See accompanying notes.

Bottomline Technologies (de), Inc.

Unaudited Condensed Consolidated Statements of Cash Flows

(in thousands)

See accompanying notes.

Bottomline Technologies (de), Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

September 30,December 31, 2005

Note 1—Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals and adjustments) considered necessary for a fair presentation of the interim financial information have been included. Operating results for the three and six months ended September 30,December 31, 2005 are not necessarily indicative of the results that may be expected for any other interim period or for the fiscal year ending June 30, 2006. For further information, refer to the financial statements and footnotes included in the Company’s Annual Report on Form 10-K as filed with the Securities and Exchange Commission (SEC) on September 12, 2005.

Certain prior period amounts have been reclassified to conform to the current year presentation.

Note 2—Share Based Payments

Effective July 1, 2005, the Company adopted Statement of Financial Accounting Standard No. 123 (revised 2004), “Share Based Payment” (SFAS 123R). Under SFAS 123R, the Company is required to recognize, as expense, the estimated fair value of all share based payments to employees. For the three and six months ended September 30,December 31, 2005, the Company recorded expense of approximately $1.7 and $3.4 million, respectively, in connection with its share-based payment awards.

The Company adopted SFAS 123R under the modified prospective method. Under this method, the Company recognized compensation cost for all share-based payments to employees based on the grant date estimate of fair value for those awards, beginning on July 1, 2005. Prior period financial information has not been restated.

For periods prior to the adoption of SFAS 123R, the Company had elected to follow Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees,” (APB 25) and related Interpretations in accounting for its share based payment awards. Under APB 25, since the exercise price of the Company’s employee stock options equaled the market price of the underlying stock on the date of the grant and, in the case of the Company’s stock purchase plans, since the plans are non-compensatory, no compensation expense was recorded in the financial statements.

The following table illustrates the effect on net income and earnings per share as if the Company had applied the fair value recognition provisions of FASB Statement No. 123, “Accounting for Stock Based Compensation,” to its share based payment arrangementsstock-based employee compensation for the three and six months ended September 30,December 31, 2004.

Share Based Compensation Plans

Employee Stock Purchase Plan

2000 Employee Stock Purchase Plan

On November 16, 2000, the Company adopted the 2000 Employee Stock Purchase Plan, which was amended on November 18, 2004 (2000 Stock Purchase Plan), and which provides for the issuance of up to a total of 1,500,000 shares of common stock to participating employees. Eligible employees may contribute between 1% and 10% of their base pay to the 2000 Stock Purchase Plan.

At the end of a designated purchase period, which occurs every six months on March 31 and September 30, employees purchase shares of the Company’s common stock with contributions accumulated via payroll deductions, at an amount equal to 85% of the lower of the fair market value of the common stock on the first day of each 24-month offering period or the last day of the applicable six-month purchase period.

The Company’s employee stock purchase plan has several complex features that make determining fair value on the grant date impracticable. Accordingly, and as permitted by SFAS 123R, the Company measures the fair value of its awards under the employee stock purchase plan at intrinsic value (the value of the Company’s common stock less the employee stock purchase plan exercise price) at the end of each reporting period. For the three monthsand six month periods ended September 30,December 31, 2005, the Company recorded compensation cost of approximately $116,000$29,000 and $145,000, respectively, associated with its employee stock purchase plan. ThereAt December 31, 2005, based on employee withholdings and the Company’s common stock price at that date, approximately 15,000 shares would have been eligible for issuance were no outstanding options under the plan as of September 30,December 31, 2005 as this wasto have been a stockdesignated purchase date. As a result of the employee stock purchase on September 30, 2005, the Company issued 34,249 shares of its common stock with an intrinsic value of approximately $259,000. No additional shares were issued during the three months ended December 31, 2005.

Stock Incentive Plans

1998 Non-Employee Director Stock Option Plan

On November 12, 1998, the Company adopted the 1998 Non-Employee Director Stock Option Plan (the Director Plan), which provides for the issuance of non-statutory stock options with a 10-year contractual term. The Company has reserved up to 300,000 shares of its common stock for issuance under the Director Plan. Under the terms of the Director Plan, each non-employee director is granted an option to purchase 15,000 shares of common stock upon his or her initial election to the Board of Directors. Such options vest over four years from the date of the grant, with 25% of the award vesting at the end of each year. Additionally, until November 17, 2005, each non-employee director iswas granted an option to purchase 7,500 shares of common stock at each annual meeting of stockholders following the annual meeting of the initial year of the election. Such options vestvested one year from the date of the grant.

Effective November 17, 2005, the Company determined that, in lieu of the annual stock option grants described above, the Company will now grant restricted stock awards for 3,000 shares of the Company’s common stock to each non-employee director on the date of each annual meeting of stockholders, with such awards vesting over a one year period. Accordingly, 18,000 shares of restricted stock were issued by the Company in November 2005 to its non-employee directors, as compensation for their service as directors.

2000 Employee Stock Incentive Plan

On November 16, 2000, the Company adopted the 2000 Employee Stock Incentive Plan (the 2000 Plan), which provides for the issuance of stock options, non-statutory stock options and restricted stock. Stock option awards under this plan have a 10-year contractual term. The 2000 Plan is administered by the Board of Directors, which has the authority to determine to whom options may be granted, the period of exercise and what other restrictions, if any, should apply. Vesting for awards granted under the 2000 Plan is principally over four years from the date of the grant, with 25% of the award vesting after one year and 6.25% of the award vesting each quarter thereafter. The Company initially reserved 1,350,000 shares of its common stock for issuance under the 2000 Plan.

On the first day of each fiscal year, beginning in fiscal year 2001 and ending in fiscal year 2010, the number of shares of common stock authorized for issuance under the 2000 Plan will automatically increase, without additional Board or stockholder approval. The number of shares authorized for issuance will increase, when added to the remaining available shares, to total an amount equal to 12% of the number of shares of common stock outstanding on the first day of the fiscal year, or such lesser number as the Board of Directors may determine prior to such increase. The annual increase can never

exceed 5,000,000 shares. Stock options issued under the 2000 Plan must be issued at an exercise price not less than 100% of the fair market value of the common stock at the date of grant.

Compensation cost associated with employee stock options represented approximately $1.5$1.4 million and $2.9 million of the total share based payment expense recorded for the three and six months ended September 30,December 31, 2005. The stock options were valued using a Black Scholes method of valuation, and the resulting fair value is recorded as compensation cost on a straight line basis over the option vesting period. The assumptions made for purposes of estimating fair value under the Black Scholes model for options granted during the threesix months ended September 30,December 31, 2005 were as follows:

The Company’s estimate of an expected option term was derived based on a review of its historic option holding periods, including a consideration of the holding period inherent in currently vested but unexercised options. The estimated stock price volatility was derived based on a review of the Company’s actual historic stock prices over the past five years. The specific stock option valuation assumptions used for awards granted prior to July 1, 2005 are as disclosed in the Company’s prior annual reports on Form 10-K, as filed with the SEC.

A summary of stock option activity under the 2000 Plan for the three months ended September 30,December 31, 2005 is as follows:

The weighted average grant date fair value of options granted during the three months ended September 30,December 31, 2005 and 2004 was $11.54$8.56 and $5.94,$8.09, respectively. The total intrinsic value of options exercised during the three months ended September 30,December 31, 2005 and 2004 was approximately $3.1$700,000 and $1.9 million, and $64,000, respectively. As of September 30,December 31, 2005, there was approximately $12.2$11.5 million of unrecognized compensation cost related to stock option awards that is expected to be recognized as expense over a weighted average period of 2.92.8 years. The total fair value of stock options that vested during the three months ended September 30,December 31, 2005 and 2004 was approximately $1.2$1.6 million and $1.5$1.2 million, respectively.

DuringA summary of stock option activity under the 2000 Plan for the six months ended December 31, 2005 is as follows:

The weighted average grant date fair value of options granted during the six months ended December 31, 2005 and 2004 was $9.62 and $6.40, respectively. The total intrinsic value of options exercised during the six months ended December 31, 2005 and 2004 was approximately $3.8 million and $1.9 million, respectively. The total fair value of stock options that vested during the six months ended December 31, 2005 and 2004 was approximately $2.8 million and $2.7 million, respectively.

A summary of restricted stock activity for the three months ended December 31, 2005 is as follows:

Prior to the quarter ended September 30, 2005, the Company granted 177,000 shares of restricted stock. Prior to this, the Company had not granted awards of restricted stock. The majority of the restricted stock awards vest over a four year period on a graded vesting schedule similar to the Company’s employee stock options.options, however restricted stock awards granted to the Company’s non-employee directors vest over a one year period. The restricted stock awards were valued based on the closing price of the Company’s common stock on the date of grant, withand compensation cost is recorded on a straight line basis over the share vesting period. The intrinsic value of the restricted stock awards was approximately $2.8 million and $2.7 million on the date of grant and on September, 30, 2005, respectively. The Company recorded expense of approximately $69,000 during$274,000 and $343,000 associated with its restricted stock awards in the three and six months ended September 30, 2005.December 31, 2005, respectively. As of September 30,December 31, 2005, there was approximately $2.7$5.7 million of unrecognized compensation cost related to restricted stock awards that will be recognized as expense over a weighted average period of 3.93.7 years. The Company believes thatNone of the restricted stock will be more effective, and will produce a lower accounting charge, than similar stock option based awards designed to incentivize and retain senior management.were vested at December 31, 2005.

Note 3—Business Combinations

Visibillity, Inc.

On December 31, 2005, the Company acquired all of the outstanding stock of Visibillity, Inc. (Visibillity), a provider of legal e-billing solutions specializing in the insurance industry. The purchase consideration for Visibillity was $11,500,000 in cash (reported as Other Current Liabilities in the Company’s unaudited condensed consolidated balance sheet) which was funded by the Company on January 3, 2006 from its existing cash balances. As more fully disclosed in Note 12, the Company will recover $500,000 of the purchase consideration from the Visibillity selling stockholders pursuant to the terms of the acquisition.

The Company believes that Visibillity complements the Company’s existing Legal eXchange product and that the acquisition will strengthen its position as a leading provider of Web-based legal spend management services to the insurance industry. As the acquisition was completed after the close of business on December 31, 2005, it had no impact on the Company’s operating results for the three or six months ended December 31, 2005. Visibillity operating results will be included in the Company’s operating results from the acquisition date forward, as a component of the Outsourced Solutions segment.

At December 31, 2005, the allocation of the purchase price was preliminary as the Company was still in the process of obtaining information relating to the fair value of assets acquired and liabilities assumed, including the value that should be allocated to intangible assets. The Company expects that a substantial portion of the purchase price will ultimately be allocated to intangible assets, and such assets are likely to include acquired core technology, customer related assets and goodwill. There was no acquired in-process research and development associated with the Visibillity acquisition. The Company expects to finalize its purchase price allocation no later than June 30, 2006. As Visibillity’s operations were immaterial to those of Bottomline, pro-forma financial information has not been included.

In connection with the acquisition the Company accrued approximately $154,000 and $188,000 related to involuntary termination costs of Visibillity employees and facility exit costs, respectively. The Company expects that all such amounts will be funded by April 30, 2006.

Note 4—Net Income Per Share

The following table sets forth the computation of basic and diluted net income per share:

The effectfollowing table denotes the number of 444,908 outstanding stock options and warrants that have been excluded from the calculation of diluted net income per share for the three months ended September 30, 2005, as their effect would be anti-dilutive. The effect of 2,131,513 outstanding stock options and 100,000 warrants have been excluded from the calculation of diluted net income per share for the three months ended September 30, 2004, as their effect would be anti-dilutive.

Note 4—5—Comprehensive Income or Loss

Comprehensive income or loss represents net income or loss plus the results of certain stockholders’ equity changes not reflected in the unaudited condensed consolidated statements of operations. The components of comprehensive income or loss, net of tax, are as follows:

Note 5—6—Operations by Segments and Geographic Areas

Segment Information

SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information”, establishes standards for reporting information about operating segments in financial statements. Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance.

The Company’s operating segments are organized principally by the type of products or services offered, and to a lesser degree, by geography. As of July 1, 2005, the Company consolidated the structure of its internal operating segments and changed the nature of the financial information that is provided to and used by the Company’s chief operating decision

makers. The change in segment composition on July 1, 2005 resulted in the consolidation of the Licensed Technology and Tailored Solutions segments into a single segment, Licensed Technology, and is reflected for all financial periods presented.

Licensed Technology.The Company’s Licensed Technology segment is a supplier of licensed software products that provide a range of financial business process management solutions including making and collecting payments, sending and receiving invoices, and generating and storing business documents. The Licensed Technology segment also provides solutions designed for banking and financial institution customers, which typically involve longer implementation periods and a significant level of professional resources. This segment also provides an array of standard professional services and equipment and supplies that complement and enhance the Company’s core software products. Revenue associated with this segment is generally recorded upon delivery, except in situations whenwhere a customized software solution is being delivered in which case revenue is normally recorded on a percentage of completion basis.

Outsourced Solutions.Solutions .The Outsourced Solutions segment provides customers with outsourced or hosted solutions offerings that facilitate payment processing and invoice receipt and presentment. Revenue for this segment is generally recognized on a per transaction basis or proportionately over the estimated life of the contract.

Each operating segment has separate sales forces and periodically a sales person in one operating segment will sell products and services that are typically sold within a different operating segment. In such cases, the transaction is generally recorded by the operating segment to which the sales person is assigned. Accordingly, segment results can include the results of transactions that have been allocated to a specific segment based on the contributing sales resources, rather than the nature of the product or service. Conversely, a transaction can be recorded by the operating segment primarily responsible for delivery to the customer, even if the sales person is assigned to a different operating segment.

The Company’s chief operating decision makers assess performance based on segment revenue and a segment measure of profit or loss. Each segment’s measure of profit or loss is on a pre-tax basis, and excludes stock compensation expense and acquisition-related expenses such as amortization of intangible assets and charges related to acquired in-process research and development. There are no intersegmentinter-segment sales; accordingly the measure of segment revenue and profit or loss reflects only revenues from external customers. The costs of certain corporate level expenses, primarily general and administrative expenses, are allocated to the Company’s operating segments at predetermined rates that approximate cost.

The Company does not track or assign its assets by operating segment.

The following represents a summary of the Company’s reportable segments:

A reconciliation of the measure of segment profit to GAAP operating income before the provision for income taxes is as follows:

The following depreciation expense amounts are included in the segment measure of profit:

Geographic Information

Revenues, based on the point of sales, not the location of the customer, by geographic area were as follows:

Long-lived assets, which are based on geographical designation, were as follows:

Note 6—7—Income Taxes

In the three and six month periodperiods ended September 30,December 31, 2005, and 2004 the Company recorded income tax expense of $310,000$344,000 and $158,000,$654,000, respectively. The provision for income taxes asin each of September 30, 2005 consistedthese periods consists of a small amount of US state income tax expense, which will be incurred irrespective of the Company’sour net operating loss carryforward,position in the US, and a provision for income taxes in Australia and the UK. The Company has provided a valuation allowance for its deferred tax expense associated with the Company’s Australian and UK operations. The majorityassets as it has concluded that it is more likely than not that these assets will not be realized. A portion of the incomevaluation allowance pertains to deferred tax provision, approximately $250,000, relates to income tax expense associatedassets established in connection with purchase business combinations. To the Company’s UK operations andextent that this portion of the valuation allowance is arisingreversed in part due to certain expenses that are not deductible for UK tax purposes.the future, goodwill will be adjusted.

Note 7—8—Goodwill and Other Intangible Assets

The following tables set forth the information for intangible assets subject to amortization and for intangible assets not subject to amortization:

Estimated amortization expense for the current fiscal year, and subsequent fiscal years, is as follows:

The increase in the carrying value of goodwill since June 30, 2005 is due to the acquisition of Visibillity, partially offset by a decrease in foreign currency exchange rates. The purchase price allocation for Visibillity is preliminary as of December 31, 2005 and all of the purchase consideration of $11.5 million has been allocated to goodwill in the presentation above. The Company expects to finalize the purchase price allocation of Visibillity no later than June 30, 2006, and any amounts relating to other classes of intangible assets will be reclassified as needed.

Note 9—Credit Facility

In December 2005, the Company’s subsidiary, Bottomline Europe, renewed through December 31, 2006 its Committed Overdraft Facility (Overdraft Facility), to provide for borrowings of up to 500,000 British Pound Sterling. Borrowings under this Overdraft Facility are secured by substantially all assets of Bottomline Europe, bear interest at the bank’s base rate (4.5% at December 31, 2005) plus 2% and are due on the expiration date of the Overdraft Facility. There were no outstanding borrowings under this Overdraft Facility at December 31, 2005.

Note 8—10—Commitments and Contingencies

In October 2005, the Company was served as a defendant in a lawsuit filed on June 3, 2005 in the United States District Court, Central District of California, Western Division, by R&N Check, Corp., alleging that a feature of the Legal eXchange product infringes the plaintiff’s patent 6,622,128 and seeking unspecified damages and an injunction. Based on a review of the plaintiff’s claim,In January 2006, the Company does not believe that its Legal eXchange product infringes saidacquired the ownership rights to patent 6,622,128 and, intendsin connection with the patent acquisition, R&N Check, Corp. agreed to vigorously defend itselfdismiss the lawsuit against this claim. The Company expects to incur legal costs in the course of defending this action, however does not believe that this matter will have a material impact on its financial position or operating results.Company.

In December 2004, Bottomline Europe entered into a contract with a vendor to provide software installation services to certain Bottomline Europe customers. Under the terms of the arrangement, Bottomline Europe has agreed to a minimum purchase commitment of £450,000 (approximately $797,000$774,000 based on exchange rates in effect at September 30,December 31, 2005) from this vendor. The services procured by Bottomline Europe are beingwere used to supplement the Company’s existing professional services team with respect to UK product installations. In the event that Bottomline Europe has not expended the minimum purchase commitment by June 30, 2006, any remaining, unused amount is due and payable to the vendor. As of September 30,December 31, 2005, Bottomline Europe had expended approximately £359,000 underthe full amount of this arrangement (approximately $635,000). The Company believes that it will satisfy the remaining commitment through ongoing operations, and accordingly has not accrued for any amount beyond the actual costs of services rendered by the vendor as of September 30, 2005.commitment.

Note 9—11—Stock Offering

In July 2005, the Company completed a follow-on offering of its common stock. In connection with this offering, the Company issued 3,560,000 shares of stock and generated proceeds, after underwriting discounts, of approximately $47 million. General Atlantic, an existing stockholder, sold 1,500,000 shares of the Company’s common stock in connection with this offering. The Company did not receive any proceeds for the shares sold by General Atlantic.

The Company expects to use the offering proceeds for general corporate purposes, including working capital, product development and capital expenditures. The Company may also use a portion of the proceeds to acquire other complimentary products, technologies or businesses, however there are currently no commitments or agreements with respect to any such transactions.

Note 12—Subsequent Events

On January 24, 2006, the Company acquired all of the outstanding stock of Tranmit Plc (“Tranmit”). Tranmit is a UK-based company that provides Web-based purchase-to-pay automation solutions. The purchase consideration for Tranmit was approximately $6.0 million of cash and $4.2 million (316,970 shares) of the Company’s common stock, as valued on the date of acquisition.

On January 25, 2006, the Company acquired a patent that addresses the process of online budgeting and evaluation of legal invoices. The purchase price for the patent was $935,000 in cash. Per the terms of the patent purchase, the Company will be obligated to make certain earn-out payments should the Company recover royalty payments from third parties or, beginning in fiscal 2009, should specific legal billing product revenues of the Company exceed $12.5 million on a per annum basis. In connection with the acquisition of this patent, the Company will recover $500,000 from the Visibillity selling stockholders, representing purchase consideration that had been held in escrow as per the terms of the Visibillity acquisition agreement.

This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. The statements contained in this report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Without limiting the foregoing, the words “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” and similar expressions are intended to identify forward-looking statements. All forward-looking statements included in this Quarterly Report on Form 10-Q are based on information available to us up to, and including, the date of this document, and we assume no obligation to update any such forward-looking statements, even if our estimates change. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth below under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Certain Factors That May Affect Future Results” and elsewhere in this Form 10-Q. You should carefully review those factors and also carefully review the risks outlined in other documents that we file from time to time with the SEC.

Overview

We provide software products and services for business payments and invoice management. Our solutions enable organizations to automate, manage, standardize and control transaction-based processes across the enterprise, particularly

those that involve making payments, sending and receiving invoices, receiving payments, generating business documents and conducting electronic banking. We offer software designed to run on-site at the customer’s location as well as hosted solutions. Our software is sold on both a license and subscription basis.

Our software applications address the global payment and related process requirements of business enterprises, permitting them to achieve greater operating efficiency, increase visibility of the cash cycle and better comply with applicable regulations and standards. We support a broad range of global networks and payment standards, including Automated Clearing House (ACH), Financial Electronic Data Interchange (EDI), Fed Wire transfer, BACS (ACH for the UK), BACSTEL-IP and SWIFT, as well as new and evolving standards.

For the first quartersix months of fiscal year 2006, our revenue increased to $24.7$50.8 million from $21.7$45.7 million in the same quarterperiod of lastthe prior year. The revenueThis increase was primarily attributable to growth ofin our subscription services,and transaction revenues, driven primarily by the contribution of revenue from HMSL, a company we acquired in April 2005, and increases in revenue from our Legal eXchange product in North America. The increase in revenue was offset in part by a decrease in BACSTEL IP product salessoftware license revenues in the UK, as the technology adoption date of December 2005 approaches.arrived. As of September 30,December 31, 2005, we estimate that we were 89% complete the BACSTEL-IP migration in the UK. WeUK was substantially complete. In the first six months of 2006, we derived approximately one half of our revenue through our international operations, of which the majority was attributable to our Bottomline Europe subsidiary. We expect to continue to grow revenue during fiscal 2006 as a result of increased purchases by both new and existing financial institution customers in North America, the continued market adoption of our Legal eXchange product in the US and the contribution of revenue from new products.

We had net income of $147,000$1.2 million in the threesix months ended September 30,December 31, 2005 compared to net income of $679,000$1.9 million in the threesix months ended September 30,December 31, 2004. For the threesix months ended September 30,December 31, 2005, our operating results were significantly impacted, in the form of additional expense, by the adoption of SFAS 123R “Share Based Payment”. As a result of the adoption of SFAS 123R, the fair value of all stock-based compensation is now recorded as expense in our financial statements, rather than as a footnote disclosure. Accordingly, we recorded approximately $1.7$3.4 million in stock compensation expense for the threesix months ended September 30,December 31, 2005.

Critical Accounting Policies

We believe that several accounting policies are important to understanding our historical and future performance. We refer to these policies as “critical” because these specific areas generally require us to make judgments and estimates about matters that are uncertain at the time we make the estimate, and different estimates—which also would have been reasonable—could have been used, which would have resulted in different financial results.

The critical accounting policies we identified in our most recent Annual Report on Form 10-K for the fiscal year ended June 30, 2005 related to revenue recognition, goodwill and intangible assets and valuation of acquired intangible assets. With the adoption of SFAS 123R on July 1, 2005, we have identified the estimates and assumptions that accompany the fair value determination of our stock option awards as critical, as discussed below. It is important that the discussion of our operating results that follows be read in conjunction with the critical accounting policies discussed below as well as those disclosed in our Annual Report on Form 10-K, as filed with the SEC on September 12, 2005.

Stock-Based Compensation

Effective July 1, 2005, we adopted accounting rules (SFAS 123R, “Share-Based Payment”) requiring the expense recognition of the estimated fair value of all share-based payments issued to employees. Prior to this, the estimated fair value associated with such awards was not recorded as an expense, but rather was disclosed in a footnote to our financial statements. For the quarterthree and six month periods ended September 30,December 31, 2005, we recorded approximately $1.7 million and $3.4 million of expense, respectively, associated with share-based payments, with the majority of this expense, approximately $1.5$1.4 and $2.9 million, attributable to employee stock options.options in the three and six month periods ended December 31, 2005, respectively.

The valuation of employee stock options is an inherently subjective process, since market values are generally not available for long-term, non-transferable employee stock options. Accordingly, an option pricing model is utilized to derive an estimated fair value. In calculating the estimated fair value of our stock options, we used a Black-Scholes pricing model which requires the consideration of the following six variables for purposes of estimating fair value:

Of the variables above, the selection of an expected term and expected stock price volatility are the most subjective. For purposes of calculating an estimated expected term, we reviewed our historic option activity, considered the underlying option holding period (including the holding period inherent in currently vested but unexercised options) and estimated an expected term of 4.9 years. In estimating our stock price volatility, we analyzed our historical volatility for a period equal to the expected term of our stock option awards, and, by reference to actual stock prices during this period, calculated an estimated volatility ofranging from 83% to 87%. We believe that each of these estimates, both expected term and volatility, is reasonable in light of the historic data we analyzed. However, as with any estimate, the ultimate accuracy of these estimates is only verifiable over time.

The specific valuation assumptions noted above were applied to stock options that we granted subsequent to our adoption of SFAS 123R, however the majority of the stock option expense recorded in the quarterthree and six month periods ended September 30,December 31, 2005 relates to the

continued vesting of stock options that were granted prior to July 1, 2005. In accordance with the transition provisions of SFAS 123R, the grant date estimates of fair value associated with prior awards, which were also calculated using a Black-Scholes option pricing model, have not been changed. The specific valuation assumptions that were utilized for purposes of deriving an estimate of fair value at the time that prior awards were issued are as disclosed in our prior annual reports on Form 10-K, as filed with the SEC.

Upon the adoption of SFAS 123R, we were also required to estimate the level of award forfeitures expected to occur, and record compensation cost only for those awards that are ultimately expected to vest. This requirement applies to all awards that are not yet vested, including awards granted prior to July 1, 2005. Accordingly, we performed a historical analysis of option awards that were forfeited (such as by employee separation) prior to vesting, and ultimately recorded total stock option expense of approximately $1.5 million, that reflected this estimated forfeiture rate. Our annual forfeiture estimate was calculated at 3.6%. From a sensitivity perspective, had we estimated our forfeiture rate at 0% the stock option expense for the quarterthree and six month periods ended September 30,December 31, 2005 would have increased by $233,000.$227,000 and $460,000, respectively.

Three Months Ended September 30,December 31, 2005 Compared to the Three Months Ended September 30,December 31, 2004

Revenues by segment

As of July 1, 2005, we consolidated the structure of our internal operating segments and changed the nature of the financial information that is provided to and used by our chief operating decision makers. We have aggregated similar operating segments into two reportable segments, Licensed Technology and Outsourced Solutions. The change in segment composition on July 1, 2005 resulted in the consolidation of our Licensed Technology and Tailored Solutions segments into a single segment, Licensed Technology, and is reflected for all financial periods presented. The following table represents our revenues by segment: