**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTOND.C. 20549**

**FORM 10-Q**

**QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

**For thequarterly period ended September30, 2006**

**Commissionfile number 000-26621**

**NICINC.**(Exact name of registrant as specified in its charter)

| **Colorado**                                                     | ** ** | **52-2077581**                       |
|------------------------------------------------------------------|------------|--------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |       | (I.R.S Employer  Identification No.) |
|                                                             |       |                                 |
| **10540  South Ridgeview Road  Olathe, Kansas**                  |       | **66061**                            |
| (Address of  principal executive offices)                        |       | (Zip Code)                           |
|                                                             |       |                                 |
| **(877)  234-3468**                                              |
| (Registrant’s  telephone number, including area code)       |

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

Yes  x  No o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer andlarge 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 ashell company (as defined in rule 12b-2 of the Exchange Act).

Yes  o  No x

The number of shares outstanding of the registrant’scommon stock as of October 31, 2006 was 61,570,900.

 

----

**PART I -FINANCIAL INFORMATION**

**Item1.  Consolidated Financial Statements**

 

**NIC INC.CONSOLIDATED BALANCE SHEETS(UNAUDITED)thousands except for share amounts**
| ** **                                                                                                    | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                    |       |                         |       |                        |       |
| Current assets:                                                                                               |       |                         |       |                        |       |
| Cash and cash  equivalents                                                                                    |       | $                            | 32,661     |                        | $          | 36,902 |   |
| Marketable  securities                                                                                        |       | 42,000                       |       | 20,500                      |       |
| Trade accounts  receivable                                                                                    |       | 28,213                       |       | 22,269                      |       |
| Unbilled  revenues                                                                                            |       | 406                          |       | 2,198                       |       |
| Deferred income  taxes                                                                                        |       | 755                          |       | 421                         |       |
| Prepaid expenses  & other current assets                                                                  |       | 1,331                        |       | 1,632                       |       |
| Total current  assets                                                                                         |       | 105,366                      |       | 83,922                      |       |
| Property and equipment,  net                                                                                  |       | 3,666                        |       | 3,327                       |       |
| Unbilled revenues                                                                                             |       | —                       |       | 1,395                       |       |
| Deferred income taxes                                                                                         |       | 22,979                       |       | 28,916                      |       |
| Other assets                                                                                                  |       | 345                          |       | 285                         |       |
| Total assets                                                                                                  |       | $                            | 132,356    |                        | $          | 117,845 |   |
|                                                                                                          |       |                         |       |                        |       |
| **LIABILITIES  AND SHAREHOLDERS' EQUITY**                                                                     |       |                         |       |                        |       |
| Current liabilities:                                                                                          |       |                         |       |                        |       |
| Accounts payable                                                                                              |       | $                            | 30,011     |                        | $          | 24,458 |   |
| Accrued expenses                                                                                              |       | 5,372                        |       | 6,642                       |       |
| Application  development contracts                                                                            |       | 557                          |       | 1,261                       |       |
| Other current  liabilities                                                                                    |       | 350                          |       | 317                         |       |
| Total current  liabilities                                                                                    |       | 36,290                       |       | 32,678                      |       |
|                                                                                                          |       |                         |       |                        |       |
| Commitments and  contingencies (Note 2)                                                                       |       | —                       |       | —                      |       |
|                                                                                                          |       |                         |       |                        |       |
| Shareholders' equity:                                                                                         |       |                         |       |                        |       |
| Common stock, no  par, 200,000,000 shares authorized 61,570,900 and 61,073,505 shares issued  and outstanding |       | —                       |       | —                      |       |
| Additional  paid-in capital                                                                                   |       | 209,699                      |       | 207,444                     |       |
| Accumulated  deficit                                                                                          |       | (113,465                     | )          | (122,093                    | )          |
|                                                                                                          |       | 96,234                       |       | 85,351                      |       |
| Less treasury  stock                                                                                          |       | (168                         | )          | (184                        | )          |
| Total  shareholders' equity                                                                                   |       | 96,066                       |       | 85,167                      |       |
| Total liabilities and  shareholders' equity                                                                   |       | $                            | 132,356    |                        | $          | 117,845 |   |

 

*The accompanying Notes toConsolidated Financial Statements are an integral part of these statements.*

1

----

 

**NIC INC.CONSOLIDATED STATEMENTS OF INCOME(UNAUDITED)thousands except for per share amounts**

 
| ** **                                                                              | ** ** | **Three-months ended  September 30,** | ** ** | **Nine-months ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                              | ** ** | **2006**                                        | ** ** | **2005**                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenues:                                                                               | ** ** | ** **                                      | ** ** | ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Portal revenues                                                                         |       | $                                               | 17,214     |                                           | $          | 14,637 |   | $ | 51,997 |   | $ | 42,684 |   |
| Software & services revenues                                                        |       | 821                                             |       | 1,321                                          |       | 547 |   | 171 |   |
| Total revenues                                                                          |       | 18,035                                          |       | 15,958                                         |       | 52,544 |   | 42,855 |   |
| Operating  expenses:                                                                    |       |                                            |       |                                           |       |   |   |   |   |
| Cost of portal revenues, exclusive of depreciation &  amortization                  |       | 9,478                                           |       | 7,620                                          |       | 26,685 |   | 21,428 |   |
| Cost of software & services revenues, exclusive  of depreciation & amortization |       | 565                                             |       | 1,117                                          |       | 3 |   | 4,442 |   |
| Selling & administrative                                                            |       | 3,916                                           |       | 2,948                                          |       | 10,904 |   | 9,507 |   |
| Depreciation & amortization                                                         |       | 501                                             |       | 422                                            |       | 1,531 |   | 1,141 |   |
| Total operating expenses                                                                |       | 14,460                                          |       | 12,107                                         |       | 39,123 |   | 36,518 |   |
| Operating income                                                                        |       | 3,575                                           |       | 3,851                                          |       | 13,421 |   | 6,337 |   |
| Other income  (expense):                                                                |       |                                            |       |                                           |       |   |   |   |   |
| Interest income                                                                         |       | 666                                             |       | 197                                            |       | 1,544 |   | 432 |   |
| Equity in net loss of affiliates                                                        |       | —                                          |       | —                                         |       | (97 | ) | — |   |
| Other income (expense), net                                                             |       | (49                                             | )          | —                                         |       | (49 | ) | (3 | ) |
| Total other income (expense)                                                            |       | 617                                             |       | 197                                            |       | 1,398 |   | 429 |   |
| Income before  income taxes                                                             |       | 4,192                                           |       | 4,048                                          |       | 14,819 |   | 6,766 |   |
| Income tax  provision                                                                   |       | 1,727                                           |       | 1,661                                          |       | 6,191 |   | 2,806 |   |
| Net income                                                                              |       | $                                               | 2,465      |                                           | $          | 2,387 |   | $ | 8,628 |   | $ | 3,960 |   |
|                                                                                    |       |                                            |       |                                           |       |   |   |   |   |
| Basic net income  per share                                                             |       | $                                               | 0.04       |                                           | $          | 0.04 |   | $ | 0.14 |   | $ | 0.07 |   |
| Diluted net  income per share                                                           |       | $                                               | 0.04       |                                           | $          | 0.04 |   | $ | 0.14 |   | $ | 0.07 |   |
|                                                                                    |       |                                            |       |                                           |       |   |   |   |   |
| Weighted average  shares outstanding:                                                   |       |                                            |       |                                           |       |   |   |   |   |
| Basic                                                                                   |       | 61,536                                          |       | 60,271                                         |       | 61,353 |   | 59,838 |   |
| Diluted                                                                                 |       | 61,798                                          |       | 61,226                                         |       | 61,749 |   | 60,902 |   |

 

*Theaccompanying Notes to Consolidated Financial Statements are an integral part ofthese statements.*

2

----

#  

**NIC INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(UNAUDITED)thousands**

 
| ** **                                                                         | ** ** | **Nine-months ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2006**                                       | ** ** | **2005** | ** ** |
| Cash flows from  operating activities:                                             | ** ** | ** **                                     | ** ** | ** ** | ** ** |
| Net income                                                                         |       | $                                              | 8,628      |   | $ | 3,960 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                                           |       |   |   |
| Depreciation & amortization                                                    |       | 1,531                                          |       | 1,141 |   |
| Stock-based compensation expense                                                   |       | 829                                            |       | — |   |
| Application development contracts                                                  |       | (704                                           | )          | 1,338 |   |
| Deferred income taxes                                                              |       | 5,603                                          |       | 2,510 |   |
| Equity in net loss of affiliates                                                   |       | 97                                             |       | — |   |
| Loss on disposal of property and equipment                                         |       | 49                                             |       | — |   |
| Changes in operating assets and liabilities:                                       |       |                                           |       |   |   |
| (Increase) in trade accounts receivable                                            |       | (5,944                                         | )          | (4,708 | ) |
| Decrease in unbilled revenues                                                      |       | 3,187                                          |       | 2,992 |   |
| (Increase) decrease in prepaid expenses & other  current assets                |       | 286                                            |       | (92 | ) |
| (Increase) decrease in other assets                                                |       | (140                                           | )          | 76 |   |
| Increase in accounts payable                                                       |       | 5,553                                          |       | 6,505 |   |
| (Decrease) in accrued expenses                                                     |       | (1,270                                         | )          | (302 | ) |
| Increase (decrease) in other current liabilities                                   |       | 33                                             |       | (35 | ) |
| Net cash provided by operating activities                                          |       | 17,738                                         |       | 13,385 |   |
|                                                                               |       |                                           |       |   |   |
| Cash flows from  investing activities:                                             |       |                                           |       |   |   |
| Purchases of property and equipment                                                |       | (1,919                                         | )          | (1,304 | ) |
| Purchases of marketable securities                                                 |       | (21,500                                        | )          | (30,900 | ) |
| Maturities of marketable securities                                                |       | —                                         |       | 15,000 |   |
| Cash and cash equivalents - restricted                                             |       | —                                         |       | 3,000 |   |
| Net cash used in investing activities                                              |       | (23,419                                        | )          | (14,204 | ) |
|                                                                               |       |                                           |       |   |   |
| Cash flows from  financing activities:                                             |       |                                           |       |   |   |
| Proceeds from sale of treasury stock                                               |       | 65                                             |       | — |   |
| Proceeds from employee common stock purchases                                      |       | 157                                            |       | 122 |   |
| Proceeds from exercise of employee stock options                                   |       | 1,218                                          |       | 2,227 |   |
| Net cash provided by financing activities                                          |       | 1,440                                          |       | 2,349 |   |
|                                                                               |       |                                           |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                              |       | (4,241                                         | )          | 1,530 |   |
| Cash and cash  equivalents, beginning of period                                    |       | 36,902                                         |       | 30,769 |   |
| Cash and cash  equivalents, end of period                                          |       | $                                              | 32,661     |   | $ | 32,299 |   |
| Other cash flow  information:                                                      |       |                                           |       |   |   |
| Interest paid                                                                      |       | $                                              | —     |   | $ | — |   |
| Income taxes  paid                                                                 |       | $                                              | 363        |   | $ | 542 |   |

 

*Theaccompanying Notes to Consolidated Financial Statements are an integral part ofthese statements.*

3

----

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

NIC Inc. (“NIC” or the “Company”)has prepared the consolidated interim financial statements included hereinwithout audit, pursuant to the rules and regulations of the Securities andExchange Commission (“SEC”).  Certaininformation and disclosures normally included in financial statements preparedin accordance with generally accepted accounting principles have been omittedpursuant to such rules and regulations. In management’s opinion, the consolidated interim financial statementsreflect all adjustments (which include only normal recurring adjustments,except as disclosed) necessary to state fairly the results of operations forthe interim periods presented.  Theseconsolidated financial statements and notes should be read in conjunction withthe audited consolidated financial statements and related notes included in theCompany’s Annual Report on Form 10-K for the year ended December 31, 2005,filed with the SEC on March 16, 2006, and Item 2. Management’s Discussion andAnalysis of Financial Condition and Results of Operations included in this Form10-Q.  The consolidated balance sheetdata included herein as of December 31, 2005 was derived from audited financialstatements, but does not include all disclosures required by accountingprinciples generally accepted in the United States of America.

**1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

*Basis of presentation*

TheCompany’s consolidated statement of cash flows for the nine-month period endedSeptember 30, 2005 reflects changes in restricted cash as an investingactivity.  Changes in restricted cashhave previously been reflected as a financing activity.

*Marketable securities*

The Company’s marketablesecurities at September 30, 2006 were classified as available-for-sale andconsisted primarily of short-term auction rate government-backed obligations.These investments are stated at fair value. The cost of securities sold is based on the specific identificationmethod. The fair values of the Company’s marketable securities are based onquoted market prices at the reporting date.

*Stock-based compensation*

Effective January 1, 2006, theCompany adopted the provisions of Statement of Financial Accounting Standards (“SFAS”)No. 123R (revised 2004), “Share-Based Payment,” which establishes theaccounting for equity instruments exchanged for employee services.  Prior to January 1, 2006, the Companyaccounted for its stock-based compensation plans in accordance with AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued to Employees,”and related interpretations.  The Companyalso followed the disclosure requirements of SFAS No. 123, “Accounting forStock-Based Compensation,” as amended by SFAS No. 148, “Accounting forStock-Based Compensation — Transition and Disclosure.”  See Note 3 for additional discussion of theCompany’s adoption of SFAS No. 123R.

*Earnings per share*

Basic earnings per share arecalculated on the basis of the weighted average number of common sharesoutstanding during the period.  Diluted 

4

----

earnings per shareare calculated on the basis of the weighted average number of common sharesoutstanding during the period and common stock equivalents that would arisefrom the exercise of employee common stock options and common stock warrants orthe issuance of restricted stock awards to employees and nonemployee directorsusing the treasury stock method.  Thefollowing table sets forth the computation of basic and diluted earnings pershare (in thousands, except per share amounts):
| ** **                                                 | ** ** | **Three-months  Ended Sep. 30,** | ** ** | **Nine-months  Ended Sep. 30,** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                 | ** ** | **2006**                                   | ** ** | **2005**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Numerator:**                                             |       |                                       | ** ** | ** **                                |       |   |   |   |   |
| Net income                                                 |       | $                                          | 2,465      | ** **                                | $          | 2,387 |   | $ | 8,628 | ** ** | $ | 3,960 |   |
| **Denominator:**                                           |       |                                       |       |                                      |       |   |   |   |   |
| Weighted average  shares – basic                      |       | 61,536                                     | ** ** | 60,271                                    |       | 61,353 | ** ** | 59,838 |   |
| Employee common  stock options and restricted stock awards |       | 262                                        |       | 955                                       |       | 396 |   | 1,064 |   |
| Weighted average  shares – diluted                    |       | 61,798                                     |       | 61,226                                    |       | 61,749 |   | 60,902 |   |
| **Basic  earnings per share:**                             |       |                                       |       |                                      |       |   |   |   |   |
| Net income                                                 |       | $                                          | 0.04       |                                      | $          | 0.04 |   | $ | 0.14 |   | $ | 0.07 |   |
| **Diluted  earnings per share:**                           |       |                                       |       |                                      |       |   |   |   |   |
| Net income                                                 |       | $                                          | 0.04       |                                      | $          | 0.04 |   | $ | 0.14 |   | $ | 0.07 |   |

 

Outstanding employee commonstock options totaling approximately 0.4 million and 0.3 million shares duringthe three- and nine-month periods ended September 30, 2006, respectively, werenot included in the computation of diluted weighted average shares outstandingbecause their exercise prices were in excess of the average stock price of theCompany during the periods.  Outstandingemployee common stock options totaling approximately 0.4 million and 0.6million shares during the three- and nine-month periods ended September 30,2005, respectively, were not included in the computation of diluted weightedaverage shares outstanding because their exercise prices were in excess of theaverage stock price of the Company during the periods.

**2. CALIFORNIA SECRETARY OF STATE APPLICATIONDEVELOPMENT CONTRACT**

In September 2001,NICUSA, Inc. and the Company’s NIC Conquest subsidiary were awarded afive-year, $25 million contract by the California Secretary of State (the “CaliforniaSOS”) to develop and implement a comprehensive information management andfiling system.  The Company recognizesrevenues from this contract on the percentage of completion method, utilizingcosts incurred to date as compared to the estimated total cost.  Revenues and profit (loss) from this contractare based on the Company’s cost estimates to complete and are reviewedperiodically, with adjustments recorded in the period revisions are made.  Any anticipated contract loss is charged tooperations as soon as determinable.

Priorto the first quarter of 2005, key elements of the Company’s obligations underthe California SOS contract were subcontracted to various third parties underfixed price contracts.  At the end of thefirst quarter of 2005, as a result of system delivery issues and the concernover the ability of one of the two remaining subcontractors to meet the criteriaset forth by the California SOS, the Company determined it would assume thelead project manager role on the contract, which was previously performed bythis subcontractor.  As a result of thischange, the Company further evaluated the status of the project and concludedthat a further modification to the management and oversight structure of theproject was necessary to improve performance under the contract and thatadditional internal project 

5

----

management and technicalpersonnel would be required on the engagement. The Company also reevaluated the expected completion date of theproject, which was previously estimated to be in the first quarter of 2006, anddetermined to revise the estimated completion date to the end of 2006.  As a result of the Company’s decision tocommit these additional resources and the extension of the expected projectcompletion date, the Company recorded a $5.0 million adjustment underpercentage of completion accounting in the first quarter of 2005, as theCompany expected to incur a loss of approximately $4.2 million on this project,instead of a previously projected profit of approximately $1.0 million.

Theadjustment in the Company’s consolidated statement of income for the nine-monthperiod ended September 30, 2005 resulted in a reduction of software &services revenues of approximately $3.5 million and an increase in cost ofsoftware & services revenues of approximately $1.5 million.  The adjustment in the Company’s consolidatedbalance sheet was a reduction in unbilled revenues of approximately $3.5million and an increase in application development contracts (a currentliability) of approximately $1.5 million.

On March 13, 2006,the Company and the California SOS entered into an amendment (the “Amendment”)to the California Business Programs Automation Agreement (the “Agreement”).  Among other changes to the Agreement, theAmendment reduced the aggregate contract value to approximately $19 million andreleased the Company from the obligation to deliver the business filings, orBE, portion of the project, except for maintenance of hardware and delivery ofBE images as expressly set forth in the Amendment.  The Amendment also set forth the finalcriteria in order for the California SOS to accept the Uniform Commercial Code,or UCC, portion of the project and move it into the maintenance and operationsphase.

The Company has reviewed its cost estimates tocomplete based on the revised terms and conditions in the Amendment and doesnot believe its estimated contract loss will exceed the $4.2 million estimateestablished in the first quarter of 2005. However, because of the inherentuncertainties surrounding the ultimate outcome of subcontract negotiationsbetween the Company and its subcontractors as a result of the Amendment, it isat least reasonably possible that the estimate will change in the nearterm.  Further, it is possible that theCompany will similarly incur cost overruns in the future as it has in the pastas a result of unforeseen difficulties such as rising development,subcontractor and personnel costs or other reasons. If this occurs, the Company’sresults of operations, financial condition and cash flows could be adverselyaffected.

Asa result of the Amendment, the Company recorded an adjustment under percentageof completion accounting in the first quarter of 2006.  The adjustment in the Company’s consolidatedstatement of income for the nine-month period ended September 30, 2006 resultedin a reduction of software & services revenues of approximately $2.1million and a reduction of cost of software & services revenues ofapproximately $2.1 million.  Theadjustment in the Company’s consolidated balance sheet was a reduction inunbilled revenues of approximately $2.1 million, a reduction of accruedliabilities of approximately $1.6 million, and a reduction of applicationdevelopment contracts of approximately $0.5 million.  This adjustment did not affect operatingincome, net income or basic and diluted earnings per share.

6

----

 

In June 2006, theCalifornia SOS officially accepted the UCC portion of the project, which alsocommenced the 42-month maintenance and operations phase.  Upon acceptance, the Company was relieved ofits obligation to provide a $5 million performance bond to the California SOS.  The bond was collateralized by a $5 millionletter of credit.  Also upon acceptance,approximately $1.5 million in milestone payments became due to the Company,thus reducing unbilled revenues. Unbilled revenues under this contract totaled approximately $0.4 million at September 30, 2006 and $3.4million at December 31, 2005.

At September 30,2006, the Company’s UCC and corporate filings software development business wasprimarily engaged in servicing the maintenance and operations obligation underits contract with the California SOS. This software & services business is not marketing its applicationsand services for new engagements.

**3. STOCK-BASED COMPENSATION**

Prior to January 1, 2006, theCompany accounted for its stock-based compensation plans using the intrinsicvalue method in accordance with Accounting Principles Board Opinion (“APB”) No.25, “Accounting for Stock Issued to Employees,” and relatedinterpretations.  Accordingly, nocompensation expense was recognized if the exercise price of a stock optionequaled or exceeded the market price of the underlying stock on the date ofgrant.  However, stock-based compensationhas been included in prior period pro-forma disclosures in the financialstatement footnotes as required under SFAS No. 123, “Accounting for Stock-BasedCompensation,” which was amended by SFAS No. 148, “Accounting for Stock-BasedCompensation — Transition and Disclosure.”

Effective January 1, 2006, theCompany adopted the provisions of SFAS No. 123R (revised 2004), “Share-BasedPayment,” which establishes the accounting for equity instruments exchanged foremployee services.  Under the provisionsof SFAS No. 123R, stock-based compensation cost is measured at the grant date,based on the calculated fair value of the award, and is recognized as expenseover the employee’s requisite service period (generally the vesting period ofthe grant).

The Company elected to adoptthe modified prospective application transition method as provided by SFAS No.123R and, accordingly, financial statement amounts for the three- andnine-month periods ended September 30, 2005 presented in this Form 10-Q havenot been restated to reflect the fair value method of expensing stock-basedcompensation.  For vested stock-basedawards that were outstanding on January 1, 2006, the Company was not requiredto record any additional compensation expense. For unvested stock-based awards that were outstanding on January 1,2006, awards that were previously included as part of the pro-forma net incomeand earnings per share calculations of SFAS No. 123 will be charged to expenseover the remaining vesting period, without any changes in measurement.  For all new stock-based awards that aregranted or modified after January 1, 2006, the Company will use SFAS No. 123R’smeasurement model, expense recognition and settlement provisions.  Upon adoption of SFAS No. 123R, the Companydiscontinued its historical accounting practice of recognizing forfeitures whenthey occurred and now estimates compensation cost related to awards notexpected to vest.

7

----

 

The followingtable illustrates the effect on net income and net income per share for thethree- and nine-month periods ended September 30, 2005, had the Company appliedthe fair value recognition provisions of SFAS No. 123 to stock-basedcompensation (in thousands, except per share amounts):
| ** **                                                                                                                                    | ** ** | **Three-months  Ended  September 30,  2005** | ** ** | **Nine-months  Ended  September 30,  2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | ** **                                        | ** ** | ** **                                       | ** ** |
| Net income, as  reported                                                                                                                      |       | $                                                 | 2,387      |                                             | $          | 3,960 |   |
| Add: Stock-based  employee compensation included in reported net income, net of related tax  effects                                          |       | —                                            |       | —                                           |       |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |       | (161                                              | )          | (644                                             | )          |
|  Pro forma net income                                                                                                                    |       | $                                                 | 2,226      |                                             | $          | 3,316 |   |
| Basic and  diluted net income per share, as reported                                                                                          |       | $                                                 | 0.04       |                                             | $          | 0.07 |   |
|  Basic net income per share, pro forma                                                                                                   |       | $                                                 | 0.04       |                                             | $          | 0.06 |   |
|  Diluted net income per share, pro forma                                                                                                 |       | $                                                 | 0.04       |                                             | $          | 0.05 |   |

 

Thefollowing table presents stock-based compensation expense included in theCompany’s consolidated statements of income for the three- and nine-monthperiods ended September 30, 2006 pursuant to the provisions of SFAS No. 123R(in thousands):

|                                                                                       | ** ** | **Three-months  Ended  September 30,  2006** | ** ** | **Nine-months  Ended  September 30,  2006** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                            | ** ** | ** **                                        | ** ** | ** **                                       | ** ** |
| Cost of portal  revenues, exclusive of depreciation & amortization                |       | $                                                 | 115        |                                             | $          | 220 |   |
| Cost of software  & services revenues, exclusive of depreciation and amortization |       | 7                                                 |       | 12                                               |       |
| Selling &  administrative                                                         |       | 356                                               |       | 597                                              |       |
| Stock-based  compensation expense before income taxes                                 |       | 478                                               |       | 829                                              |       |
| Income tax  benefit                                                                   |       | (194                                              | )          | (336                                             | )          |
|                                                                                  |       |                                              |       |                                             |       |
| Net stock-based  compensation expense                                                 |       | $                                                 | 284        |                                             | $          | 493 |   |

 

*Stock option and restricted stock plans*

The Company hastwo formal stock-option and incentive plans (the “NIC” plan and the “SDR” plan)to provide for the granting of incentive stock options, non-qualified stockoptions or restricted stock awards to encourage certain employees of theCompany and its subsidiaries, and certain directors of the Company, toparticipate in the ownership of the Company, and to provide additional incentivefor such employees and directors to promote the success of its business throughsharing the future growth of such business.

8

----

 

The NIC plan wasadopted in May 1998, amended in November 1998 and May 1999, revised inAugust 1999, and amended and restated in May 2004 and May 2006.  The May 2006 amendment and restatement, asapproved by the Company’s Board of Directors and shareholders, modified the NICplan to allow for the granting of restricted stock awards in addition to stockoptions.  Under the NIC plan, the Companyis authorized to grant stock options and restricted stock awards for up to9,286,754 common shares.  At September30, 2006, a total of 1,287,838 shares were available for future grants underthe NIC plan.  There have been no optionrepricings under the NIC plan.

The SDR plan wasadopted in May 2000 in conjunction with NIC’s acquisition of SDRTechnologies.  Under the SDR plan, theCompany is authorized to grant options for up to 229,965 common shares.  No options that are in addition to those grantedupon the close of the SDR acquisition will be granted under the SDR plan.  There have been no option repricings underthe SDR plan.

Stock options aregenerally exercisable one year from date of grant in cumulative annualinstallments of 25% and expire five years after the grant date.  The Company did not grant any stock optionsduring the nine-month period ended September 30, 2006, and does not currentlyanticipate granting stock options in the future.  Instead, the Company expects to grant onlyrestricted stock awards, as further discussed below.

During the three-and nine-month periods ended September 30, 2005, the Company granted 70,500stock options to employees with an exercise price of $4.95.  The fair value of each option grant wasdetermined using the Black-Scholes option-pricing model and applying thefollowing assumptions: 
| Risk-free  interest rate         |   | 3.78      | %      |
|----------------------------------|--------|-----------|--------|
| Expected  dividend yield         |   | 0.00      |   |
| Expected option  life            |   | 3.2 years |   |
| Expected stock  price volatility |   | 53        | %      |
|                             |   |      |   |
| Fair value of options  granted   |   | $         | 1.99   |   |
|                                  |        |           |        |  |

 

The Black-Scholes option-pricing model was not developed for use invaluing employee stock options, but was developed for use in estimating thefair value of traded options that have no vesting restrictions and are fullytransferable.  In addition, it requiresthe use of subjective assumptions including expectations of future dividendsand stock price volatility.  Suchassumptions are only used for making the required fair value estimate andshould not be considered as indicators of future dividend policy or stock priceappreciation, or should not be used to predict the value ultimately realized byemployees who receive equity awards. Because changes in the subjective assumptions can materially affect thefair value estimate and because employee stock options have characteristicssignificantly different from those of traded options, the use of theBlack-Scholes option-pricing model may not provide a reliable estimate of thefair value of employee stock options.

9

----

 

Summary stock option activity for the nine-monthperiod ended September 30, 2006 is presented below:
| ** **                         | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Life (Years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|------------------------------------|------------|------------|------------|----------------------------------------|------------|------------------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at  January 1, 2006    |       | 2,179,802  |       | $                                      | 4.07       |                                                             |       |                            |       |   |
| Granted                            |       | —     |       | —                                 |       |                                                             |       |                            |       |
| Exercised                          |       | (445,898   | )          | $                                      | 2.73       |                                                             |       |                            | $          | 1,487,000 |   |
| Expired                            |       | (140,771   | )          | $                                      | 6.65       |                                                             |       |                            |       |   |
| Canceled                           |       | (32,250    | )          | $                                      | 5.48       |                                                             |       |                            |       |   |
| Outstanding at  September 30, 2006 |       | 1,560,883  |       | $                                      | 4.19       |                                                             | 2.4        |                            | $          | 1,497,000 |   |
| Exercisable at  September 30, 2006 |       | 833,571    |       | $                                      | 4.33       |                                                             | 2.1        |                            | $          | 681,000 |   |

 

The aggregateintrinsic value of options exercised during the three-month period endedSeptember 30, 2006 was $169,000.  Cashproceeds from the exercise of employee stock options for the three- andnine-month periods ended September 30, 2006 were approximately $219,000 and$1,218,000, respectively.  Cash proceedsfrom the exercise of employee stock options for the three- and nine-monthperiods ended September 30, 2005 were approximately $745,000 and $2,227,000,respectively.

Summary nonvested stock option activity for thenine-month period ended September 30, 2006 is presented below:
| ** **                       | ** ** | **Shares** | ** ** | **Weighted Average  Fair Value** | ** ** |
|----------------------------------|------------|------------|------------|--------------------------------------------|------------|
| Nonvested at  January 1, 2006    |       | 1,115,723  |       | $                                          | 2.15       |   |
| Granted                          |       | —     |       | —                                     |       |
| Vested                           |       | (356,911   | )          | $                                          | 2.04       |   |
| Expired                          |       | —     |       | —                                     |       |
| Canceled                         |       | (31,500    | )          | $                                          | 3.40       |   |
| Nonvested at September  30, 2006 |       | 727,312    |       | $                                          | 2.17       |   |

 

The fair value ofoptions vested during the three- and nine-month periods ended September 30,2006 was approximately $647,000 and $727,000, respectively.

In 2005, certainemployees of the Company exercised non-qualified stock options.  As a result, the Company received federalincome tax deductions, or windfall tax benefits.  The tax benefit for the deductions of approximately$390,000 and $1,070,000 for the three- and nine-month periods ended September30, 2005 increased deferred tax assets and was credited directly to additionalpaid-in capital.

Under the guidanceof footnote 82 of paragraph A94 of SFAS No. 123R, the Company is not permittedto recognize a credit to additional paid-in capital for windfall tax benefitsunless such windfall tax benefits reduce income taxes payable.  Since the Company is not currently payingfederal income taxes (with the exception of federal alternative minimum tax),such windfall tax benefits generally increase the Company’s tax net operatingloss carryforwards.  Accordingly, theCompany did not record an increase to deferred tax assets with an offsettingincrease to additional paid-in capital for the windfall tax benefit ofapproximately $69,000 and $572,000 relating 

10

----

to the exercise ofnon-qualified stock options during the three- and nine-month periods endedSeptember 30, 2006.

As of September30, 2006, there was approximately $988,000****oftotal unrecognized compensation cost, net of estimated forfeitures, related tononvested stock options.  The Companyexpects to recognize this cost over a weighted-average period of 1.7 years.

The Company begangranting shares of restricted stock in the second quarter of 2006, when itgranted 21,600 shares to certain non-executive employees of the Company with agrant date fair value of $6.85 per share. In the third quarter of 2006, the Company granted an additional 493,254shares to executive officers and management-level employees of the Company witha grant date fair value of $5.65 per share. Grants of restricted stock vest one year from the date of grant incumulative annual installments of 25%. Restricted stock is valued at the date of grant, based on the closingmarket price of the Company’s common stock, and expensed using thestraight-line method over the requisite service period.

Summary restricted stock activity for the nine-monthperiod ended September 30, 2006 is presented below:
| ** **                       | ** ** | **Shares** | ** ** | **Weighted Average Grant  Date Fair Value** | ** ** |
|----------------------------------|------------|------------|------------|-----------------------------------------------------------------|------------|
| Nonvested at  January 1, 2006    |       | —     |       | —                                                          |       |
| Granted                          |       | 514,854    |       | $                                                               | 5.71       |   |
| Vested                           |       | —     |       | —                                                          |       |
| Expired                          |       | —     |       | —                                                          |       |
| Canceled                         |       | (4,579     | )          | $                                                               | 5.65       |   |
| Nonvested at September  30, 2006 |       | 510,275    |       | $                                                               | 5.71       |   |

 

Approximately$118,000 and $121,000 in stock-based compensation expense related to restrictedstock awards is included in the Company’s consolidated statements of income forthe three- and nine-month periods ended September 30, 2006, respectively.  At September 30, 2006, the Company hadapproximately $1,810,000 of total unrecognized compensation cost, net ofestimated forfeitures, related to nonvested restricted stock awards.  The Company expects to recognize this costover the next 3.8 years.

*EmployeeStock Purchase Plan*

In May 1999, the Company’s Board ofDirectors approved an employee stock purchase plan (“ESPP”) intended to qualifyas an “employee stock purchase plan” under Section 423 of the InternalRevenue Code. A total of 2,321,688 shares of NIC common stock have beenreserved for issuance under this plan. Terms of the plan permit eligibleemployees to purchase NIC common stock through payroll deductions up to 15% ofeach employee’s compensation. Amounts deducted and accumulated by theparticipant are used to purchase shares of NIC’s common stock at 85% of thelower of the fair value of the common stock at the beginning or the end of theoffering period, as defined in the plan. In the offering period commencing onApril 1, 2004 and ending on March 31, 2005, 30,031 shares were purchased at aprice of $4.055 per share, resulting in total cash proceeds to the Company ofapproximately $122,000.  In the offeringperiod commencing on April 1, 2005 and ending on March 31, 2006, 40,343 shareswere purchased at a price of $3.9015 per share, resulting in total cashproceeds to the Company of approximately $157,000.  The next offering period under this plancommenced on April 1, 2006.  The closingfair 

11

----

market value of NICcommon stock on the first day of the current offering period was $6.10 pershare.

Included in the Company’s stock-basedcompensation expense for the three- and nine-month periods ended September 30,2006 is a portion of the cost (approximately $13,000 and $26,000, respectively)relating to the ESPP offering period ending on March 31, 2007.  Included in the Company’s stock-basedcompensation expense for the nine-month period ended September 30, 2006 is aportion of the cost (approximately $12,000) relating to the ESPP offeringperiod that ended on March 31, 2006.  Thefair values of the offerings were estimated on the dates of grant using theBlack-Scholes model using the assumptions in the following table.
| ** **                                  | ** ** | **March 31, 2007  Offering** | ** ** | **March 31, 2006  Offering** | ** ** |
|---------------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|
| Risk-free  interest rate                    |       | 4.77                                   | %          | 3.31                                   | %          |
| Expected  dividend yield                    |       | 0.00                                   | %          | 0.00                                   | %          |
| Expected life                               |       | 1.0 year                               |       | 1.0 year                               |       |
| Expected stock  price volatility            |       | 30                                     | %          | 30                                     | %          |
|                                        |       |                                   |       |                                   |       |
| Weighted average fair  value of ESPP rights |       | $                                      | 1.60       |                                   | $          | 1.18 |   |
|                                             |            |                                        |            |                                        |            |  |  |

 

**4.OUTSOURCED GOVERNMENT PORTAL CONTRACTS**

The Company’soutsourced government portal contracts generally have an initial term of threeto five years with provisions for renewals for various periods at the option ofthe government.  The Company’s primarybusiness obligation under these contracts is to design, build and operateInternet-based portals on behalf of governments desiring to provideaccess to government information and to complete government-basedtransactions online. NIC typically markets the services and solicits users tocomplete government-based transactions and to enter into subscribercontracts permitting the user to access the portal and the governmentinformation contained therein in exchange for transactional and/or subscriptionuser fees. The Company is typically responsible for funding up front investmentand ongoing operational costs of the government portals.  The Company enters into separate agreementswith various agencies and divisions of the government to provide specificservices and to conduct specific transactions. These agreements preliminarilyestablish the pricing of the electronic transactions and data access servicesthe Company provides and the division of revenues between the Company and thegovernment agency. The government must approve prices and revenue sharingagreements.  The Company generally ownsall the applications developed under these contracts. After completion of adefined contract term, the government agency typically receives a perpetual,royalty-free license to the applications for use only. If the Company’scontract were not renewed after a defined term, the government agency would beentitled to take over the portal in place with no future obligation of theCompany. Under a typical portal contract, the Company is required to fullyindemnify its government clients against claims that the Company’s servicesinfringe upon the intellectual property rights of others and against claimsarising from the Company’s performance or the performance of the Company’ssubcontractors under the contract.

12

----

The following is a summary of the Company’s eighteenoutsourced state government portal contracts at September 30, 2006:
| **NIC  Subsidiary**              | ** ** | **Portal Web Site (State)**   | ** ** | **Year  Services  Commenced** | ** ** | **Contract Expiration  Date (Renewal  Option Through)** |
|----------------------------------|------------|-------------------------------|------------|-------------------------------|------------|---------------------------------------------------------|
| Colorado  Interactive            |       | www.Colorado.gov (Colorado)   |       | 2005                          |       | 5/19/2010 (5/19/2014)                                   |
| South Carolina  Interactive      |       | www.SC.gov (South Carolina)   |       | 2005                          |       | 7/15/2007 (7/15/2009)                                   |
| Kentucky  Interactive            |       | www.Kentucky.gov (Kentucky)   |       | 2003                          |       | 1/31/2007 (1/31/2013)                                   |
| Alabama  Interactive             |       | www.Alabama.gov (Alabama)     |       | 2002                          |       | 10/31/2007 (10/31/2010)                                 |
| New England  Interactive         |       | www.RI.gov (Rhode Island)     |       | 2001                          |       | 6/18/2007 (6/18/2010)                                   |
| NICUSA                           |       | www.OK.gov (Oklahoma)         |       | 2001                          |       | 6/30/2007 (6/30/2009)                                   |
| Montana  Interactive             |       | www.MT.gov (Montana)          |       | 2001                          |       | 12/31/2010                                              |
| NICUSA                           |       | www.Tennessee.gov (Tennessee) |       | 2000                          |       | 8/27/2010                                               |
| Hawaii  Information Consortium   |       | www.Hawaii.gov (Hawaii)       |       | 2000                          |       | 1/3/2007                                                |
| Idaho  Information Consortium    |       | www.Idaho.gov (Idaho)         |       | 2000                          |       | 12/6/2006                                               |
| Utah Interactive                 |       | www.Utah.gov (Utah)           |       | 1999                          |       | 5/6/2007 (5/6/2009)                                     |
| New England  Interactive         |       | www.Maine.gov (Maine)         |       | 1999                          |       | 1/14/2008                                               |
| Arkansas  Information Consortium |       | www.Arkansas.gov (Arkansas)   |       | 1997                          |       | 6/30/2008                                               |
| Iowa Interactive                 |       | www.Iowa.gov (Iowa)           |       | 1997                          |       | 3/31/2011 (3/31/2012)                                   |
| Virginia  Interactive            |       | www.Virginia.gov (Virginia)   |       | 1997                          |       | 8/31/2012                                               |
| Indiana  Interactive             |       | www.IN.gov (Indiana)          |       | 1995                          |       | 6/30/2010 (6/30/2014)                                   |
| Nebraska  Interactive            |       | www.Nebraska.gov (Nebraska)   |       | 1995                          |       | 1/31/2007 (1/31/2010)                                   |
| Kansas  Information Consortium   |       | www.Kansas.gov (Kansas)       |       | 1992                          |       | 12/31/2007 (12/31/2009)                                 |

 

Duringthe first quarter of 2006, the Company signed a new five-year contract with thestate of Iowa, which includes an option to extend the contract for anadditional one-year renewal term, and was granted a five-year contract renewalfrom the state of Virginia and a four-year contract extension from the state ofMontana.

Duringthe second quarter of 2006, the Company was granted a one-year contract renewalfrom the State of Oklahoma, and a contract extension from the state of Maine,which extended the contract expiration date to January 2008.  Also during the second quarter of 2006, theCompany signed a new long-term contract with the state of Indiana thatcommenced on July 1, 2006.  The contractincludes an initial four-year term and renewal options that run through June2014.  The new contract is based on a fundingmodel that includes recurring fixed monthly fees for baseline services andprimarily project-based pricing for variable services.  Historically, the majority of revenues underthis contract were DMV and non-DMV transaction-based.  In addition, during the second quarter of2006, the state of Rhode Island elected to rebid its portal services contractand therefore extended the initial term of the contract with the New EnglandInteractive subsidiary of the Company by one year to allow time for the rebidprocess to occur. The extension is subject to being superceded if the State electsto renew the present contract, or terminated early if the state elects adifferent portal provider.

**5. REPORTABLE SEGMENTS AND RELATED INFORMATION**

The Company’s tworeportable segments consist of its Outsourced Portal businesses and Software& Services businesses.  TheOutsourced Portals segment includes the Company’s subsidiaries operatingoutsourced government portals and the corporate divisions that directly supportportal operations.  The Software &Services segment primarily includes the Company’s UCC and corporate filingssoftware development business (NIC Conquest) and ethics & elections filingsbusiness (NIC Technologies).  Each of theCompany’s Software & Services businesses is an operating segment and hasbeen aggregated to form the Software & Services reportable segment.Unallocated corporate-level expenses are reported in the reconciliationof the segment 

13

----

totals to the related consolidated totals as “OtherReconciling Items.”  There have been nosignificant intersegment transactions for the periods reported.

The measure of profitability by which managementevaluates the performance of its segments and allocates resources to them isoperating income (loss).  Segment assetor other segment balance sheet information is not presented to the Company’schief operating decision maker. Accordingly, the Company has not presented information relating tosegment assets.

Thetable below reflects summarized financial information concerning the Company’sreportable segments for the three months ended September 30 (in thousands): 
| ** **                       | ** ** | **Outsourced  Portals** | ** ** | **Software  &  Services** | ** ** | **Other  Reconciling  Items** | ** ** | **Consolidated  Total** | ** ** |
|----------------------------------|------------|-------------------------|------------|-------------------------------|------------|-------------------------------|------------|-------------------------|------------|
| **2006**                         | ** ** | ** **              | ** ** | ** **                    | ** ** | ** **                    | ** ** | ** **              | ** ** |
| Revenues                         |       | $                       | 17,214     |                          | $          | 821                           |       | $                       | —     |   | $ | 18,035 |   |
|                             | ** ** | ** **              |       |                          | ** ** | ** **                    |       |                    |       |
| Costs &  expenses            |       | 10,455                  | ** ** | 627                           |       | 2,877                         |       | 13,959                  |       |
| Depreciation  & amortization |       | 457                     | ** ** | 16                            |       | 28                            |       | 501                     |       |
| Operating income  (loss)         |       | $                       | 6,302      | ** **                    | $          | 178                           |       | $                       | (2,905     | ) | $ | 3,575 |   |
|                             |       |                    |       |                          |       |                          |       |                    |       |
| **2005**                         | ** ** | ** **              | ** ** |                          | ** ** | ** **                    | ** ** | ** **              | ** ** |
| Revenues                         |       | $                       | 14,637     |                          | $          | 1,321                         |       | $                       | —     |   | $ | 15,958 |   |
|                             | ** ** | ** **              |       |                          | ** ** | ** **                    |       |                    |       |
| Costs &  expenses            |       | 8,195                   | ** ** | 1,171                         |       | 2,319                         |       | 11,685                  |       |
| Depreciation  & amortization |       | 373                     | ** ** | 26                            |       | 23                            |       | 422                     |       |
| Operating income (loss)          |       | $                       | 6,069      | ** **                    | $          | 124                           |       | $                       | (2,342     | ) | $ | 3,851 |   |

 

The following is areconciliation of total segment operating income to total consolidated incomebefore income taxes for the three months ended September 30 (in thousands):
| ** **                                      | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|-------------------------------------------------|------------|------------|------------|------------|------------|
| Total operating  income for reportable segments |       | $          | 3,575      |       | $          | 3,851 |   |
| Interest income                                 |       | 666        |       | 197        |       |
| Other income  (expense), net                    |       | (49        | )          | —     |       |
|                                            | ** ** | ** ** | ** ** | ** ** | ** ** |
|  Consolidated income before income taxes   |       | $          | 4,192      |       | $          | 4,048 |   |

 

14

----

 

Thetable below reflects summarized financial information concerning the Company’sreportable segments for the nine months ended September 30 (in thousands): 
| ** **                       | ** ** | **Outsourced  Portals** | ** ** | **Software  &  Services** | ** ** | **Other  Reconciling  Items** | ** ** | **Consolidated  Total** | ** ** |
|----------------------------------|------------|-------------------------|------------|-------------------------------|------------|-------------------------------|------------|-------------------------|------------|
| **2006**                         | ** ** | ** **              | ** ** | ** **                    | ** ** | ** **                    | ** ** | ** **              | ** ** |
| Revenues                         |       | $                       | 51,997     |                          | $          | 547                           |       | $                       | —     |   | $ | 52,544 |   |
|                             | ** ** | ** **              |       |                          | ** ** | ** **                    |       |                    |       |
| Costs &  expenses            |       | 29,047                  |       | 513                           |       | 8,032                         |       | 37,592                  |       |
| Depreciation  & amortization |       | 1,397                   |       | 51                            |       | 83                            |       | 1,531                   |       |
| Operating income  (loss)         |       | $                       | 21,553     |                          | $          | (17                           | )          | $                       | (8,115     | ) | $ | 13,421 |   |
|                             | ** ** | ** **              |       |                          | ** ** | ** **                    | ** ** | ** **              | ** ** |
|                             |       |                    |       |                          |       |                          |       |                    |       |
| **2005**                         | ** ** | ** **              |       |                          | ** ** | ** **                    | ** ** | ** **              | ** ** |
| Revenues                         |       | $                       | 42,684     |                          | $          | 171                           |       | $                       | —     |   | $ | 42,855 |   |
|                             | ** ** | ** **              |       |                          | ** ** | ** **                    |       |                    |       |
| Costs &  expenses            |       | 23,285                  |       | 4,829                         |       | 7,263                         |       | 35,377                  |       |
| Depreciation  & amortization |       | 959                     |       | 122                           |       | 60                            |       | 1,141                   |       |
| Operating income (loss)          |       | $                       | 18,440     |                          | $          | (4,780                        | )          | $                       | (7,323     | ) | $ | 6,337 |   |

 

The following is a reconciliation of totalsegment operating income to total consolidated income before income taxes forthe nine months ended September 30 (in thousands):
| ** **                                      | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|-------------------------------------------------|------------|------------|------------|------------|------------|
| Total operating  income for reportable segments |       | $          | 13,421     |       | $          | 6,337 |   |
| Interest income                                 |       | 1,544      |       | 432        |       |
| Equity in net  loss of affiliates               |       | (97        | )          | —     |       |
| Other income  (expense), net                    |       | (49        | )          | (3         | )          |
|                                            | ** ** | ** ** | ** ** | ** ** | ** ** |
|  Consolidated income before income taxes   |       | $          | 14,819     |       | $          | 6,766 |   |

 

**6. INCOME TAXES**

The Company’sincome tax provision for the nine-month period ended September 30, 2006includes the establishment of a valuation allowance totaling approximately$101,000 for a state income tax loss carryforward that the Company may beunable to fully utilize.  Prospectively,the Company expects its effective tax rate to be between 40 and 42%.

**7.RECENTLY ISSUED ACCOUNTING STANDARDS**

*Accountingfor Uncertainty in Income Taxes*

In July 2006, theFinancial Accounting Standards Board (“FASB”) issued FASB Interpretation (“FIN”)48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASBStatement No. 109.”  FIN 48 clarifies theaccounting for uncertainty in income taxes recognized in an entity’s financialstatements.  FIN 48 is effective forfiscal years beginning after December 15, 2006. The Company will be required to adopt FIN 48 in the first quarter of2007.  The Company is currentlyevaluating the requirements of FIN 48 and has not yet determined the impact, ifany, on its consolidated financial statements.

15

----

*Quantifying Financial Statement Errors*

In September 2006, the staff of the Securities and Exchange Commission (“SEC”)issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects ofPrior Year Misstatements when Quantifying Misstatements in Current YearFinancial Statements.”  SAB No. 108 wasissued to eliminate diversity in practice surrounding how public companiesquantify financial statement misstatements by putting forward a singlequantification framework.  The Companywill be required to apply the provisions of SAB No. 108 for its fiscal yearending December 31, 2006.  The Company is currently evaluating therequirements of SAB No. 108 and has not yet determined the impact, if any, onits consolidated financial statements.

16

----

 

**ITEM2.  MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

***FORWARD-LOOKING STATEMENTS***

# *“Safe Harbor” statement under the Private Securities Litigation ReformAct of 1995: Statements in this Quarterly Report on Form 10-Qregarding NIC and its business, which are not historical facts, are “forward-lookingstatements” that involve risks and uncertainties.  Certain matters discussed in this report mayconstitute forward-looking statements within the meaning of the federalsecurities laws that inherently include certain risks and uncertainties. Forexample, statements like we “expect,” we “believe,” we “plan,” we “intend” orwe “anticipate” are forward-looking statements. Investors should be awarethat our actual operating results and financial performance may differmaterially from our expressed expectations because of risks and uncertaintiesabout the future including those risks discussed in our 2005 Annual Report onForm 10-K filed with the Securities and Exchange Commission on March 16, 2006.  In addition, we will not necessarily updatethe information in this Quarterly Report on Form 10-Q if any forward-lookingstatement later turns out to be inaccurate. Management continuously updates andrevises these estimates and assumptions based on actual conditionsexperienced.  However, it is notpracticable to publish all revisions and, as a result, no one should assumethat results projected in or contemplated by the forward-looking statementswill continue to be accurate in the future.*

**OVERVIEW**

Thefollowing discussion summarizes the significant factors affecting operatingresults for the three- and nine-month periods ended September 30, 2006 and2005.  This discussion and analysisshould be read in conjunction with our consolidated interim financialstatements and the related notes included in this Form 10-Q.

**CALIFORNIASECRETARY OF STATE CONTRACT**

Resultsof operations for the nine-month period ended September 30, 2005 include a $5.0million charge we recorded on our software & services engagement with theCalifornia Secretary of State (the “California SOS”) in the first quarter of2005, as further discussed in Note 2 in the Notes to Consolidated FinancialStatements included in this Form 10-Q. Prior to the first quarter of 2005, key elements of our obligationsunder the California SOS contract were subcontracted to various third partiesunder fixed price contracts.  At the endof the first quarter of 2005, as a result of system delivery issues and theconcern over the ability of one of the two remaining subcontractors to meet thecriteria set forth by the California SOS, we determined we would assume thelead project manager role on the contract, which was previously performed bythis subcontractor.  As a result of thischange, we further evaluated the status of the project and concluded that afurther modification to the management and oversight structure of the projectwas necessary to improve performance under the contract and that additionalinternal project management and technical personnel would be required on theengagement.  We also reevaluated theexpected completion date of the project, which was previously estimated to bein the first quarter of 2006, and determined to revise the estimated completiondate to the end of 2006.  As a result ofour decision to commit these additional resources and the extension of theexpected project completion date, we recorded a $5.0 million 

17

----

adjustment under percentage of completion accountingin the first quarter of 2005, as we expected to incur a loss of approximately$4.2 million on this project, instead of a previously projected profit ofapproximately $1.0 million.

Theadjustment in our consolidated statement of income for the nine-month periodended September 30, 2005 resulted in a reduction of software & servicesrevenues of approximately $3.5 million and an increase in cost of software& services revenues of approximately $1.5 million.  The adjustment in our consolidated balancesheet was a reduction in unbilled revenues of approximately $3.5 million and anincrease in application development contracts (a current liability) ofapproximately $1.5 million.

On March 13, 2006,we entered into an amendment to our contract with the California SOS.  Among other changes, the amendment reducedthe aggregate contract value from approximately $25 million to approximately$19 million, and released us from the obligation to deliver the businessfilings, or BE, portion of the project, except for maintenance of hardware anddelivery of BE images as expressly set forth in the amendment.  The amendment also set forth the finalcriteria in order for the California SOS to accept the Uniform Commercial Code,or UCC, portion of the project and move it into the maintenance and operationsphase.

We have reviewed our cost estimates to complete basedon the revised terms and conditions in the amendment and do not believe ourestimated contract loss will exceed the $4.2 million estimate established inthe first quarter of 2005. However, because of the inherent uncertainties surroundingthe ultimate outcome of subcontract negotiations between our subcontractors andus as a result of the amendment, it is at least reasonably possible that ourestimate will change in the near term. Further, it is possible that we will similarly incur cost overruns inthe future as we have in the past as a result of unforeseen difficulties suchas rising development, subcontractor and personnel costs or other reasons. Ifthis occurs, our results of operations, financial condition and cash flows couldbe adversely affected.

Asa result of the amendment, we recorded an adjustment under percentage ofcompletion accounting in the first quarter of 2006.  The adjustment in our consolidated statementof income for the nine-month period ended September 30, 2006 resulted in areduction of software & services revenues of approximately $2.1 million anda reduction of cost of software & services revenues of approximately $2.1million.  The adjustment in our consolidatedbalance sheet was a reduction in unbilled revenues of approximately $2.1million, a reduction of accrued liabilities of approximately $1.6 million, anda reduction of application development contracts of approximately $0.5million.  This adjustment did not affectoperating income, net income or basic and diluted earnings per share.

InJune 2006, the California SOS officially accepted the UCC portion of theproject, which also commenced the 42-month maintenance and operationsphase.  At September 30, 2006, ourcorporate filings software & services business was primarily engaged inservicing the maintenance and operations obligation under its contract with theCalifornia SOS.  This business is notmarketing its applications and services for new engagements.

18

----

**STOCK-BASEDCOMPENSATION**

InDecember 2004, the Financial Accounting Standards Board issued Statement ofFinancial Accounting Standards (“SFAS”) No. 123R (revised 2004), “Share—BasedPayment,” that requires companies to expense the grant-date fair value of stockoptions and other equity-based compensation issued to employees.  SFAS No. 123R eliminates the use of theintrinsic value method prescribed in Accounting Principles Board Opinion (“APB”)No. 25, “Accounting for Stock Issued to Employees,” that we used to account forour stock-based compensation plans prior to January 1, 2006.

EffectiveJanuary 1, 2006, we adopted the provisions of SFAS No. 123R using the modifiedprospective application transition method, which did not require us to restateour financial statements prior to the effective date of SFAS No. 123R.  For vested stock option awards that wereoutstanding on January 1, 2006, the modified prospective application transitionmethod did not require us to record any additional compensation expense.  For unvested stock option awards that were outstandingon January 1, 2006, awards that were previously included as part of the proforma net income and earnings per share calculations of SFAS No. 123 will becharged to expense over the remaining vesting period, without any changes inmeasurement.  For all new equity-basedawards that are granted or modified after January 1, 2006, we will use SFAS No.123R’s measurement model, expense recognition, and settlement provisions.

Priorto the adoption of SFAS No. 123R, we did not recognize stock-based compensationexpense if the exercise price of stock options granted to employees ornonemployee directors was greater than or equal to the price of our commonstock on the grant date.  In addition, wedid not recognize stock-based compensation expense for shares issued under ouremployee stock purchase plan.  BeginningJanuary 1, 2006 with the adoption of SFAS No. 123R, we began recognizingstock-based compensation expense for the cost of stock options, restrictedstock awards and shares issued under our employee stock purchase plan.  The following table presents stock-basedcompensation expense included in our consolidated statements of income (inthousands):
| ** **                                                                            | ** ** | **Three-months  Ended  September 30,  2006** | ** ** | **Nine-months  Ended  September 30,  2006** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                            | ** ** | ** **                                        | ** ** | ** **                                       | ** ** |
| Cost of portal revenues,  exclusive of depreciation & amortization                |       | $                                                 | 115        |                                             | $          | 220 |   |
| Cost of software  & services revenues, exclusive of depreciation and amortization |       | 7                                                 |       | 12                                               |       |
| Selling &  administrative                                                         |       | 356                                               |       | 597                                              |       |
| Stock-based  compensation expense before income taxes                                 |       | 478                                               |       | 829                                              |       |
| Income tax  benefit                                                                   |       | (194                                              | )          | (336                                             | )          |
|                                                                                  |       |                                              |       |                                             |       |
| Net stock-based  compensation expense                                                 |       | $                                                 | 284        |                                             | $          | 493 |   |

 

As of September30, 2006, there was approximately $988,000****oftotal unrecognized compensation cost, net of estimated forfeitures, related tononvested stock options and approximately $1,810,000 of total unrecognizedcompensation cost, net of estimated forfeitures, related to nonvested 

19

----

restricted stock awards.  The Company expects to recognize the costrelated to stock options over a weighted-average period of 1.7 years and thecost related to restricted stock awards over the next 3.8 years.

On October 26, 2005, our Board of Directors approved the acceleration ofvesting of all unvested options to purchase common stock of the Company thathad an exercise price that was greater than the market price on that date.  The closing price of our common stock on theNasdaq National Market on October 26, 2005 was $5.63 per share.  As a condition of the acceleration and to prevent unintendedpersonal benefit, the Company’s directors, executive officers and employeesmust refrain from selling common stock acquired upon the exercise ofaccelerated options until the original vesting date or, if earlier, terminationof employment with or service to the Company. All other terms andconditions applicable to such options, including exercise prices, remainedunchanged.  This action resulted in theaccelerated vesting of options to purchase 163,873 shares of common stock ofthe Company, or approximately six percent of the total of all then outstandingCompany options.

Weaccelerated the vesting of these options because we believed it was in the bestinterest of our shareholders to reduce future compensation expense that wewould otherwise be required to report in our statement of income upon adoptionof SFAS No. 123R in the first quarter of 2006. Further, because the options had exercise prices in excess of thecurrent market price, they were viewed to have limited economic value and werenot fully achieving their objective of incentive compensation andretention.  As a result of the vestingacceleration, approximately $0.5 million in aggregate future expense will beeliminated over the next three fiscal years.

We believe that equity-based compensation willcontinue to play an important role in supporting employee retention andproviding individuals with long-term incentives to meet Company goals.  For additional information regardingour adoption of SFAS No. 123R, see Note 3 in the Notes to ConsolidatedFinancial Statements included in this Form 10-Q.

**RESULTS OFOPERATIONS**
| ** **                                                             | ** ** | **Three-months  ended   September 30,** | ** ** | **Nine-months  ended   September 30,** | ** ** |
|------------------------------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|
| **Key Financial Metrics**                                    | ** ** | **2006**                                          | ** ** | **2005**                                         | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenue growth –  outsourced portals                              |       | 18                                                | %          | 23                                               | %          | 22 | % | 17 | % |
| Same state  revenue growth – outsourced portals                   |       | 8                                                 | %          | 20                                               | %          | 8 | % | 18 | % |
| Recurring portal  revenue %                                            |       | 95                                                | %          | 97                                               | %          | 96 | % | 97 | % |
| Gross profit % -  outsourced portals                                   |       | 45                                                | %          | 48                                               | %          | 49 | % | 50 | % |
| Selling &  administrative expenses as % of portal revenues         |       | 23                                                | %          | 20                                               | %          | 21 | % | 22 | % |
| Operating income  margin% (operating income as a % of portal revenues) |       | 21                                                | %          | 26                                               | %          | 26 | % | 15 | % |

 

PORTAL REVENUES. Wecategorize our portal revenues according to the underlying source ofrevenue.  A brief description of eachcategory follows:

·                  DMVtransaction-based: these are transaction fees from the sale of electronicaccess to driver history records, referred to as DMV records, from our stateportals to data resellers, insurance companies 

20

----

 

and otherpre-authorized customers on behalf of our state partners, and are generallyrecurring.

·                  Non-DMVtransaction-based: these are transaction fees from sources other than thesale of DMV records, for transactions conducted by business users and consumerusers through our portals, and are generally recurring.  For a representative listing of non-DMVservices we currently offer through our portals, refer to Part I, Item 1 of our December 31, 2005 Form 10-K filed withthe SEC on March 16, 2006.

·                  Softwaredevelopment & portal management: these are fees from the performance ofsoftware development projects and other time and materials or fixed feeservices for our government partners. While we actively market time and materials services, they may not havethe same degree of predictability as our transaction-based revenues.

In the analysis below, we have categorized our portalrevenues according to the underlying source of revenue (in thousands) with thecorresponding percentage change from the prior year period.
| ** **                                    | ** ** | **Three-Months Ended  September 30,** | ** ** | **Nine-Months Ended  September 30,** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                        | ** ** | **% Change**                                   | ** ** | **2005** | ** ** | **2006** | ** ** | **% Change** | ** ** | **2005** | ** ** |
| DMV  transaction-based                        |       | $                                               | 9,844      |                                           |       | 8 | % |   | $ | 9,109 |   | $ | 31,858 |   |   | 21 | % |   | $ | 26,408 |   |
| Non-DMV  transaction-based                    |       | 5,438                                           |       |                                           | 7          | % |   | 5,089 |   | 16,997 |   |   | 15 | % |   | 14,737 |   |
| Software  development & portal management |       | 1,932                                           |       |                                           | 340        | % |   | 439 |   | 3,142 |   |   | 104 | % |   | 1,539 |   |
|                                          |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                         |       | $                                               | 17,214     |                                           |       | 18 | % |   | $ | 14,637 |   | $ | 51,997 |   |   | 22 | % |   | $ | 42,684 |   |

 

Portal revenues in the current quarter increased 18%, orapproximately $2.6 million, over the prior year quarter.  Of this increase, 8%, or approximately$1.1 million, was attributable to an increase in same state portal revenues(outsourced portals in operation and generating recurring revenues for two fullyears), and 10%, or approximately $1.5 million, was attributable to our newColorado portal, which began generating DMV revenues in October 2005.

OurIndiana portal subsidiary signed a new long-term contract with the state ofIndiana that commenced on July 1, 2006. The new contract is based on a funding model that includes recurringfixed monthly fees for baseline services and primarily project-based pricingfor variable services.  Historically, themajority of revenues under this contract were DMV and non-DMV transaction-based.  Under the new contract, the majority ofrevenues will be classified as portal management.  Prior to July 1, 2006, we defined same staterevenues as those from states in operation and generating DMV revenues for twofull years.  Because the majority ofrevenues from the new Indiana contract are generally recurring, we willcontinue to include Indiana portal revenues in the calculation of same staterevenue growth even though we no longer earn DMV transaction-based revenuesunder the contract.  Same state portalrevenues in the current quarter increased 8% over the prior year quarterprimarily due to increased transaction revenues from our Montana, Oklahoma,Tennessee and Utah portals, among others.

21

----

 

ExcludingIndiana, same state portal revenues in the current quarter increased 11% overthe prior year, with same state DMV transaction-based revenues increasing 1%and same state non-DMV transaction-based revenues increasing 26% (primarily dueto the addition of several new revenue generating applications in existingportals).  Our same state revenue growth in the currentquarter was lower than the 20% growth we achieved in the prior year quarterprimarily due to decreases in same state DMV and non-DMV transaction-basedrevenue growth and due to a $0.3 million decrease in revenues fromIndiana.  Excluding Indiana, same stateDMV revenue growth in the current quarter was 1% compared to 12% in the prioryear quarter. The higher growth in the prior year quarter was primarily due tothe effect of modest DMV price increases in two of our larger portalstates.  Same state DMV revenue growth isexpected to range from 1% to 3% in 2006. Absent DMV price increases, same state DMV revenues have historicallygrown at a rate of 1% to 3% per year. Same state non-DMV transaction based revenue growth was 46% in the prioryear quarter.  Same state non-DMVtransaction growth is expected to range from 20% to 25% in 2006.

Portal revenues for the nine months in the currentperiod increased 22%, or approximately $9.3 million, over the prior yearperiod.  Of this increase, 8%, or approximately $3.4 million, wasattributable to an increase in same state portal revenues and 14%, orapproximately $5.9 million, was attributable to our new Colorado and SouthCarolina portals.  Consistent with ourresults in the current quarter, same state portal revenues in the currentyear-to-date period increased 8% over the prior year period.  Same state revenues in the prior year-to-dateperiod increased 18%.

COST OF PORTAL REVENUES.  Cost of portal revenues for the currentquarter increased 24%, or approximately $1.9 million, over the prior yearquarter.  Of this increase, 16%, or approximately $1.2 million, wasattributable to an increase in same state cost of portal revenues, and 8%, orapproximately $0.7 million, was primarily attributable to our new Coloradoportal.  Cost of portal revenues in thecurrent quarter includes approximately $0.1 million in stock-based compensationexpense, as further discussed above and in Note 3 in the Notes to ConsolidatedFinancial Statement included in this Form 10-Q.

The increase in same state cost of portal revenues wasmostly attributable to additional personnel in several of our portals due toour continued growth and reinvestment in our core business, coupled withmid-year 2006 salary increases across all portals that were in addition tonormal annual increases, in an effort to better align our employee compensationstructure with the general market.  Alsocontributing to this increase was an increase in bank fees.  A growing percentage of our non-DMVtransaction-based revenues are generated from online applications whereby userspay for information or transactions via credit cards.  We typically earn a percentage of the creditcard transaction amount, but also must pay an associated fee to the bank thatprocesses the credit card transaction. We earn a lower gross profit percentage on these transactions ascompared to our other non-DMV applications. However, we anticipate these revenues and the associated bank fees willcontinue to increase in the future, as these transactions contribute favorablyto our operating income growth.

Our portal gross profit rate in the current quarterwas 45% compared to 48% in the prior year quarter, with cost of portal revenuesgrowing at a higher rate (24%) than portal revenues (18%), as further discussedabove.  We carefully monitor our portalgross profit percentage in an effort to balance 

22

----

generating a solid financial return and deliveringvalue to our government partners through reinvestment in our portals.

Consistent with our results in the current quarter,cost of portal revenues for the nine months in the current period increased25%, or approximately $5.3 million, over the prior year period.  Of thisincrease, 15%, or approximately $3.3 million, was attributable to anincrease in same state cost of portal revenues, and 10%, or approximately $2.2million, was primarily attributable to our new Colorado and South Carolinaportals.  Partially offsetting theseincreases was a $0.2 million decrease in cost of portal revenues relating tothe shutdown of our remaining stand-alone local portals in 2005. Cost of portalrevenues in the current year-to-date period includes approximately $O.2 millionin stock-based compensation expense, as further discussed above and in Note 3in the Notes to Consolidated Financial Statement included in this Form 10-Q.Additionally, we incurred approximately $0.2 million in costs for legal feesand information technology security consultation relating to the December 2005security breach in our Rhode Island portal. We do not expect to incur significant additional costs in future periodsrelating to this matter.  Our portal grossprofit rate for the nine months in the current period was 49% compared to 50%in the prior year period.

SOFTWARE & SERVICES REVENUES. In the analysisbelow, we have categorized our software & services revenues by type ofbusiness (in thousands), with the corresponding percentage change from theprior year period.
| ** **              | ** ** | **Three-Months Ended  September 30,** | ** ** | **Nine-Months Ended  September 30,** | ** ** |
|-------------------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|
| ** **              | ** ** | **2006**                                        | ** ** | **% Change**                                   | ** ** | **2005** | ** ** | **2006** | ** ** | **% Change** | ** ** | **2005** | ** ** |
| Corporate  filings      |       | $                                               | 250        |                                           |       | (64 | )% |   | $ | 704 |   | $ | (1,099 | ) |   | 41 | % |   | $ | (1,872 | ) |
| Ethics &  elections |       | 475                                             |       |                                           | (11        | )% |   | 533 |   | 1,368 |   |   | 19 | % |   | 1,686 |   |
| Other                   |       | 96                                              |       |                                           | 14         | % |   | 84 |   | 278 |   |   | (22 | )% |   | 357 |   |
|                    |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                   |       | $                                               | 821        |                                           |       | (38 | )% |   | $ | 1,321 |   | $ | 547 |   |   | 220 | % |   | $ | 171 |   |

 

Software &services revenues in the current quarter decreased 38%, or approximately $0.5million, from the prior year quarter due to primarily to a decrease in revenuesfrom our corporate filings business.  Inour corporate filings business, we recognized approximately $0.2 million inrevenue from our contract with the California SOS in the current quartercompared to $0.7 million in the prior year quarter.  We recognize revenue on our contract with theCalifornia SOS using the percentage of completion method as we make progress,utilizing costs incurred to date as compared to the estimated total cost forthe contract.  Software & services revenues for the nine-month periods endedSeptember 30, 2006 and 2005 primarily reflect revenue adjustments underpercentage of completion accounting relating to our contract with theCalifornia SOS, as further discussed in Note 2 in the Notes to ConsolidatedFinancial Statements included in this Form 10-Q.

COST OF SOFTWARE& SERVICES REVENUES.  The 49%decrease in cost of software & services revenues in the current quarter isconsistent with the corresponding decrease in software & services revenuesin the current quarter.  Year-to-datecost of software & services revenues in the current and prior year periodsprimarily reflects expense adjustments under percentage of completionaccounting relating to our contract with the 

23

----

California SOS as further discussed above and in Note2 in the Notes to Consolidated Financial Statements included in this Form10-Q.  Cost of software & servicesrevenues in the current quarter and year-to-date periods includes approximately$7,000 and $12,000 in stock-based compensation expense, as further discussedabove.

SELLING &ADMINISTRATIVE.  Selling &administrative expenses in the current quarter and year-to-date periodsincreased 33% and 15%, respectively, or approximately $1.0 million and $1.4million, over the prior year periods. The increase in selling & administrative expenses was mostlyattributable to additional personnel across our corporate-level divisions,coupled with mid-year 2006 salary increases across all corporate-leveldivisions that were in addition to normal annual increases, in an effort tobetter align our employee compensation structure with the general market.  Since the third quarter of 2005, ourcorporate-level headcount has increased by approximately 33%, as we have addedpersonnel to support and enhance corporate-wide information technology securityand portal operations, in addition to sales & marketing and growthinitiatives.  In addition, selling &administrative expenses in the current quarter and year-to-date periods includeapproximately $0.4 million and $0.6 million, respectively, in stock-basedcompensation expense, as further discussed above and in Note 3 in the Notes toConsolidated Financial Statements included in this Form 10-Q. As a percentageof portal revenues, selling & administrative expense increased to 23% inthe current quarter from 20% in the prior year. On a year-to-date basis, selling & administrative expenses decreasedto 21% of portal revenues compared to 22% in the prior year.

DEPRECIATION& AMORTIZATION.  The increase indepreciation & amortization expense in the current periods is primarily dueto depreciation of fixed asset additions throughout our portal businesses,particularly in our newer Kentucky, South Carolina and Colorado portals, during2005 and the first half of 2006.

INTERESTINCOME.  Interest income reflectsinterest earned on our investable cash and marketable securities portfolio. In2005, we began investing our excess cash in short-term marketable debtsecurities, consisting primarily of auction rate government-backed obligations.  Our marketable securities portfolio totaled$42.0 million at September 30, 2006, up significantly from $15.9 million atSeptember 30, 2005.  Higher short-terminterest rates also contributed to the increase in interest income earned onthese investments in the current quarter and year-to-date periods.

INCOME TAXPROVISION.  Our income tax provision forthe nine-month period ended September 30, 2006 includes the establishment of avaluation allowance totaling approximately $101,000 for a state income tax losscarryforward that we may be unable to fully utilize.  Prospectively, we expect our effective taxrate to be between 40% and 42%.

**LIQUIDITY ANDCAPITAL RESOURCES**

Netcash provided by operating activities was $17.7 million in the current periodcompared to $13.4 million in the prior year period.  The increase in cash flow from operations wasprimarily the result of a year-over-year increase in operating income,excluding non-cash charges for depreciation & amortization and stock-basedcompensation, and the adjustments under percentage of completion accountingrecorded in the current and prior 

24

----

year periods on our contract with the California SOS,which did not affect operating cash flow.

Theincrease in accounts receivable in the current period was primarily attributableto a general increase in revenues across our portal businesses as compared tothe fourth quarter of 2005, which is our seasonally lowest quarter in eachcalendar year due to the smaller number of business days in the quarter and alower volume of business-to-government and citizen-to-government transactionsduring the holiday periods.  The increasein accounts payable was also attributable mainly to the general increase inrevenues across our portal businesses in the current period.

Thedecrease in unbilled revenues during the current period was primarily due tothe first quarter 2006 adjustment under percentage of completion accountingrelating to our contract with the California SOS that reduced unbilled revenuesby approximately $2.1 million.  Additionally, in June 2006, the California SOSofficially accepted the UCC portion of the project, at which time approximately$1.5 million in milestone payments under the contract became due to us, thusreducing unbilled revenues.

Thedecrease in accrued expenses during the current period was primarily due to thefirst quarter 2006 adjustment under percentage of completion accountingrelating to our contract with the California SOS that reduced accruedliabilities by approximately $1.6 million.

We recognize revenue primarily from providingoutsourced government portal services net of the transaction fees due to thegovernment when the services are provided. The fees that we must remit to thegovernment are accrued as accounts payable and accounts receivable at the timeservices are provided. As a result, trade accounts payable and accountsreceivable reflect the gross amounts outstanding at the balance sheetdates.  Gross billings for thethree-months ended September 30, 2006 and December 31, 2005 were approximately$217.3 million and $152.5 million, respectively.  We calculate days sales outstanding bydividing trade accounts receivable at the balance sheet date by gross billingsfor the period and multiplying the resulting quotient by the number of days inthat period.  Days sales outstanding forthe three-month periods ended September 30, 2006 and December 31, 2005 was 12and 13, respectively.

Webelieve that working capital is an important measure of our short-termliquidity.  Working capital, defined as currentassets minus current liabilities, increased to $69.1 million at September 30,2006 from $51.2 million at December 31, 2005. Our current ratio, defined as current assets divided by currentliabilities, was 2.9 at September 30, 2006 and 2.6 at December 31, 2005.

Cash used in investing activities in the currentperiod reflects $21.5 million in purchases of marketable debt securities in aneffort to increase the investment income from our growing cash reserves, and$1.9 million of capital expenditures, which were primarily for normal fixed assetadditions in our outsourced portal business, including Web servers, purchasedsoftware and office furniture and equipment, in addition to corporate-widespending on information technology security. Cash used in investing activities in the prior year periodreflects $15.9 million in net purchases of marketable debt securities in aneffort to increase investment income and a $3.0 million reduction in our cashcollateral requirements under the financing arrangement that covered all of theCompany’s outstanding letters of credit. Prior year 

25

----

capital expenditures of approximately $1.3 millionwere primarily for normal fixed asset additions in our outsourced portalbusiness.

Financing activities in the current period primarilyreflect approximately $1.2 million in proceeds from the exercise of employeestock options and approximately $0.2 million in proceeds from our employeestock purchase program.  Cash provided byfinancing activities in the prior year period reflect approximately $2.2million in proceeds from the exercise of employee stock options andapproximately $0.1 million in proceeds from our employee stock purchaseprogram.

At September 30, 2006, our total cash and marketablesecurities balance was $74.7 million compared to $57.4 million at December 31,2005.  We believe that our currentlyavailable liquid resources and cash generated from operations will besufficient to meet our operating requirements, capital expenditurerequirements, and current growth initiatives for at least the next twelvemonths without the need of additional capital. However, we may need to raiseadditional capital before this period ends to further:

·                  fundoperations if unforeseen costs arise, including the costs to fund our contractwith the California Secretary of State and subcontractors on that project;

·                  collateralizeletters of credit, which we are required to post as collateral for performanceon certain of our outsourced government portal contracts, as collateral forcertain performance bonds, and as collateral for certain office leases;

·                  support ourexpansion into other states and government agencies beyond what is contemplatedif unforeseen opportunities arise;

·                  expand ourproduct and service offerings beyond what is contemplated if unforeseenopportunities arise;

·                  respond tounforeseen competitive pressures; and

·                  acquiretechnologies beyond what is contemplated.

Any projections of futureearnings and cash flows are subject to substantial uncertainty. If our cash,marketable securities and cash generated from operations are insufficient tosatisfy our liquidity requirements, we may seek to sell additional equitysecurities or issue debt securities.  Thesale of additional equity securities could result in dilution to the Company’sshareholders.  There can be no assurancethat financing will be available in amounts or on terms acceptable to theCompany, if at all.

We issue letters of credit as collateral forperformance on certain of our outsourced government portal contracts, ascollateral for certain performance bonds and as collateral for certain officeleases.  These irrevocable letters ofcredit are generally in force for one year, for which we pay bank fees ofapproximately 1.25% to 1.5% of face value per annum.  We had unused outstanding letters of credittotaling approximately $1.3 million at September 30, 2006 and $5.4 million atDecember 31, 2005.  We are not currentlyrequired to cash collateralize these letters of credit.  Our collateral requirements have eased overtime as we have continued to operate 

26

----

profitably and grow our earnings.  However, even though we expect to beprofitable in fiscal 2006 and beyond, we may not be able to sustain or increaseprofitability on a quarterly or annual basis. We will need to generate sufficient revenues while containing costs andoperating expenses if we are to achieve sustained profitability.  If we are not able to sustain profitability,our cash collateral requirements may increase. Had we been required to post 100% cash collateral at September 30, 2006for the face value of all performance bonds (which are partially supported byletters of credit) and our line of credit in conjunction with a corporatecredit card agreement, unrestricted cash would have decreased and restrictedcash would have increased by approximately $3.3 million.

At September 30, 2006, wewere bound by performance bond commitments totaling approximately $2.3 millionon certain government portal outsourcing contracts.  These performance bonds are collateralized bya $1 million letter of credit.  In thesecond quarter of 2006, the California SOS officially accepted the UCC portionof the project, at which time we were relieved of our obligation to provide a$5 million performance bond.  Theofficial elimination of the bond requirement took place in the third quarter of2006, at which time our letter of credit collateral requirement to secure theremaining $2.3 million in outstanding portal performance bonds was reduced to$1 million.  We have never had any defaultsresulting in draws on performance bonds or letters of credit.

We do not haveoff-balance sheet arrangements or significant exposures to liabilities that arenot recorded or disclosed in our financial statements.  While we have significant operating leasecommitments for office space, those commitments are generally tied to theperiod of performance under related contracts.

27

----

**ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

INTERESTRATE RISK.  Our exposure to market riskfor changes in interest rates relates to the increase or decrease in the amountof interest income we can earn on our short-term investments in marketable debtsecurities and cash balances.  Becauseour investments are in short-term, investment-grade, interest-bearingmarketable securities, we are exposed to minimal risk on the principal of thoseinvestments. We limit our exposure to credit loss by depositing our cash withhigh credit quality financial institutions. We enhance the safety and preservation of our invested principal fundsby attempting to limit default risk, market risk and investment risk. We do notuse derivative financial instruments. A 10% change in interest rates would nothave a material effect on our financial condition, results of operations or cashflows.

28

----

**ITEM 4.  CONTROLS AND PROCEDURES**

**a)EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES**

TheCompany maintains a set of disclosure controls and procedures designed toensure that material information required to be disclosed in its filings underthe Securities Exchange Act of 1934 is recorded, processed, summarized andreported within the time periods specified in the Securities and ExchangeCommission’s rules and forms. Disclosure controls and procedures include,without limitation, controls and procedures designed to ensure that informationrequired to be disclosed by an issuer in the reports that it files or submitsunder the Act is accumulated and communicated to the issuer’s management,including its principal executive and principal financial officers, or personsperforming similar functions, as appropriate to allow timely decisionsregarding required disclosure. Under the supervision and with the participationof our management, including our principal executive officer and principalfinancial officer, we conducted an evaluation of the effectiveness of ourdisclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e)promulgated under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”).  Based on this evaluation, ourprincipal executive officer and our principal financial officer concluded thatour disclosure controls and procedures were effective as of the end of theperiod covered by this Quarterly Report on Form 10-Q.

**b)CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING**

As of the end of the period covered by this report,our management, including our principal executive officer and principalfinancial officer, concluded that there have been no changes in our internalcontrol over financial reporting that occurred during our third fiscal quarterof 2006 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

29

----

**PART II. OTHERINFORMATION**

**ITEM6.  EXHIBITS**

31.1 – Certificationof Chairman of the Board and Chief Executive Officer Pursuant to Section 302 ofthe Sarbanes-Oxley Act of 2002

31.2 –Certification of Chief Financial Officer Pursuant to Section 302 of theSarbanes-Oxley Act of 2002

32.1 – Section 906Certifications of Chairman of the Board and Chief Executive Officer and ChiefFinancial Officer furnished in accordance with Securities Act Release 33-8212

30

----

**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the Company has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                          |   | NIC INC.                                                             |
|--------------------------|--------|----------------------------------------------------------------------|
|                     |   |                                                                 |
| Dated: November  6, 2006 |   | /s/ Eric J. Bur                                                      |   |
|                     |   | Eric J. Bur                                                          |
|                     |   | Chief Financial  Officer                                             |
|                     |   |                                                                 |
| Dated: November  6, 2006 |   | /s/ Stephen M. Kovzan                                                |   |
|                     |   | Stephen M.  Kovzan                                                   |
|                     |   | Vice President,  Financial  Operations and Chief Accounting  Officer |
|                          |        |                                                                      |  |  |

 

31

----