared to fiscal 2005. We also believe that we are well positioned for improved profitability in fiscal 2007 as a result of anticipated revenue growth, ongoing cost containment efforts,improved operating leverage, and the decrease in scheduled amortization expense associated with certain acquisition-related intangible assets.


Results of Operations

Comparison of Three Months Ended April 30,July 31, 2006 (“Q1Q2 2006”) to Three Months Ended April 30,July 31, 2005 (“Q1Q2 2005”) and Six Months Ended July 31, 2006 (“YTD 2006”) to Six Months Ended July 31, 2005 (“YTD 2005”)

Revenues

Revenues by Segment ($ in thousands):

 

Three Months Ended
April 30,

 

Variance

 

 

Three Months Ended
July 31,

 

Variance

 

Six Months Ended
July 31,

 

Variance

 

 

2006

 

2005

 

$

 

%

 

 

2006

 

2005

 

$

 

%

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue Enhancement

 

$

8,598

 

$

8,999

 

$

(401

)

(4.4

)%

 

$

7,353

 

$

10,897

 

$

(3,544

)

(32.5

)%

$

15,951

 

$

19,896

 

$

(3,945

)

(19.8

)%

Global Payments Technologies

 

16,218

 

17,968

 

(1,750

)

(9.7

)

 

19,902

 

17,481

 

2,421

 

13.8

 

36,120

 

35,449

 

671

 

1.9

 

Global Payments Consulting

 

1,919

 

974

 

945

 

97.0

 

 

1,018

 

1,301

 

(283

)

(21.8

)

2,937

 

2,275

 

662

 

29.1

 

Business Process Outsourcing

 

510

 

257

 

253

 

98.4

 

 

530

 

241

 

289

 

119.9

 

1,040

 

498

 

542

 

108.8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Revenues

 

$

27,245

 

$

28,198

 

$

(953

)

(3.4

)%

 

$

28,803

 

$

29,920

 

$

(1,117

)

(3.7

)%

$

56,048

 

$

58,118

 

$

(2,070

)

(3.6

)%

 

Our declineOverall, total revenue declined $1.1 million, or 3.7%, to $28.8 million in total revenues of 3.4% in Q1Q2 2006 as compared to Q1$29.9 million in Q2 2005 and total revenue declined $2.1 million, or 3.6%, to $56.0 million in YTD 2006 as compared to $58.1 million in YTD 2005.  The decline on both a quarterly and YTD basis is concentrated primarilycentered within the GPTRevE business segment.

The decline in GPT segment revenue is primarily within its Payment Solution offerings. The market’s adoption of post-Check 21 related technology has been much slower than expected. We experienced isolated success with our ExchgLink solution while our IRD authoring software and remote Source Capture solution have experienced greater success with several major banks and the Federal Reserve. For instance, GPT gained acceptance of its initial Source Capture Branch installation in the quarter ended January 31, 2006 and has two smaller Source Capture engagements in progress as of April 30, 2006.

Our RevE segment revenues declined $401,000,$3.5 million, or 4.4%32.5%, in Q1 2006, as compared to Q1 2005.on a quarterly basis and $3.9 million, or 19.8%, on a YTD basis.  RevE’s traditional contingent consulting revenues declined $205,000,$2.6 million, or 2.7%29.2%, on a quarterly basis and $2.8 million, or 16.8%, on a YTD basis.  There were 15 revenue producing consulting engagements in both Q2 2006 and Q2 2005 and 17 revenue producing consulting engagements in YTD 2006 and YTD 2005.  RevE did not derive any consulting revenue from its international customers in the first six months of fiscal 2006, which compares to $7.5$3.9 million in Q1 2006 as comparedthe first six months of fiscal 2005.  However, RevE is in the early phases of several international engagements in which the consulting revenue has yet to $7.7 million in Q1 2005.be realized.  In Q1Q2 2006, approximately $5.2$2.8 million, or 69.0%38.7%, and in YTD 2006 approximately $8.0 million, or 50.4%, of RevE’s contingent consultingtotal revenue was derived from a single consulting engagement at U.S. Bank. The number of revenue producing engagements decreased to 9that should be completed in Q1 2006 from 13 in Q1 2005 and this also led to a decline in out-of-pocket expense reimbursements of approximately $115,000 in Q1 2006 as compared to Q1 2005. Theearly Q3 2006.  Additionally, the software license, and softwaremaintenance, implementation and other services revenue derived from RevE’s CVE software and proprietary sales management offering declined approximately $80,000$801,000, or 50.7%, to $779,000 in Q1Q2 2006 as compared to Q1$1.6 million in Q2 2005 and declined approximately $882,000, or 35.7%, to $1.6 million in YTD 2006 as compared to $2.5 million in YTD 2005 as the number of active engagements declined from 3 to 2.

GPC revenuesThe increase in GPT segment revenue on both a quarterly and YTD basis is primarily the result of increased $945,000, or 97.0%, to $1.9software license revenue within our Payments solutions offerings.  In Q2 2006, a single GPT customer expanded its license for both the Image Archive and IRD Author solutions.  The expansion resulted in approximately $2.3 million of software license revenue in Q1Q2 2006.  This transaction accounted for 11.4% and 6.3% of GPT’s total revenue in Q2 2006 and YTD 2006, respectively.

GPC’s revenue decline in Q2 2006 as compared to $1.0 million in Q1 2005.Q2 2005 was primarily the result of decreased consulting revenue.  GPC has intensified its sales focus as we completed the repositioning of this business to focus on enterprise-wide payment electronification strategies, image enablement planning and integration and risk mitigation.  The quarterly consulting revenue increasedecrease can be attributed to an increasefluctuations in the average deal size for consulting engagementstiming of certain engagements.  On a YTD basis, all revenue categories within GPC have increased in YTD 2006 as compared to YTD 2005.  The largest increases are within software license and an increase in the numbersoftware implementation and other services revenue, due primarily to our introduction of engagements. Additionally, our seconda new Payments Financial Modeling application installation gained customer acceptanceand, with a rise in Q1 2006 and yielded approximately $175,000 in software license revenue.interest rates, renewed demand for our Float Management products.

Our outsourcing revenue is derived through Carretek, our 51% owned business which offers outsourcing for information technology and payment and transaction processing.  Carretek was formed in fiscal 2003 and signed its first customer agreement in the second quarter of fiscal 2004.  In 2005, we increased staffing under our initial contract and expanded our scope with this single customer to include a second and third set of transaction processing functions which has significantly increased revenue.

revenue on both a quarterly and YTD basis in fiscal 2006 as compared to fiscal 2005.


Consulting ($ in thousands):

 

Three Months Ended
April 30,

 

Variance

 

 

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

Consulting

 

$

8,558

 

$

8,318

 

$

240

 

2.9

%

 

 

Three Months Ended
July 31,

 

Variance

 

Six Months Ended
July 31,

 

Variance

 

 

 

2006

 

2005

 

$

 

%

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consulting

 

$6,839

 

$9,502

 

$(2,663

)

(28.0

)%

$15,397

 

$17,820

 

$(2,423

)

(13.6

)%

 

Most of our consulting revenues are derived from our RevE business segment.  Consulting revenues derived from our RevE segment declined 2.7%$2.6 million, or 29.2%, to $7.5$6.3 million in Q1Q2 2006 as compared to $7.7$8.8 million in Q1Q2 2005 and declined $2.8 million, or 16.8%, to $13.8 million in YTD 2006 as compared to $16.6 million in YTD 2005. Of the $7.5 million of RevE consulting revenues recorded in Q1 2006, $5.2 million were derived from one customer, U.S. Bank.  Within RevE, we continue to focus on maximizing the value to our existing customer base while expanding our expertise to new customers, both domestically and internationally.  However, thereThere were no revenue producing international consulting engagements in Q1Q2 2006 and YTD 2006 as compared to $1.8$2.1 million in Q2 2005 and $3.9 million in YTD 2006.  However, RevE is in the early phases of several international engagements in which the consulting revenue has yet to be realized.  Additionally, 45.5% of RevE’s consulting revenue in Q2 2006 and 58.3% in YTD 2006 was derived from a single international engagementone customer.  This compares to 45.2% or RevE’s consulting revenue in Q1 2005.Q2 2005 and 24.2% in YTD 2005 derived from one customer.

Consulting revenues derived from our GPC segment increased 64.6%declined $201,000, or 30.1%, to $899,000$467,000 in Q1Q2 2006 as compared to $546,000$668,000 in Q2 2005 and increased $152,000, or 12.5%, to $1.4 million in YTD 2006 as compared to $1.2 million in YTD 2005.  Beginning in Q4 2005 and carrying over into Q1 2005. The increase is primarily the result of an increase in2006, the number and size of activeGPC consulting engagements along with an increaseincreased; however, several of these engagements concluded early in deal size.Q2 2006.

Software License ($ in thousands):

 

Three Months Ended
April 30,

 

Variance

 

 

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

Software License

 

$

2,557

 

$

3,359

 

$

(802

)

(23.9

)%

 

 

Three Months Ended
July 31,

 

Variance

 

Six Months Ended
July 31,

 

Variance

 

 

 

2006

 

2005

 

$

 

%

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Software License

 

$

5,493

 

$

3,782

 

$

1,711

 

45.2

%

$

8,050

 

$

7,141

 

$

909

 

12.7

%

 

Most of our software license revenues are derived from our GPT business segment.  Software license revenues from our GPT business segment decreased 30.2%increased $2.0 million, or 58.0%, to $2.1$5.4 million in Q1Q2 2006 from $3.1as compared to $3.4 million in Q1Q2 2005 and increased $1.0 million, or 16.3%, to $7.5 million in YTD 2006 as compared to $6.5 million in YTD 2005.

Within GPT, the software license declineincrease is within the Payment Solutions suite of products, which includes products designed to address the Check 21 legislation.  Check 21 permits U.S. banks to accept digital images of checks the same way that they accept a paper check.  We have introduced several new Payment solution products to compete in this space such as ExchgLink, our solution for exchanging images with other banks, IRD Author which generates and processes substitute checks often referred to as image replacement documents (“IRD”), Image Inspector which ensures image quality and, finally, Source Capture which allows customers to capture deposits at branches, ATM’s and bank customer sites.  Delayed industry adoption rates and intensified competition have dampened results relative to our expectations. Our first Source Capture Branchexpectations; however, in Q2 2006, a single GPT customer accepted ourexpanded its license for both the Image Archive and IRD Author solutions.  This expansion resulted in approximately $2.3 million of software license revenue in Q4 2005 and we have twoQ2 2006 as no software implementation or other smaller Source Capture engagements currentlyservices were required.  This transaction accounted for 42.1% of GPT’s software license revenue in progress. We believe that industry adoption and corresponding IT spending in this area will accelerate later inQ2 2006 and into 2007.30.2% for YTD 2006.

The GPC business segment software license revenues increased $243,000decreased $87,000, or 75.7%, to $28,000 in Q1Q2 2006 as compared to Q1$115,000 in Q2 2005 and increased $156,000, or 135.6%, to $271,000 in YTD 2006 as compared to $115,000 in YTD 2005.  The YTD increase is primarily due to the acceptanceintroduction of itsa new Payments Financial Modeling application at a major domestic bank. This acceptance resulted in $175,000 of software license revenue. and renewed demand for its Float Management products.

The GPC increase in software license revenue was partially offset by software license revenuederived from our CVE product offering within theour RevE business segment declining $122,000,declined $183,000, or 40.4%72.6%, to $69,000 in Q1Q2 2006 as compared to Q1$252,000 in Q2 2005 and declined $305,000, or 55.2%, to $248,000 in YTD 2006 as compared to $553,000 in YTD 2005.

  This decline is the result of less active engagements; however, RevE’s strategy changed in fiscal 2006 to focus less on marketing CVE’s traditional software licenses and putting more emphasis on its consulting and other services, such as training.  This change in strategy has led to an expansion of our CVE services for an existing customer and a pilot project for a new customer.


Software Maintenance ($ in thousands):

 

Three Months Ended
April 30,

 

Variance

 

 

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

Software Maintenance

 

$

10,752

 

$

11,312

 

$

(560

)

(5.0

)%

 

 

Three Months Ended
July 31,

 

Variance

 

Six Months Ended
July 31,

 

Variance

 

 

 

2006

 

2005

 

$

 

%

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Software Maintenance

 

$10,899

 

$10,576

 

$323

 

3.1

%

$21,651

 

$21,888

 

$(237

)

(1.1

)%

 

As with software license fees, most of our maintenance fees are derived from our GPT business segment.  Software maintenance fees are paid pursuant to annually renewable product and telephone support agreements with our software customers.  The annual maintenance fee is generally paid by the customer at the beginning of the maintenance period and we recognize this maintenance revenue ratably over the term of the related contract.  If the annual maintenance fee is not paid at the beginning of the maintenance period, we defer revenue recognition until the time that the maintenance fee is collected.  When the payment is received, maintenance revenue is recognized for the period that maintenance revenue was previously deferred.  Also, maintenance contracts usually carry annual maintenance fee escalation clauses typically based on an index, such as the consumer price index.  Because our revenue recognition policy requires the collection of cash before revenue can begin to be recognized, our software maintenance revenue will fluctuate quarter-to-quarter.  For our GPT business segment, one large customer did not pay theirthe maintenance renewal by April 30, 2006 and this resulted in the deferral of approximately $374,000$374,000.  This renewal was paid in Q2 2006 and the previously deferred maintenance revenue to future periods.was recognized.  Typically, our software maintenance revenue fluctuates between $10.0 million and $11.0 million per quarter.

Software Implementation and Other Services ($ in thousands):

 

Three Months Ended
April 30,

 

Variance

 

 

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

Software Implementation and
Other Services

 

$

4,135

 

$

4,134

 

$

1

 

0.0

%

 

 

Three Months Ended
July 31,

 

Variance

 

Six Months Ended
July 31,

 

Variance

 

 

 

2006

 

2005

 

$

 

%

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Software Implementation and Other Services

 

$

4,249

 

$

4,892

 

$

(643

)

(13.1

)%

$

8,384

 

$

9,026

 

$

(642

)

(7.1

)%

 

In the majority of our software customer arrangements, installation services are provided to the customer.  Most of our software implementation fees are derived from our GPT business segment.  The software implementation and other services revenue derived from GPT declined 9.7%$124,000, or 3.5%, or $344,000, to $3.2$3.4 million in Q1Q2 2006 as compared to $3.5 million in Q1Q2 2005 and declined $468,000, or 6.6%, to $6.6 million in YTD 2006 as compared to $7.1 million in YTD 2005.  This decline within GPT on a quarterly basis was primarily within the Risk and Cash product offerings offset by a slight increase within the Payments solutions groupproduct offerings.  This decline within Risk and Cash is primarily the result of lower software license revenue as both product groups are introducing new and/or enhanced product offerings to their respective markets.  On a YTD basis, the decline is within the Payments product offerings.

RevE’s CVE software implementation and other services declined $535,000, or 45.5%, to $641,000 in Q2 2006 as compared to $1.2 million in Q2 2005 and declined $476,000, or 28.8%, to $1.2 million in YTD 2006 as compared to $1.7 million in YTD 2005.  This decline is related to the decreased software licensefewer revenue producing engagements and CVE’s change in product strategy discussed under “Software License” above. This decline in

GPC’s software implementation and other services revenue within GPT was completely offset by increases within GPC driven byrelatively flat at approximately $200,000 in both Q2 2006 and 2005, respectively.  However, GPC’s software implementation and other services revenue increased $302,000, or 100.0%, to $604,000 in YTD 2006 as compared to $302,000 in YTD 2005.  This increase is the new Payments Financial Modeling application, and with a rise in interest rates there has beenresult of increased demand for services related to our legacy Float Analysis and Management Systems application.software license revenue described above.


Outsourcing Services ($ in thousands):

 

Three Months Ended
April 30,

 

Variance

 

 

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

Outsourcing Services

 

$

510

 

$

257

 

$

253

 

98.4

%

 

 

Three Months Ended
July 31,

 

Variance

 

Six Months Ended
July 31,

 

Variance

 

 

 

2006

 

2005

 

$

 

%

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Outsourcing Services

 

$

530

 

$

241

 

$

289

 

119.9

%

$

1,040

 

$

498

 

$

542

 

108.8

%

 

Our outsourcing service revenue is derived through Carretek, our 51% owned business which outsources information technology and payment and transaction processing.  Carretek was formed in fiscal 2003 and signed its first agreement in the second quarter of fiscal 2004.  In fiscal 2005, we expanded our scope of business with this customer to include a second and third set of transaction processing functions which resulted in the increased revenue.revenue in fiscal 2006.  While we continue to pursue opportunities to expand the scope of the services we provide to our existing customer, we do not expect significant growth on an absolute dollar basis until additional outsourcing customers are obtained.


Out-of-Pocket Expense Reimbursements ($ in thousands):

 

Three Months Ended
April 30,

 

Variance

 

 

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

Out-of-Pocket Expense
Reimbursements

 

$

733

 

$

818

 

$

(85

)

(10.4

)%

 

 

Three Months Ended
July 31,

 

Variance

 

Six Months Ended
July 31,

 

Variance

 

 

 

2006

 

2005

 

$

 

%

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Out-of-Pocket Expense Reimbursements

 

$

793

 

$

927

 

$

(134

)

(14.5

)%

$

1,526

 

$

1,745

 

$

(219

)

(12.6

)%

 

These reimbursements tend to fluctuate period to period and the decrease for both the quarterly and YTD periods is primarily related to reduced international travel within the RevE business segment.

Cost of Revenues

Cost of Revenues by Segment ($ in thousands):

 

Three Months Ended

 

 

 

 

 

Six Months Ended

 

 

 

 

 

 

Three Months Ended
April 30,

 

Variance

 

 

July 31,

 

Variance

 

July 31,

 

Variance

 

 

2006

 

2005

 

$

 

%

 

 

2006

 

2005

 

$

 

%

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue Enhancement

 

$

4,922

 

$

4,471

 

$

451

 

10.1

%

 

$

4,903

 

$

4,911

 

$

(8

)

(0.2

)%

$

9,826

 

$

9,381

 

$

445

 

4.7

%

% of revenue

 

57.2

%

49.7

%

 

 

 

 

 

66.7

%

45.1

%

 

 

 

 

61.6

%

47.2

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Global Payments Technologies

 

$

7,744

 

$

8,143

 

$

(399

)

(4.9

)%

 

$

7,913

 

$

8,248

 

$

(335

)

(4.1

)%

$

15,656

 

$

16,391

 

$

(735

)

(4.5

)%

% of revenue

 

47.7

%

45.3

%

 

 

 

 

 

39.8

%

47.2

%

 

 

 

 

43.3

%

46.2

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Global Payments Consulting

 

$

1,068

 

$

901

 

$

167

 

18.5

%

 

$

768

 

$

872

 

$

(104

)

(11.9

)%

$

1,836

 

$

1,774

 

$

62

 

3.5

%

% of revenue

 

55.7

%

92.5

%

 

 

 

 

 

75.4

%

67.0

%

 

 

 

 

62.5

%

78.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Business Process Outsourcing

 

$

476

 

$

579

 

$

(103

)

(17.8

)%

 

$

514

 

$

434

 

$

80

 

18.4

%

$

990

 

$

1,013

 

$

(23

)

(2.3

)%

% of revenue

 

93.3

%

225.3

%

 

 

 

 

 

97.0

%

180.1

%

 

 

 

 

95.2

%

203.4

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Cost of Revenues

 

$

14,210

 

$

14,094

 

$

116

 

0.8

%

 

$

14,098

 

$

14,465

 

$

(367

)

(2.5

)%

$

28,308

 

$

28,559

 

$

(251

)

(0.9

)%

% of revenue

 

52.2

%

50.0

%

 

 

 

 

 

48.9

%

48.3

%

 

 

 

 

50.5

%

49.1

%

 

 

 

 

 

Overall,In total and by business segment, cost of revenues on an absolute dollar basis remained relatively flat in Q1for Q2 2006 and YTD 2006 as compared to Q1Q2 2005 and the increase in cost of revenues as a percentage of total revenue is the result of theYTD 2005.  The largest decline in total revenue in Q1 2006 as compared to Q1 2005 that is discussed above. RevE’s cost of revenues increasedwas within GPT and was primarily within the cost of consulting, as this group begins to change its focus around its CVE product offering from software license and services to consulting. GPT’s cost of revenues declined primarily within cost of software maintenance and is the result of GPT reducing its workforce by 29 employees in Q3 2005.  RevE’s cost of revenues increased on a YTD basis primarily within the quarter ended October 31, 2005.cost of consulting, as this group changed its focus and strategy related to its CVE product offering discussed above.

With the cost of revenues being relatively flat on a quarterly basis, the fluctuation in the cost of revenues as a percentage of total business segment revenue was primarily driven by the revenue fluctuations within the respective business segments, with the overall decline in total revenue exceeding the decline in cost of revenues.


Cost of Consulting ($ in thousands):

 

Three Months Ended
April 30,

 

Variance

 

 

Three Months Ended

 

 

 

 

 

Six Months Ended

 

 

 

 

 

 

2006

 

2005

 

$

 

%

 

 

July 31,

 

Variance

 

July 31,

 

Variance

 

 

 

 

 

 

 

 

 

 

 

2006

 

2005

 

$

 

%

 

2006

 

2005

 

$

 

%

 

Cost of Consulting

 

$

4,872

 

$

4,241

 

$

631

 

14.9

%

 

$

4,798

 

$

4,277

 

$

521

 

12.2

%

$

9,670

 

$

8,518

 

$

1,152

 

13.5

%

% of consulting revenue

 

56.9

%

51.0

%

 

 

 

 

 

70.2

%

45.0

%

 

 

 

 

62.8

%

47.8

%

 

 

 

 

 

The cost of consulting consists primarily of personnel costs related to our consulting engagements within both our RevE and GPC business segments.  In Q1 2006, RevE’sThe increase in the cost of consulting increased $498,000 dueon a quarterly and YTD basis is the result of RevE’s change in focus and strategy for its CVE offering from traditional software license, software maintenance and software services offering to a reallocation of staff to a large consulting engagement. There has not been an increase in headcount or other costs.benchmarking and training offerings.  The increase in cost of consulting within RevE, without an increase in consulting revenue, has increased the cost of consulting as a percentage of consulting revenue.


revenue on both a quarterly and YTD basis.

Cost of Software Licenses ($ in thousands):

 

Three Months Ended

 

 

 

 

 

Six Months Ended

 

 

 

 

 

 

Three Months Ended
April 30,

 

Variance

 

 

July 31,

 

Variance

 

July 31,

 

Variance

 

 

2006

 

2005

 

$

 

%

 

 

2006

 

2005

 

$

 

%

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of Software Licenses

 

$

1,840

 

$

1,536

 

$

304

 

19.8

%

 

$

1,885

 

$

1,828

 

$

57

 

3.1

%

$

3,725

 

$

3,364

 

$

361

 

10.7

%

% of software license revenue

 

72.0

%

45.7

%

 

 

 

 

 

34.3

%

48.3

%

 

 

 

 

46.3

%

47.1

%

 

 

 

 

 

The cost of software licenses consists principally of amortization of capitalized and acquired software costs along with royalties payable to third parties.  The increase in the cost of software licenses in Q1 2006 iswas relatively flat on a quarterly basis and increased on a YTD basis primarily as the result of increased royalty expense due to product mix.  The large decrease in the cost of software licenses as a percentage of software license revenue is attributed to the large increase in software license revenue within GPT discussed above.

In connection with software license, maintenance and certain consulting agreements entered into with certain banks and purchase agreements with vendors under which we acquire software technology used in products sold to our customers, we are required to pay royalties on sales of certain software products.  Under these arrangements, we recognize royalty expense when the associated revenue is recognized.  The royalty percentages generally range from 20% to 50% of the associated revenue.  Approximately $346,000$483,000 and $92,000$462,000 of royalty expense was recorded under these agreements and charged to cost of software licenses in Q1Q2 2006 and Q1Q2 2005, respectively, and $829,000 and $554,000 in YTD 2006 and 2005, respectively.  Depending on our future product mix, our margins from software license fees may be negatively impacted by increased software royalty expense.

Cost of Software Maintenance ($ in thousands):

 

Three Months Ended

 

 

 

 

 

Six Months Ended

 

 

 

 

 

 

Three Months Ended
April 30,

 

Variance

 

 

July 31,

 

Variance

 

July 31,

 

Variance

 

 

2006

 

2005

 

$

 

%

 

 

2006

 

2005

 

$

 

%

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of Software Maintenance

 

$

3,172

 

$

3,975

 

$

(803

)

(20.2

)%

 

$

3,189

 

$

3,436

 

$

(247

)

(7.2

)%

$

6,361

 

$

7,411

 

$

(1,050

)

(14.2

)%

% of software maintenance revenue

 

29.5

%

35.1

%

 

 

 

 

 

29.3

%

32.5

%

 

 

 

 

29.4

%

33.9

%

 

 

 

 

 

Cost of maintenance consists primarily of personnel and facility costs to provide telephone support, product defect support and other enhancements to our existing products which are not significant enough to extend the product’s life cycle, or substantially increase its marketability.  These costs are primarily contained within our GPT business segment.  The decline in costs of maintenance in absolute dollars of $803,000 or 20.2% in Q1 2006, as compared to Q1 2005,on a quarterly and YTD basis is primarily the result of reduced personnel related costs and personnel relatedcontract labor costs within the GPT business segment which began primarily in the last half of fiscal 2005 and was the result of the personnel reductions carried out at the beginning of the quarter ended October 31,Q3 2005.


The annual maintenance fee is generally paid by the customer at the beginning of the maintenance period and we recognize this maintenance revenue ratably over the term of the related contract.  If the annual maintenance fee is not paid at the beginning of the maintenance period, we defer revenue recognition until the time that the maintenance fee is paid by the customer.  When the payment is received, maintenance revenue is recognized for the period that maintenance revenue was previously deferred.  As a result, our cost of software maintenance as a percentage of related maintenance revenue will fluctuate.


Cost of Software Implementation and Other Services ($ in thousands):

 

Three Months Ended

 

 

 

 

 

Six Months Ended

 

 

 

 

 

 

Three Months Ended
April 30,

 

Variance

 

 

July 31,

 

Variance

 

July 31,

 

Variance

 

 

2006

 

2005

 

$

 

%

 

 

2006

 

2005

 

$

 

%

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of Software Implementation and Other Services

 

$

3,076

 

$

2,973

 

$

103

 

3.5

%

 

$

2,938

 

$

3,682

 

$

(744

)

(20.2

)%

$

6,014

 

$

6,655

 

$

(641

)

(9.6

)%

% of software implementation and other services revenue

 

74.4

%

71.9

%

 

 

 

 

 

69.1

%

75.3

%

 

 

 

 

71.7

%

73.7

%

 

 

 

 

 

Cost of software implementation consists primarily of personnel and facility costs to provide software implementation and project management support to customer software implementations primarily within our GPT business segment.  The decline in the cost of software implementation and other services on both a quarterly and YTD basis was relatively flatprimarily the result of a decline in Q1 2006 as comparedpersonnel costs within both our GPT and RevE business segments due to Q1 2005.reduced levels of software implementation and other services revenue in both business segments.

Cost of Outsourcing Service ($ in thousands):

 

Three Months Ended

 

 

 

 

 

Six Months Ended

 

 

 

 

 

 

Three Months Ended
April 30,

 

Variance

 

 

July 31,

 

Variance

 

July 31,

 

Variance

 

 

2006

 

2005

 

$

 

%

 

 

2006

 

2005

 

$

 

%

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of Outsourcing Service

 

$

476

 

$

579

 

$

(103

)

(17.8

)%

 

$

514

 

$

434

 

$

80

 

18.4

%

$

990

 

$

1,013

 

$

(23)

 

(2.3

)%

% of outsourcing services revenue

 

93.3

%

225.3

%

 

 

 

 

 

97.0

%

180.1

%

 

 

 

 

95.2

%

203.4

%

 

 

 

 

 

The cost of outsourcing service fees relates to the operation of Carretek, our 51% owned business outsourcer for information technology and payment and transaction processing.  To date, this business only hadhas a single customer. Early in fiscal 2005, we expandedcustomer and our scope of business with this single customer fromincludes outsourcing one functionthree business functions.  The cost of outsourcing service on both a quarterly and YTD basis is relatively flat.  The decline in the percentage of cost of outsourcing service as a percentage of outsourcing service revenue is primarily the result of increased revenue as two of the outsourced functions ramp up to three functions, which resulted in increased costs in this area due to more training, travel and other up front costs being incurred in Q1 2005. Costs have returned to normalized levels in Q1 2006.full capacity on a relatively fixed cost structure.

Out-of-Pocket Expenses ($ in thousands):

 

Three Months Ended

 

 

 

 

 

Six Months Ended

 

 

 

 

 

 

Three Months Ended
April 30,

 

Variance

 

 

July 31,

 

Variance

 

July 31,

 

Variance

 

 

2006

 

2005

 

$

 

%

 

 

2006

 

2005

 

$

 

%

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of Out-of-Pocket Expenses

 

$

774

 

$

790

 

$

(16

)

(2.0

)%

 

$

774

 

$

808

 

$

(34

)

(4.2

)%

$

1,548

 

$

1,598

 

$

(50

)

(3.1

)%

% of out-of-pocket expense reimbursements

 

105.6

%

96.6

%

 

 

 

 

 

97.6

%

87.2

%

 

 

 

 

101.4

%

91.6

%

 

 

 

 

 

These costs represent travel, meals and other sundry expenses incurred by our employees.  These costs are invoiced to the customer, without mark-up, usually on a monthly basis.  The costs have remained relatively flat for Q1 2006 as compared to Q1 2005.on both a quarterly and YTD basis.  In addition, certain customer contracts contain expense maximums, so in certain cases not all expenses incurred can be passed along to the customer without contractual revisions or the customer’s express written approval, which can increase the volatility of the cost of out-of-pocket expense as a percentage of out-of-pocket expense reimbursements.

36





Operating Costs and Expenses:

Selling, General and Administrative Expenses ($($ in thousands):

 

Three Months Ended
April 30,

 

Variance

 

 

Three Months Ended
July 31,

 


Variance

 

Six Months Ended
July 31,

 


Variance

 

 

2006

 

2005

 

$

 

%

 

 

2006

 

2005

 

$

 

%

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling, General and Administrative Expenses

 

$

10,780

 

$

10,904

 

$

(124

)

(1.1

)%

 

$

11,423

 

$

11,593

 

$

(170

)

(1.5

)%

$

22,203

 

$

22,497

 

$

(294

)

(1.3

)%

% of total revenue

 

39.6

%

38.7

%

 

 

 

 

 

39.7

%

38.7

%

 

 

 

 

39.6

%

38.7

%

 

 

 

 

 

Selling, general and administrative expenses generally consist of personnel costs such as salaries, commissions and other incentive compensation along with travel associated with selling, marketing, general management and software management.  Additionally, the provision for doubtful accounts, insurance, including directors and officers liability insurance, as well as professional services, such as legal and accounting expenses, and other related costs are classified within selling, general and administrative expense.  Although ourOur selling, general and administrative expenses were essentially flat in absolute dollars in Q1 2006, as compared to Q1 2005,on both a quarterly and YTD basis.  However, there were significant changes within the underlying expense categories:  corporatecategories.  Corporate sales and marketing declined $493,000, along with$584,000 on a $664,000 decline in sales-related costs withinquarterly basis and $1.1 million on a YTD basis and our three primary business segments.segments also reduced their sales cost by $735,000 on a quarterly basis and $1.4 million on a YTD basis.  These declines were partiallyprimarily achieved through reduced personnel and personnel related costs.  These cost reductions were offset by increased general and administrative costs of $1.1 million on a quarterly basis and $2.2 million on a YTD basis.  The increases in general and administrative costs related toconsist of increased professional fees of $703,000 resulting fromincluding legal fees arising out of lawsuits in which we are the plaintiff, and increased accounting and other professional fees related to the restatement of our financial statements whichthat was announced in April 2006. See Item 4. Controls and Procedures.  Additionally, in Q1 2006, we began to expense stock-based compensation and approximately $303,000 of expense$212,000 on a quarterly basis and $437,000 YTD 2006 was charged to selling, general and administrative expense.  Finally, $347,000 of bonus expense was recorded within general and administrative expense in Q2 2006.

Selling, general and administrative costs as a percentage of total revenue increased on both a quarterly and YTD basis, primarily as the result of the decline in total revenue in both periods.

Research and Development ($ in thousands):

 

Three Months Ended
April 30,

 

Variance

 

 

Three Months Ended
July 31,

 


Variance

 

Six Months Ended
July 31,

 


Variance

 

 

2006

 

2005

 

$

 

%

 

 

2006

 

2005

 

$

 

%

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and Development Expenses

 

$

2,205

 

$

2,521

 

$

(316

)

(12.5

)%

 

$

2,453

 

$

2,516

 

$

(63

)

(2.5

)%

$

4,658

 

$

5,037

 

$

(379

)

(7.5

)%

% of total revenue

 

8.1

%

8.9

%

 

 

 

 

 

8.5

%

8.4

%

 

 

 

 

8.3

%

8.7

%

 

 

 

 

 

Research and development expenses consist primarily of personnel, contract labor, travel and facilities expenses.  Research and development costs are typically limited to development of new software products, or enhancements to existing software products, which extend the product’s life cycle and/or substantially increase its marketability.  In both Q1 2006 and Q1 2005, theThe majority of research and development costs were related to new product development within our GPT Payment Solutions group.group, although in Q2 2006 a new CVE offering within the RevE business segment reached technological feasibility and capitalization of development costs commenced.

In accordance with SFAS No. 86, “Accounting for Costs of Software to be Sold, Leased or Otherwise Marketed,” we capitalized $526,000 of software development costs$718,000 and $271,000 in Q1Q2 2006 as compared to $437,000and Q2 2005, respectively, and $1.2 million and $708,000 in Q1 2005.YTD 2006 and YTD 2005, respectively.  Software development costs of a product are capitalized from the time technological feasibility is reached until the general release of the product.  We establish technological feasibility through the process of creating a detailed program design and reviewing the detailed program design for any high risk development issues or through the creation of a working model.  Capitalization only occurs if we believe costs capitalized are recoverable through future sales of the software product under development.  We currently have sixAt July 31, 2006, we had seven projects underway infor which costs were capitalized in Q1Q2 2006.  Three of these projects are within Risk solutions andsolutions; three are within Cash & Logistics solutions.solutions and one is a CVE solution.  All six solutionsdevelopment projects are scheduled to be completed in late Q2 2006 or early Q3by the end of fiscal 2006.


Amortization of Customer Relationships:  Amortization of customer relationships was $350,000 in both Q1Q2 2006 and Q1Q2 2005, and $700,000 for YTD 2006 and YTD 2005.  The amortization results from the periodic recognition of amortization expense of intangible customer relationships acquired in the Check Solutions acquisition in fiscal 2001, and this amortization will continue until May 2007.

Restructuring and Other Charges:  There were no restructuring and other charges recorded during Q1to date in fiscal 2006.  However, we recorded $127,000 in restructuring and other charges during Q1 2005, principally associated with the separation of 6 employees, and we recorded $28,000 in restructuring and other charges during Q2 2005, principally associated with the separation of 2 employees.  WeIn Q1 2005, we also lowered our estimate by $32,000 for the costs associated with the discontinuance of one of our software offerings originally recorded in January 2004.

The activity related to the accrued merger and restructuring costs during Q1to date in fiscal 2006 is as follows (in thousands):

 

Workforce
Reductions

 

CheckFlow
Suite

 

Other

 

Total

 

 

 

 

 

 

 

 

 

 

 

Reserve balance at January 31, 2006

 

$

87

 

$

200

 

$

47

 

$

334

 

Additions to reserve balance:

 

 

 

 

 

 

 

 

 

Severance charges

 

 

 

 

 

Reductions to reserve balances:

 

 

 

 

 

 

 

 

 

Change in estimate

 

 

 

 

 

Cash paid

 

(87

)

 

 

(87

)

Reserve balance at April 30, 2006

 

$

 

$

200

 

$

47

 

$

247

 

 

Workforce
Reductions

 

CheckFlow
Suite

 


Other

 


Total

 

 

 

 

 

 

 

 

 

 

 

Reserve balance at January 31, 2006

 

$

87

 

$

200

 

$

47

 

$

334

 

Cash paid

 

(87

)

 

 

(87

)

Reserve balance at April 30, 2006 and July 31, 2006

 

$

 

$

200

 

$

47

 

$

247

 

 

We anticipateexpect to complete these existing obligations by the remaining reserve accruals at April 30, 2006 will be paid or remaining customer obligations completed within the next 3 months.end of fiscal 2006.

Other Income (Expense):

Interest Income ($ in thousands):

 

Three Months Ended
April 30,

 

Variance

 

 

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

Interest Income

 

$

271

 

$

144

 

$

127

 

88.2

%

 

 

Three Months Ended
July 31,

 

Variance

 

Six Months Ended
July 31,

 

Variance

 

 

 

2006

 

2005

 

$

 

%

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest Income

 

$

407

 

$

166

 

$

241

 

145.2

%

$

678

 

$

310

 

$

368

 

118.7

%

 

Interest income consists of interest earned on marketable securities and cash and cash equivalents.  The increase in interest income in Q1 2006, as compared to Q1 2005,on both a quarterly and YTD basis is primarily the result of higher average invested balances in Q1fiscal 2006 and higher yields on these investments.

Interest Expense ($ in thousands):

 

Three Months Ended
April 30,

 

Variance

 

 

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

Interest Expense

 

$

(105

)

$

(105

)

$

 

%

 

 

Three Months Ended
July 31,

 

Variance

 

Six Months Ended
July 31,

 

Variance

 

 

 

2006

 

2005

 

$

 

%

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest Expense

 

$

(106

)

$

(107

)

$

(1

)

(0.9

)%

$

(211

)

$

(212

)

$

(1

)

(0.5

)%

 

Interest expense is primarily the result of the commitment fees associated with the maintenance of our $30.0 million revolving credit agreement.  As discussed below in “Liquidity and Capital Resources,” we did not renew our credit facility following its expiration on July 31, 2006.  Additionally, the amortization of the deferred loan costs is also included in interest expense.expense and this amortization concluded on July 31, 2006.  There have been no borrowings outstanding under this credit agreement since the quarter ended April 30,Q1 2004.


Other income ($ in thousands):

 

Three Months Ended
April 30,

 

Variance

 

 

Three Months Ended
July 31,

 


Variance

 

Six Months Ended
July 31,

 


Variance

 

 

2006

 

2005

 

$

 

%

 

 

2006

 

2005

 

$

 

%

 

2006

 

2005

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Minority share of net loss of Carretek LLC

 

$

133

 

$

318

 

$

(185

)

(58.2

)%

 

194

 

213

 

(19

)

(8.9

)%

327

 

531

 

(203

)

(38.3

)%

Foreign exchange (losses) / gains

 

70

 

(17

)

87

 

511.8

%

Foreign exchange gains (losses)

 

123

 

(84

)

207

 

246.4

%

193

 

(101

)

294

 

291.1

%

Other

 

(3

)

5

 

(8

)

(160.0

)%

 

(2

)

 

(2

)

%

(5

)

5

 

(11

)

(183.3

)%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

200

 

$

306

 

$

(106

)

(34.6

)%

 

$

315

 

$

129

 

$

186

 

144.2

%

$

515

 

$

435

 

$

80

 

18.4

%

 

We own a 51% interest in Carretek LLC (“Carretek”), through which we offer financial institutions offshore-centric outsourcing of their business processes.  Carretek has generated approximately $291,000$368,000 and $626,000$434,000 in losses for Q1in Q2 2006 and Q1Q2 2005, respectively.respectively, and $667,000 and $1.1 million in losses YTD 2006 and YTD 2005.  Accordingly, the 49% share in these losses relating to the minority interest held by Majesco Software, Inc., or $133,000$194,000 and $318,000$213,000 in Q2 2006 and Q2 2005, respectively, and $327,000 and $531,000 in YTD 2006 and 2005, respectively, was recorded in other income (expense) in Q1 2006 and Q1 2005, respectively..

Provision for Income Taxes:  The provision for income taxes is based on the estimated annual effective tax rate, and includes federal, state and foreign income taxes. In Q1 2006 and Q1 2005, the majority ofWe have established a valuation allowance to reserve our tax provision consisted of foreign taxes incurred that could not be offset with U.S. tax benefits. For us to realize the benefit of our net operating loss carryforward and other deferred tax assets recorded asat July 31, 2006 because of April 30, 2006, we must generate substantial future taxable income. Due to our inconsistent history of generating profitable operations and taxable income,income.  The tax provision was computed based on actual results by jurisdiction which resulted in a foreign tax provision of $134,000 and $102,000 for the three months ended July 31, 2006 and 2005, respectively, and $234,000 and $183,000 for the six months ended July 31, 2006 and 2005, respectively.  In addition to the provision for foreign taxes, we maintain a valuation allowance to fully reserverecorded $20,000 and $15,000 of U.S. Federal and State tax expense in the net deferredthree and six months ended July 31, 2006 and 2005, respectively, for alternative minimum tax assets.purposes.

41




Liquidity and Capital Resources

Historically, we have funded our operations and cash expenditures primarily with cash generated from operating activities.  At April 30,July 31, 2006, we had working capital of $19.6$22.0 million compared to $17.9 million at January 31, 2006.  We had $34.8$27.6 million in cash and cash equivalents at April 30,July 31, 2006, an increasea decrease of $5.1$2.1 million from $29.7 million in cash and cash equivalents at January 31, 2006.  However, we also had $5.9 million of “available for sale” marketable securities at April 30,July 31, 2006, compared to $4.7 million at January 31, 2006.  At April 30, 2006 and January 31, 2006, we did not have any borrowings outstanding under our revolving line of credit. We expect that existing cash and cash equivalents, marketable securities and our cash projected to be generated from operating activities will be sufficient to meet our presently anticipated liquidity requirements for the foreseeable future.

Cash used in operating activities was $5.8 million for Q1 2006 compared to cash used in operating activities of $5.9 million in Q1 2005.  Cash provided by operating activities was $7.9$2.1 million for the three months ended April 30,in YTD 2006 as compared to cash provided byused in operating activities of $2.1$3.8 million in the three months ended April 30,YTD 2005. The increase was primarily the result of the timing of the collection of 2006 calendar year maintenance billings as compared to the collection of the 2005 calendar year maintenance billings.

Average days’ sales outstanding fluctuate for a variety of reasons, including the timing of billings specified by contractual agreement, and receivables for expense reimbursements.  The following table contains the quarterly days’ sales outstanding (DSO):

Quarter ended

 

DSO

 

 

 

 

July 31, 2006

54

 

April 30, 2006

 

33

 

January 31, 2006

 

37

 

October 31, 2005

 

42

 

July 31, 2005

 

49

 

April 30, 2005

35


The increase in DSO is primarily the result of our RevE business segment providing payment terms for several large contracts recorded in Q1 and Q2 2006 which extended into Q3 and Q4 2006.

Cash used in investing activities increaseddecreased to $2.8$1.9 million during the three months ended April 30,in Q2 2006 as compared to $1.1$5.5 million during the three months ended April 30, 2005. Capital expenditures of $1.0in Q2 2005 and decreased to $4.6 million were made in the three months ended April 30,YTD 2006 as compared to $698,000 for$6.6 million in YTD 2005.  The reduction in both the three months ended April 30, 2005quarterly and haveYTD periods reflected a reduction in the purchase of marketable securities offset partially by increased due topurchases of property and equipment and increased capitalized software.  The increase in property and equipment is primarily the result of leasehold improvements performed in Charlotte, N.C., along with costs capitalized in connection with our ERP system upgrade.  Purchases of marketable securities were $3.5 million and sales of marketable securities were $2.3 million for the three months ended April 30, 2006. Additionally, the amount of capitalized computer software costs increased to $526,000 in the three months ended April 30, 2006, as compared to $437,000 for the three months ended April 30, 2005, due to increasedmore product development activity within our GPT and RevE business segment.segments.

There were no financing activities in the three months ended April 30, 2006; however, financingFinancing activities provided cash of $254,000$484,000 in the three months ended April 30,Q2 2006 as compared to a use of cash of $2.7 million in Q2 2005.  At April 30,Financing activities provided cash of $484,000 in YTD 2006 as compared to a use of cash of $2.4 million in YTD 2005.  The cash provided by financing activities in both Q2 2006 and YTD 2006 was related to proceeds from stock option exercises along with a minority shareholder cash investment in Carretek LLC.  The cash used in financing activities in Q2 2005 we purchased $349,000and YTD 2005 was related to $2.9 million and $3.2 million of ourtreasury stock purchases in Q2 2005 and YTD 2005, respectively.  These common stock purchases were performed under a program to purchase up to $5.0 million of the Company’s outstanding common stock during the period April 18, 2005 through October 14,15, 2005.  TheseThe cash used for these treasury stock purchases werewas partially offset by $52,000 of proceeds from the exercise of stock options and a $551,000additional minority shareholder cash investmentequity contributions in Carretek LLC.

We arewere a party to a revolving credit agreement with a group of banks providing for a commitment amount of $30.0 million and a maturity date of July 31, 2006.  At April 30, 2006 and April 30, 2005, the Company did notThere have anybeen no borrowings outstanding. Borrowingsoutstanding under the credit agreement bear interest equal to either the greater of prime or federal funds rate plus a margin ranging from 1.25% to 2.25% depending onfacility since Q1 2004 and we believe our ratio of funded debt to Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”); or London Interbank Offered Rate (“LIBOR”) plus a margin equal to 2.75% to 3.75% depending on our ratio of funded debt to EBITDA. Interest payments are due quarterly. We are required to pay an annual commitment fee equal to 0.50% on the unused amount of the revolving credit agreement. The revolving credit agreement contains customary affirmative and negative covenants, some of which have been amended, including financial covenants requiring the maintenance of specified interest coverage, ratio of EBITDA to funded debt, and ratio of 80% of accounts receivable,current cash and short term investmentscash equivalents, marketable securities and our cash projected to funded debt. Additionally,be generated from operations to be sufficient to meet our cash requirements for the payment of dividends andforeseeable future.  Therefore, we chose not to renew the purchase of treasury stock is precluded subject to the approval of the banks. Substantially all of our assets collateralize this revolving credit agreement. As of April 30, 2006, we are in compliance with the covenants of the revolving credit agreement, as amended.

We are currently discussing the renewal of our credit facility with our existing lenders. Thewhich expired by its terms of any renewal are not expected to be significantly different than the current terms should the facility be renewed by and with our existing lenders. Any renewal is expected to be complete byon July 31, 2006.


The following summarizes our contractual obligations at April 30,July 31, 2006 and the effect these contractual obligations are expected to have on our liquidity and cash flows in future periods (in thousands):

 

 

Payments Due by Period

 

 

 

Total

 

1 Year
or Less

 

Years 2-3

 

Years 4-5

 

After
5 Years

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating leases

 

$

11,273

 

$

3,300

 

$

5,581

 

$

2,392

 

$

 

 

 

$

11,273

 

$

3,300

 

$

5,581

 

$

2,392

 

$

 

 

 

Payments Due by Period

 

 

 

Total

 

1 Year
or Less

 

Years 2-3

 

Years 4-5

 

After
5 Years

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating leases

 

$

10,376

 

$

3,142

 

$

5,367

 

$

1,867

 

$

 

 

 

$

10,376

 

$

3,142

 

$

5,367

 

$

1,867

 

$

 

We believe that current cash balances and cash equivalents, marketable securities and expected future cash flows will be sufficient to meet our anticipated cash needs for working capital and routine capital expenditures during fiscal 2006.  However, if current sources are not sufficient to meet our needs, we may seek additionalnew equity or debt financing.  There can be no assurance that additional financing would be available on acceptable terms, if at all.  Further, we may in the future pursue acquisitions of businesses, products or technologies that could complement or expand our business and product offerings, and change our financing needs.  Our forecast of the period of time through which our financial resources will be adequate to support our operations areis a forward looking statementsstatement that involveinvolves risks and uncertainties, and actual results could vary.  The failure to secure additionalnew financing when needed could have a material adverse effect on our business, financial condition and results of operations.


Critical Accounting Policies

In preparing our financial statements in conformity with accounting principles generally accepted in the United States, we use certain estimates and assumptions that affect the reported amounts and related disclosures and our estimates may vary from actual results.  We consider the following seven accounting policies the most important to the portrayal of our financial condition and those that require the most subjective judgment.  Although we believe that our estimates and assumptions are reasonable, actual results may differ, and such differences could be significant to our financial results.

Revenue Recognition

The Company’s revenue recognition policies are in accordance with Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” as amended by SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions,” Staff Accounting Bulletin (“SAB”) No. 104,Revenue Recognition,” and Emerging Issues Task Force (“EITF”) No. 00-21, “Revenue Arrangements with Multiple Deliverables.”  In the case of software arrangements that require significant production, modification, or customization of software, or the license agreement requires the Company to provide implementation services that are determined to be essential to other elements of the arrangement, the Company follows the guidance in SOP 81-1, “Accounting for Performance of Construction—Construction–Type and Certain Production—Production–Type Contracts.”

In the case of non-software arrangements, we apply EITF No. 00-21 and revenues related to arrangements with multiple elements are allocated to each element based on the element’s relative fair value.  Revenue allocated to separate elements is recognized for each element in accordance with our accounting policies described below.  If we cannot account for items included in a multiple-element arrangement as separate units of accounting, they are combined and accounted for as a single unit of accounting and generally recognized as the undelivered items or services are provided to the customer.


Consulting.The Company employs three primary pricing methods in connection with its delivery of consulting services. First, the Company may price its delivery of consulting services on the basis of time and materials, in which case the customer is charged agreed-upon daily rates for services performed and out-of-pocket expenses. In this case, the Company is generally paid fees and related amounts usually on a monthly basis, and the Company recognizes revenues as the services are performed. Second, the Company may deliver consulting services on a fixed-price basis. In this case, the Company is paid on a monthly basis or pursuant to an agreed upon payment schedule, and the Company recognizes revenues on a proportionate performance basis.  The Company believes that this method is appropriate because of its ability to determine performance milestones and determine dependable estimates of its costs applicable to each phase of a contract.  Because financial reporting of these contracts depends on estimates, which are assessed continually during the term of the contract, costs are subject to revisions as the contract progresses.  Anticipated losses on fixed-price contracts are recognized when estimable.  Third, the Company may deliver consulting services pursuant to a value-priced contract with the customer. In this case, the Company is paid, on an agreed upon basis with the customer, either a specified percentage of (1) the projected increased revenues and/or decreased costs that are expected to be derived by the customer generally over a period of up to twelve months following implementation of its solution or (2) the actual increased revenues and/or decreased costs experienced by the customer generally over a period of up to twelve months following implementation of its solution, subject in either case to a maximum, if any is agreed to, on the total amount of payments to be made to the Company.  The Company must first commit time and resources to develop projections associated with value-pricing contracts before a customer will commit to purchase its solutions, and the Company therefore assumes the risk of making these commitments with no assurance that the customer will purchase the solution.  Costs associated with these value-pricing contracts are expensed as incurred.  These contracts typically include payments to be made to the Company pursuant to an agreed upon schedule ranging from one to twelve months in length.  The Company recognizes revenues generated from consulting services in connection with value-priced contracts once customer acknowledgement is obtained that confirms fees have become fixed and determinable.  In some cases, these acknowledgements contain future deliverables or services, in which case the revenue from these engagements is recognized on a proportionate performance basis based on the efforts to be incurred following the customer acknowledgement.  In an effort to allow customers to more closely match expected benefits from services with payments to the Company, the Company on occasion, may offer payment terms which extend beyond 12 months.  When the Company enters into an agreement which has a significant component of the total amount payable under the agreement due beyond 12 months or if it is determined payments are not fixed and determinable at the date the agreement was entered into, revenue under the arrangement will be recognized as payments become due and payable.  When fees are to be paid based on a percentage of actual revenues and/or savings to customers, the Company recognizes revenues only upon completion of all services and as the amounts of actual revenues or savings are confirmed by the customer with a fixed payment date.

Costs associated with time and materials, fixed-priced and value-priced consulting fee arrangements are expensed as incurred and are included as a component of the cost of consulting fees.


The Company expects that value-pricing contracts will continue to account for a significant portion of its revenues in the future. As a consequence of the use of value-pricing contracts and due to the revenue recognition policy associated with those contracts, the Company’s results of operations will likely fluctuate significantly from period to period.

Regardless of the pricing method employed by the Company in a given contract, the Company is typically reimbursed on a monthly basis for out-of-pocket expenses incurred on behalf of its customers.

Software License.A perpetual software license is sold either together with implementation services or on a stand-alone basis.  The Company is usually paid software license fees in one or more installments, as provided in the customer’s contract but not to exceed twelve months.  The Company recognizes software license revenue upon execution of a contract and delivery of the software, provided that the license fee is fixed and determinable, no significant production, modification or customization of the software is required and collection is considered probable by management.  When the software license arrangement requires the Company to provide implementation services that are essential to the functionality of the software or significant production, customization or modification of the software is required, both the product license revenue and implementation fees are recognized as services are performed.  A term software license is sold either together with implementation services and/or with maintenance services.  These term licenses are usually paid in annual installments over the term of the license.  If the term software license is sold without essential implementation services, the revenue is recognized ratably over the non-cancelable license term.  If the term license is sold with essential implementation services, the license revenue is recognized as the lesser of the amount of license revenue recognized as services are performed or on a ratable basis.

In certain instances, especially with recently developed software, the Company defers software license revenue recognition until the earlier of the product being determined to be generally available and subject to revenue recognition or when the services are completed and the project is accepted by the customer.  This practice is followed for the first two installations of a recently developed software product.  After two successful implementations, the product is considered generally available (“GA”).


Software licenses are often sold as part of a multiple element arrangement that may include maintenance, implementation or consulting.  The Company determines whether there is vendor specific objective evidence of fair value (“VSOEFV”) for each element identified in the arrangement to determine whether the total arrangement fees can be allocated to each element.  If VSOEFV exists for each element, the total arrangement fee is allocated based on the relative fair value of each element.  In cases where there is not VSOEFV for each element, or if it is determined services are essential to the functionality of the software being delivered, or if significant production, modification or customization of the software is required, the Company initially defers revenue recognition of the software license fees until VSOEFV is established or the services are performed.  However, if VSOEFV is determinable for all of the undelivered elements, and assuming the undelivered elements are not essential to the delivered elements, the Company will defer recognition of the full fair value related to the undelivered elements and recognize the remaining portion of the arrangement value through application of the residual method.  Where VSOEFV has not been established for certain undelivered elements, revenue for all elements is deferred until those elements have been delivered or their fair values have been determined.  Evidence of VSOEFV is determined for software products based on actual sales prices for the product sold to a similar class of customer and based on pricing strategies set forth in the Company’s price book.  Evidence of VSOEFV for services (implementation and consulting) is based upon standard billing rates and the estimated level of effort for individuals expected to perform the related services.  The Company establishes VSOEFV for maintenance agreements using the percentage method such that VSOEFV for maintenance is a percentage of the license fee charged annually for a specific software product, which in most instances is 20% of the portion of arrangement fees allocated to the software license element.

Although substantially all of the Company’s current software licenses provide for a fixed price license fee, some licenses instead provide for the customer to pay a monthly license fee based on actual use of the software product.  The level of license fees earned by the Company under these arrangements will vary based on the actual amount of use by the customer.  Revenue under these arrangements is recognized on a monthly basis as the usage becomes determinable.

Software Maintenance.In connection with the sale of a software license, a customer may elect to purchase software maintenance services. Most of the customers that purchase software licenses from the Company also purchase software maintenance services, which typically are renewed annually.  The Company charges an annual maintenance fee, which is typically a percentage of the initial software license fee. The annual maintenance fee generally is paid to the Company at the beginning of the maintenance period, and the Company recognizes these revenues ratably over the term of the related contract.  If the annual maintenance fee is not paid at the beginning of the maintenance period, the Company defers revenue recognition until the time that the maintenance fee is paid by the customer.  The Company normally continues to provide maintenance service while awaiting payment from customers.  When the payment is received, revenue is recognized for the period that revenue was previously deferred.  This may result in volatility in software maintenance revenue from period to period.


Software Implementation and Other Services.In connection with the sale of a software license, a customer may elect to purchase software implementation services, including software enhancements and other software services. Most of the customers that purchase software licenses from the Company also purchase software implementation services.  TheThe Company prices its implementation services on a time-and-materials or on a fixed-price basis, and the Company recognizes the related revenues as services are performed.  Costs associated with these engagements are expensed as incurred.

Outsourcing Services.While outsourcing revenue has been minimal to date, we currently recognize revenue based on the number of items processed.  These services are billed currently on a monthly basis.

Return Provisions.The Company’s contracts typically do not include right of return clauses, and as a result, the Company does not record a provision for returns.

Royalties

We are required to pay royalties in connection with software license, maintenance and consulting agreements entered into with certain customers under which we acquired third party software technology or other intellectual property used in products and services sold to our customers.  Under these arrangements, we accrue royalty expense when the associated revenue is recognized.  For current product offerings, the royalty percentages generally range from 20%-50% of the associated revenues.  Royalty expense is primarily included as a component of the cost of software license revenues; however, certain amounts are also included in cost of consulting and cost of software maintenance in the accompanying consolidated statements of operations.


Allowance for Doubtful Accounts

A large proportion of our revenues and receivables are attributable to our customers in the banking industry.  Our trade accounts receivable balance is recorded net of allowances for amounts not expected to be collected from our customers.  Because our accounts receivable are typically unsecured, we periodically evaluate the collectibility of our accounts based on a combination of factors, including a particular customer’s ability to pay as well as the age of receivables.  In cases where the evidence suggests a customer may not be able to satisfy its obligation to us or if the collection of the receivable becomes doubtful due to a dispute that arises subsequent to the delivery of our products and services, we set up a specific reserve in an amount we determine appropriate for the perceived risk.  If circumstances change, such as higher than expected defaults or an unexpected material adverse change in a customer’s ability to meet their financial obligations to us, our estimates of recoverability of amounts due us could be reduced by a material amount.

Software Costs Capitalized, Acquired Developed Technology, Goodwill, Other Intangible Assets and Other Long-Lived Assets

Software costs capitalized include developed technology acquired in acquisitions and costs incurred by us in developing our products that qualify for capitalization.  We capitalize our software development costs, other than costs for internal-use software, in accordance with Statement of Financial Accounting Standards No. 86, “Accounting for Costs of Computer Software to be Sold, Leased or Otherwise Marketed” (“SFAS 86”).  Our policy is to capitalize software development costs incurred in developing a product once technological feasibility of the product has been established.  Software development costs capitalized also include amounts paid for purchased software on products that have reached technological feasibility. Technological feasibility of the product is determined after completion of a detailed program design and a determination has been made that any uncertainties related to high-risk development issues have been resolved. If the process of developing the product does not include a detailed program design, technological feasibility is determined only after completion of a working model. All capitalized software development costs are amortized using an amount determined as the greater of: (1) the ratio that current gross revenues for a capitalized software project bears to the total of current and future projected gross revenues for that project or (2) the straight-line method over the estimated remaining economic life of the product (generally three to six years).  We continually monitor the net realizable value of the software capitalized and acquired developed technology for factors that would indicate impairment, such as a decline in the demand or loss of a significant customer.  During the quarterly period ended January 31, 2006, we performed our annual formal evaluation for impairment and determined that the carrying amount of these assets was not impaired and have noted no subsequent factors that would indicate impairment.


Goodwill is assessed on an annual basis for impairment at the reporting unit level by applying a fair value based test utilizing the results of a third party appraisal.  We perform an annual impairment assessment on November 1st of each year or when factors indicate that goodwill should be evaluated for possible impairment.  During the quarterly period ended January 31, 2006, we performed our annual evaluation for goodwill impairment and determined that the carrying amount of goodwill was not impaired and have not noted any factors subsequent that would indicate impairment.  Goodwill at April 30,July 31, 2006 totaled $20.8 million.  Any deterioration in market conditions, increases in interest rates and changes in our projections with respect to the Global Payments Technologies reporting unit to which goodwill is allocated would result in additional impairment charges in the future.

Restructuring and Other Charges

These operational restructuring reserves contain significant estimates pertaining to work force reductions, and the settlement of contractual obligations resulting from our actions.  Although we do not anticipate any significant changes in the future, the actual costs may differ from these estimates.

Contingencies

We are subject to proceedings, lawsuits and other claims.  We are required to assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses.  A determination of the amount or reserves required, if any, for these contingencies is made after careful analysis of each individual issue.  The required reserves may change in the future due to new developments in each matter or changes in insurance coverage or approach such as a change in settlement strategy.


Income Taxes

We recognize deferred tax assets or liabilities for the expected future tax consequences of temporary differences between the book and tax basis of assets and liabilities.  We review our deferred tax assets for recoverability and establish a valuation allowance based on historical taxable income, projected future taxable income and the expected timing of the reversals of existing temporary differences.  As a result of our recent history of inconsistent profitability, we have provided a full valuation allowance against our net deferred tax assets.  In addition, we expect to provide a full valuation allowance of any future tax benefits until we can sustain a level of profitability that demonstrates our ability to utilize these assets.

Recently Issued Accounting Standards

None.In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” – an interpretation of FAS 109, “Accounting for Income Taxes” (“FIN 48”) to create a single model to address accounting for uncertainty in tax positions.  FIN 48 clarifies the accounting for income taxes, by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements.  FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition.  FIN 48 is effective for fiscal years beginning after December 15, 2006.  We will adopt FIN 48 as of February 1, 2007, as required.  The cumulative effect of adopting FIN 48 will be recorded in retained earnings and other accounts as applicable.  We have not determined the effect, if any, that the adoption of FIN 48 will have on our financial position and results of operations.

44




Item 3.Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

We invest our cash in a variety of financial instruments.  The vast majority of these investments areis denominated in U.S. dollars and maintained with nationally recognized financial institutions.

Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk.  Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall.  Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates, or we may suffer losses in principal if forced to sell securities which have seen a decline in market value due to various factors including changes in interest rates.  At April 30,July 31, 2006, we held $5.9 million of auction rate securities.  The interest rate for these notes will adjust to the current market interest rate at each interest reset date, which is typically on at least a monthly basis.

We had no outstanding borrowings under our revolving credit agreement at April 30, 2006. As described in Note 4 of our Notes to Condensed Consolidated Unaudited Financial Statements, the interest rate under the revolving credit agreement is variable.

Foreign Currency Risk

We currently have sales and marketing operations in several international locations including Canada, United Kingdom, South Africa and Australia.  As a result, we have assets and liabilities outside the United States that are subject to fluctuations in foreign currency exchange rates.  Due to the nature of these operations, we currently utilize the U.S. Dollar as the functional currency for all international operations.  Within Carretek LLC, our 51% owned subsidiary which offers financial institutions offshore-centric outsourcing of their business processes, the majority of the labor costs is denominated in Indian Rupees while the revenues from this operation are denominated in U.S. Dollars.  As our operations increase, fluctuating labor costs may increase our foreign currency risk.

An insignificant portionLess than 10% of our accounts receivable balance at April 30,July 31, 2006 wasincludes amounts denominated in a foreign currency.  We do not currently hedge our foreign currency exposure; however, we do try to limit our foreign currency exposure by negotiating these foreign contracts in U.S. Dollars.  In the future we may change this practice.  We will continue to evaluate the need to adopt a hedge strategy in the future and may implement a formal strategy in future periods.

Foreign exchange gains were $70,000$123,000 for the three months ended April 30,July 31, 2006 and foreign exchange losses were $17,000$84,000 in the three months ended April 30,July 31, 2005.  These gains/losses were primarily the result of software license, maintenance and services contracts denominated in the British Pound and the Euro.


Item 4.  Controls and Procedures

Disclosure Controls and Procedures

We maintain disclosure controls and procedures designed to ensure that we are able to collect the information we are required to disclose in the reports we file under the Securities Exchange Act of 1934 (“Exchange Act”), and to process, summarize and disclose this information within the time periods specified in the rules under the Exchange Act.

As previously reported in our Annual Report on Form 10-K for the year ended January 31, 2006, our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of our disclosure controls and procedures as of January 31, 2006. Based on their evaluation, a material weakness in our internal control over financial reporting was identified, and the Chief Executive Officer and Chief Financial Officer concluded that, as of January 31, 2006, our disclosure controls and procedures were ineffective.

A material weakness is a control deficiency, or a combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of our annual or interim financial statements will not be prevented or detected. In connection with the evaluation described above, it was determined that as of January 31, 2006 we did not maintain effective controls over the preparation and review of our deferred software maintenance reconciliations. As a result of this material weakness, software maintenance revenue and deferred maintenance revenue were over and understated, respectively, by $2.0 million for the year ended January 31, 2004, and accumulated deficit and deferred maintenance revenue were over and understated, respectively, by $2.0 million for the year ended January 31, 2005. We restated our audited consolidated financial statements for the years ended January 31, 2005 and 2004 to correct these errors, which financial statements were included in our Annual Report on Form 10-K for the year ended January 31, 2006.

Following identification of the material weakness described above, we took certain remediation steps more fully described below, and management believes that the implementation of these steps has remediated the identified material weakness.

Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, has again evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act).  As of April 30,July 31, 2006, they carried out an evaluation of our disclosure controls and procedures, and the Chief Executive and Chief Financial Officers believe that these disclosure controls and procedures are effective to ensure that we are able to collect, process and disclose the information we are required to disclose in the reports we file with the SEC within the required time periods.

In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Changes in Internal Control over Financial Reporting

As described above, as of January 31, 2006 our management identified a material weakness in our internal control over financial reporting. In response to this material weakness, we established specific processes and controls and modified others to provide reasonable assurance that reconciliations are performed as a part of standardized procedures and reconciling items are properly identified and reported on a periodic basis. As a result of the implementation of these measures, management believes as of April 30, 2006 that this material weakness has been remediated. Except for the referenced remediation steps, thereThere have been no other changes in our internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


PART II:   OTHER INFORMATION

ITEM 1.          LEGAL PROCEEDINGS

The information with respect to certain legal proceedings set forth under “Contingencies” in Note 8 of the Notes to Condensed Consolidated Unaudited Financial Statements, is hereby incorporated by reference.  Reference is also made to the information contained in Part I,II, Item 3.1. Legal Proceedings in our Form 10-K10-Q for the period ended January 31,April 30, 2006.

Shareholder Derivative Suit.

In May 2006, the District Court approved the final settlement of the pending shareholder derivative suit and the litigation was terminated.

Shareholder Class Action.

The proposed settlement was preliminarily approved byThere were no material developments in this case during the fiscal quarter ended July 31, 2006.  On August 17, 2006, the District Court on May 5, 2006, but remains subject to final court approval.entered a Final Judgment and Order of Dismissal with Prejudice, concluding the litigation.

ITEM 1A.       RISK FACTORS

We face a number of significant risks and uncertainties in our business, which are detailed under “Risk Factors” in our Annual Report on Form 10-K for the year ended January 31, 2006 and summarized in this report under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”  There have been no material changes from the risk factors disclosed in the Form 10-K, except for the additional risk factor described below.  These risks and uncertaintiesrisk factors may affect our current position and future prospects, and should be considered carefully in evaluating us and an investment in our common stock.

We are exploring a range of strategic alternatives that we may or may not pursue and that may yield unforeseen results.

On June 12, 2006, we announced that our Board of Directors had authorized that we explore various strategic alternatives designed to increase our scale and capabilities in the marketplace.  These strategic alternatives include, but are not limited to, a merger with a strategic partner, a sale of the company and other possible transactions.  There can be no assurance that any particular strategic alternative will be pursued or that any transaction will occur, or on what terms.  If we choose to continue to execute our operating plan instead of pursuing a strategic alternative, our stock price could decline.  In addition, we may be unsuccessful in implementing an alternative that is chosen by our Board of Directors or we may implement an alternative that yields unexpected results.  The process of continuing to review, and potentially executing, strategic alternatives is likely to be costly and time-consuming and may distract our management and otherwise disrupt our operations, which could have a material adverse effect on our business, financial condition and results of operations.

ITEM 2.          UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3.          DEFAULTS UPON SENIOR SECURITIES

None.


ITEM 4.          SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

NoneAt our Annual Meeting of Stockholders held on July 13, 2006, two proposals were adopted by our stockholders: (1) the election of three directors as Class II directors for terms expiring at the Annual Meeting of Stockholders in 2009 as described in our Proxy Statement for the Annual Meeting (Messrs. J. Coley Clark, William C. Hammett, Jr. and Gregory B. Tomlinson were elected as directors), and (2) the ratification of the appointment of Ernst & Young LLP as independent registered public accountants of the Company for the fiscal year ending January 31, 2007.  The number of shares cast for and against as well as the number of abstentions as to each of these matters (other than the election of directors) are as follows:

Election of Directors

 

Shares For

 

Shares Withheld

 

 

 

 

 

 

 

J. Coley Clark

 

22,812,502

 

493,365

 

William C. Hammett, Jr.

 

22,813,568

 

492,299

 

Gregory B. Tomlinson

 

22,813,980

 

491,887

 

Proposal

 

Shares For

 

Shares Against

 

Abstentions

 

 

 

 

 

 

 

 

 

Ratification of accountants

 

23,217,991

 

84,180

 

3,696

 

ITEM 5.          OTHER INFORMATION

None.


ITEM 6.          EXHIBITS

Number

 

Exhibit Description

 

10.1

 

Board Representation Agreement dated March 24,June 26, 2006 between the Company, Prescott Group CapitalRiley Investment Management L.L.C., Phil FrohlichLLC, SACC Partners LP, and Jeffrey D. WatkinsBryant R. Riley, (incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K filed on MarchJune 27, 2006)

 

 

 

10.2

 

Employment Agreement dated AprilMay 19, 2006 between the Company and Blake A. WilliamsJohn D. Carreker, III

 

10.3

First Amendment to Employment Agreement dated August 10, 2006 between the Company and John D. Carreker, III

 

 

 

31.1

 

Certification Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002

 

 

 

31.2

 

Certification Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002

 

 

 

32.1

 

Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

 

 

32.2

 

Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002


SIGNATURES

Pursuant to the requirements of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

CARREKER CORPORATION

By:

/s/ John D. Carreker, Jr.

Date:

September 8, 2006

John D. Carreker, Jr.

Chairman of the Board and

Chief Executive Officer

 

 

 

By:

/s/ John D. Carreker, Jr.

      Date: June 8, 2006/s/ Lisa K. Peterson

 

John D. Carreker, Jr.Date:

Chairman of the Board and Chief Executive OfficerSeptember 8, 2006

 

 

 

By:

/s/ Lisa K. Peterson

      Date: June 8, 2006

Lisa K. Peterson

 

 

Chief Financial Officer

 

 

4951