**United States**

**Securities and ExchangeCommission**

**Washington,D.C.  20549**

# **FORM 10-Q**

**x****Quarterly Report Pursuant toSection 13 or 15(d) of the Securities Exchange Act of 1934**

**Forthe Period Ended October 31, 2006.**

**o****Transition Report Pursuant toSection 13 or 15(d) of the Securities Exchange Act of 1934**

**Forthe Transition Period from                       to                           .**

**Commission file number**   **0-24201**

**Carreker Corporation**

(Exact name ofregistrant as specified in its charter)

| **Delaware**                             |   | **75-1622836**                     |
|------------------------------------------|--------|------------------------------------|
| (State or other  jurisdiction of         |   | (IRS Employer  Identification No.) |
| incorporation or  organization)          |   |                               |
|                                     |   |                               |
| **4055 Valley View Lane, #1000**         |   | ** **                         |
| **Dallas, Texas**                        |   | **75244**                          |
| (Address  of principal executive office) |   | (Zip Code)                         |

 

**(972) 458-1981**

(Registrant’stelephone number, including area code)

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

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter periods that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes    x     No    o

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

Yes o        No x

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practical date.

Common Stock, $.01 parvalue – 25,636,223 shares as of November 30, 2006.

 

----

 

**CARREKERCORPORATION**

**Index**
| **PART 1:**    | ** ** | **FINANCIAL  INFORMATION**                                                                                                         | ** ** | ** ** |
|----------------|------------|------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| ** **     | ** ** | ** **                                                                                                                         | ** ** | ** ** |
| **Item  1.**   | ** ** | **Financial  Statements (unaudited)**                                                                                              | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                                         | ** ** | ** ** |
| ** **     | ** ** | **Condensed Consolidated Balance Sheets at October 31,  2006 and January 31, 2006**                                                | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                                         | ** ** | ** ** |
| ** **     | ** ** | **Condensed Consolidated Statements of Operations for the  three and nine months ended  October 31, 2006 and 2005**                | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                                         | ** ** | ** ** |
| ** **     | ** ** | **Condensed Consolidated Statements of Stockholders’  Equity for the three and nine months  ended October 31, 2006 and 2005** | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                                         | ** ** | ** ** |
| ** **     | ** ** | **Condensed Consolidated Statements of Cash Flows for the  three and nine months ended  October 31, 2006 and 2005**                | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                                         | ** ** | ** ** |
| ** **     | ** ** | **Notes to Condensed Consolidated Unaudited Financial  Statements**                                                                | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                                         | ** ** | ** ** |
| **Item 2.**    | ** ** | **Management’s Discussion and Analysis of Financial  Condition and Results of Operations**                                    | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                                         | ** ** | ** ** |
| **Item 3.**    | ** ** | **Quantitative and Qualitative Disclosures about Market  Risk**                                                                    | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                                         | ** ** | ** ** |
| **Item 4.**    | ** ** | **Controls and  Procedures**                                                                                                       | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                                         | ** ** | ** ** |
| **PART II:**   | ** ** | **OTHER INFORMATION**                                                                                                              | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                                         | ** ** | ** ** |
| **Item 1.**    | ** ** | **Legal Proceedings**                                                                                                              | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                                         | ** ** | ** ** |
| **Item 1A.**   | ** ** | **Risk Factors**                                                                                                                   | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                                         | ** ** | ** ** |
| **Item 2.**    | ** ** | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                                                   | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                                         | ** ** | ** ** |
| **Item 3.**    | ** ** | **Defaults Upon  Senior Securities**                                                                                               | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                                         | ** ** | ** ** |
| **Item 4.**    | ** ** | **Submission of  Matters to a Vote of Security Holders**                                                                           | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                                         | ** ** | ** ** |
| **Item 5.**    | ** ** | **Other Information**                                                                                                              | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                                         | ** ** | ** ** |
| **Item 6.**    | ** ** | **Exhibits**                                                                                                                       | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                                         | ** ** | ** ** |
| **SIGNATURES** | ** ** | ** **                                                                                                                         |

 

2

----

 

**PARTI:  FINANCIAL INFORMATION**

**Item 1. Financial Statements**

**CARREKERCORPORATION**

**CondensedConsolidated Balance Sheets**

**(Unaudited)**

**(In thousands, except per shareamounts)**

**ASSETS**
| ** **                                                                                                                                     | ** ** | **October 31,** | ** ** | **January 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                                                                                                                     | ** ** | **2006**             | ** ** | **2006**             | ** ** |
|                                                                                                                                           |       |                 |       |                 |       |
| Current assets                                                                                                                                 |       |                 |       |                 |       |
| Cash and cash  equivalents                                                                                                                     |       | $                    | 24,248     |                 | $          | 29,684 |   |
| Marketable  securities                                                                                                                         |       | 12,965               |       | 4,700                |       |
| Accounts  receivable, net of allowance of $695 and $601 at October 31, 2006 and January  31, 2006, respectively                                |       | 15,111               |       | 12,225               |       |
| Prepaid expenses  and other current assets                                                                                                     |       | 2,366                |       | 2,940                |       |
| Total current assets                                                                                                                           |       | 54,690               |       | 49,549               |       |
|                                                                                                                                           |       |                 |       |                 |       |
| Property and equipment,  net of accumulated depreciation of $25,037 and $23,050 at October 31, 2006  and January 31, 2006, respectively        |       | 6,363                |       | 5,947                |       |
| Capitalized software  costs, net of accumulated amortization of $14,742 and $13,686 at October 31,  2006 and January 31, 2006, respectively    |       | 3,214                |       | 2,761                |       |
| Acquired developed  technology, net of accumulated amortization of $23,600 and $20,393 at October  31, 2006 and January 31, 2006, respectively |       | 2,100                |       | 5,307                |       |
| Goodwill, net of  accumulated amortization of $3,405 at October 31, 2006 and January 31, 2006                                                  |       | 20,765               |       | 20,765               |       |
| Customer relationships,  net of accumulated amortization of $7,583 and $6,533 at October 31, 2006 and  January 31, 2006, respectively          |       | 817                  |       | 1,867                |       |
| Deferred loan costs,  net of accumulated amortization of $1,707 and $1,571 at October 31, 2006 and  January 31, 2006, respectively             |       | —               |       | 136                  |       |
| Other assets                                                                                                                                   |       | 584                  |       | 793                  |       |
| Total assets                                                                                                                                   |       | $                    | 88,533     |                 | $          | 87,125 |   |
| ** **                                                                                                                                     | ** ** | ** **           | ** ** | ** **           | ** ** |
| Current liabilities                                                                                                                            |       |                 |       |                 |       |
| Accounts payable                                                                                                                               |       | $                    | 1,206      |                 | $          | 1,168 |   |
| Accrued  compensation and benefits                                                                                                             |       | 6,543                |       | 6,153                |       |
| Other accrued  expenses                                                                                                                        |       | 4,157                |       | 4,608                |       |
| Income tax  payable                                                                                                                            |       | 84                   |       | 220                  |       |
| Deferred revenue                                                                                                                               |       | 17,862               |       | 19,151               |       |
| Accrued merger  and restructuring costs                                                                                                        |       | 212                  |       | 334                  |       |
| Total current  liabilities                                                                                                                     |       | 30,064               |       | 31,634               |       |
|                                                                                                                                           |       |                 |       |                 |       |
| Commitments and  Contingencies                                                                                                                 |       |                 |       |                 |       |
|                                                                                                                                           |       |                 |       |                 |       |
| Stockholders’ equity                                                                                                                      |       |                 |       |                 |       |
| Preferred stock,  $.01 par value:                                                                                                              |       |                 |       |                 |       |
| 2,000 shares  authorized; no shares issued or outstanding                                                                                      |       | —               |       | —               |       |
| Common stock,  $.01 par value:                                                                                                                 |       |                 |       |                 |       |
| 100,000 shares  authorized; 25,611 and 25,329 shares issued at  October 31, 2006 and January 31, 2006, respectively                            |       | 256                  |       | 254                  |       |
| Additional  paid-in capital                                                                                                                    |       | 114,611              |       | 112,316              |       |
| Accumulated  deficit                                                                                                                           |       | (53,010              | )          | (53,848              | )          |
| Less treasury  stock, at cost: 664 and 641 common shares at October 31, 2006 and January 31,  2006, respectively                               |       | (3,388               | )          | (3,231               | )          |
| Total stockholders’  equity                                                                                                               |       | 58,469               |       | 55,491               |       |
| Total liabilities and stockholders’ equity                                                                                                |       | $                    | 88,533     |                 | $          | 87,125 |   |

 

See accompanying notes.

3

----

 

**CARREKERCORPORATION**

**Condensed Consolidated Statements of Operations**

**(Unaudited)**

**(In thousands, except per share amounts)**
| ** **                                                  | ** ** | **Three Months Ended  October 31,** | ** ** | **Nine Months Ended  October 31,** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                  | ** ** | **2006**                                           | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                        |       |                                               |       |                                              |       |   |   |   |   |
| **Revenues:**                                               | ** ** | ** **                                         | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
|  Consulting                                            |       | $                                                  | 8,939      |                                              | $          | 6,720 |   | $ | 24,336 |   | $ | 24,540 |   |
|  Software  license                                     |       | 2,864                                              |       | 5,322                                             |       | 10,914 |   | 12,463 |   |
|  Software  maintenance                                 |       | 11,198                                             |       | 10,822                                            |       | 32,849 |   | 32,710 |   |
|  Software  implementation and other services           |       | 3,876                                              |       | 4,585                                             |       | 12,260 |   | 13,611 |   |
|  Outsourcing  services                                 |       | 511                                                |       | 220                                               |       | 1,551 |   | 718 |   |
|  Out-of-pocket  expense reimbursements                 |       | 887                                                |       | 701                                               |       | 2,413 |   | 2,446 |   |
|   Total  revenues                                 |       | 28,275                                             |       | 28,370                                            |       | 84,323 |   | 86,488 |   |
|                                                        |       |                                               |       |                                              |       |   |   |   |   |
| **Cost of  revenues:**                                      | ** ** | ** **                                         | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
|  Consulting                                            |       | 5,154                                              |       | 4,369                                             |       | 14,824 |   | 12,887 |   |
|  Software  license                                     |       | 1,985                                              |       | 2,155                                             |       | 5,710 |   | 5,519 |   |
|  Software  maintenance                                 |       | 3,154                                              |       | 3,588                                             |       | 9,515 |   | 10,999 |   |
|  Software  implementation and other services           |       | 3,167                                              |       | 3,562                                             |       | 9,181 |   | 10,217 |   |
|  Outsourcing  services                                 |       | 414                                                |       | 424                                               |       | 1,404 |   | 1,437 |   |
|  Out-of-pocket  expenses                               |       | 960                                                |       | 701                                               |       | 2,508 |   | 2,299 |   |
|   Total  cost of revenues                         |       | 14,834                                             |       | 14,799                                            |       | 43,142 |   | 43,358 |   |
| Gross profit                                                |       | 13,441                                             |       | 13,571                                            |       | 41,181 |   | 43,130 |   |
|                                                        |       |                                               |       |                                              |       |   |   |   |   |
| **Operating  costs and expenses:**                          | ** ** | ** **                                         | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
|  Selling,  general and administrative                  |       | 11,087                                             |       | 11,191                                            |       | 33,290 |   | 33,688 |   |
|  Research  and development                             |       | 2,519                                              |       | 2,444                                             |       | 7,177 |   | 7,481 |   |
|  Amortization  of customer relationships               |       | 350                                                |       | 350                                               |       | 1,050 |   | 1,050 |   |
|  Restructuring  and other charges                      |       | —                                             |       | 780                                               |       | — |   | 903 |   |
|   Total  operating costs and expenses             |       | 13,956                                             |       | 14,765                                            |       | 41,517 |   | 43,122 |   |
| Income (loss)  from operations                              |       | (515                                               | )          | (1,194                                            | )          | (336 | ) | 8 |   |
|                                                        |       |                                               |       |                                              |       |   |   |   |   |
| **Other  income (expense):**                                | ** ** | ** **                                         | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
|  Interest  income                                      |       | 392                                                |       | 185                                               |       | 1,070 |   | 495 |   |
|  Interest  expense                                     |       | —                                             |       | (122                                              | )          | (211 | ) | (334 | ) |
|  Other  income                                         |       | 134                                                |       | 283                                               |       | 649 |   | 718 |   |
|   Total  other income, net                        |       | 526                                                |       | 346                                               |       | 1,508 |   | 879 |   |
| Income (loss)  before provision for income taxes            |       | 11                                                 |       | (848                                              | )          | 1,172 |   | 887 |   |
| Provision for  income taxes                                 |       | 100                                                |       | 102                                               |       | 334 |   | 285 |   |
| Net income  (loss)                                          |       | $                                                  | (89        | )                                                 | $          | (950 | ) | $ | 838 |   | $ | 602 |   |
| Basic earnings  (loss) per share                            |       | $                                                  | 0.00       |                                              | $          | (0.04 | ) | $ | 0.03 |   | $ | 0.03 |   |
| Diluted earnings  (loss) per share                          |       | $                                                  | 0.00       |                                              | $          | (0.04 | ) | $ | 0.03 |   | $ | 0.03 |   |
| Shares used in  computing basic earnings (loss) per share   |       | 24,159                                             |       | 23,906                                            |       | 24,029 |   | 24,152 |   |
| Shares used in  computing diluted earnings (loss) per share |       | 24,159                                             |       | 23,906                                            |       | 24,456 |   | 24,533 |   |

 

See accompanying notes.

4

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**CARREKER CORPORATION**

**Condensed Consolidated StatementsOf Stockholders’ Equity**

**(Unaudited)**

**(In thousands, except per shareamounts)**
| ** **                                                          | ** ** | **Common Stock** | ** ** | **Additional** | ** ** | ** ** | ** ** | ** **  | ** ** | ** **      | ** ** | **Total**               | ** ** |
|---------------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|------------|------------|-------------|------------|-----------------|------------|-------------------------|------------|
| ** **                                                          | ** ** | **Unrestricted**      | ** ** | **Restricted** | ** ** | ** ** | ** ** | **Paid-In** | ** ** | **Accumulated** | ** ** | **Treasury Stock** | ** ** | **Stockholders’** | ** ** |
| ** **                                                          | ** ** | **Shares**            | ** ** | **Shares**     | ** ** | **Amount** | ** ** | **Capital** | ** ** | **Deficit**     | ** ** | **Shares**              | ** ** | **Amount** | ** ** | **Equity** | ** ** |
|                                                                |       |                  |       |           |       |       |       |        |       |            |       |                    |       |   |   |   |   |
| Balance at  January 31, 2006                                        |       | 24,596                |       | 732            |       | $          | 254        |        | $          | 112,316         |       | $                       | (53,848    | ) | 641 |   | $ | (3,231 | ) | $ | 55,491 |   |
|                                                                |       |                  |       |           |       |       |       |        |       |            |       |                    |       |   |   |   |   |
| Cancellation of  restricted stock                                   |       | —                |       | (7             | )          | —     |       | —      |       | —          |       | —                  |       | — |   | — |   |
| Compensation  expense related to issuance of restricted stock       |       | —                |       | —         |       | —     |       | 240         |       | —          |       | —                  |       | — |   | 240 |   |
| Compensation  expense related to issuance of stock options          |       | —                |       | —         |       | —     |       | 382         |       | —          |       | —                  |       | — |   | 382 |   |
| Issuance of  restricted stock                                       |       | —                |       | 46             |       | —     |       | —      |       | —          |       | —                  |       | — |   | — |   |
| Restricted  shares withheld for payroll taxes                       |       | —                |       | —         |       | —     |       | —      |       | —          |       | 7                       |       | (45 | ) | (45 | ) |
| Conversion of restricted common stock to  unrestricted              |       | 22                    |       | (22            | )          | —     |       | —      |       | —          |       | —                  |       | — |   | — |   |
| Net loss                                                            |       | —                |       | —         |       | —     |       | —      |       | (34             | )          | —                  |       | — |   | (34 | ) |
| Balance at April  30, 2006                                          |       | 24,618                |       | 749            |       | 254        |       | 112,938     |       | (53,882         | )          | 648                     |       | (3,276 | ) | 56,034 |   |
|                                                                |       |                  |       |           |       |       |       |        |       |            |       |                    |       |   |   |   |   |
| Cancellation of  restricted stock                                   |       | —                |       | (5             | )          | —     |       | —      |       | —          |       | —                  |       | — |   | — |   |
| Compensation  expense related to issuance of restricted stock       |       | —                |       | —         |       | 1          |       | 286         |       | —          |       | —                  |       | — |   | 287 |   |
| Compensation  expense related to issuance of stock options          |       | —                |       | —         |       | —     |       | 340         |       | —          |       | —                  |       | — |   | 340 |   |
| Issuance of  restricted stock                                       |       | —                |       | 164            |       | —     |       | —      |       | —          |       | —                  |       | — |   | — |   |
| Restricted  shares withheld for payroll taxes                       |       | —                |       | —         |       | —     |       | —      |       | —          |       | 15                      |       | (99 | ) | (99 | ) |
| Conversion of restricted common stock to  unrestricted              |       | 124                   |       | (124           | )          | —     |       | —      |       | —          |       | —                  |       | — |   | — |   |
| Issuance of shares of common stock upon exercises of  stock options |       | 63                    |       | —         |       | 1          |       | 283         |       | —          |       | —                  |       | — |   | 284 |   |
| Net income                                                          |       | —                |       | —         |       | —     |       | —      |       | 961             |       | —                  |       | — |   | 961 |   |
| Balance at July  31, 2006                                           |       | 24,805                |       | 784            |       | $          | 256        |        | $          | 113,847         |       | $                       | (52,921    | ) | 663 |   | $ | (3,375 | ) | $ | 57,807 |   |
|                                                                |       |                  |       |           |       |       |       |        |       |            |       |                    |       |   |   |   |   |
| Cancellation of  restricted stock                                   |       | —                |       | (7             | )          | —     |       | —      |       | —          |       | —                  |       | — |   | — |   |
| Compensation  expense related to issuance of restricted stock       |       | —                |       | —         |       | —     |       | 303         |       | —          |       | —                  |       | — |   | 303 |   |
| Compensation  expense related to issuance of stock options          |       | —                |       | —         |       | —     |       | 351         |       | —          |       | —                  |       | — |   | 351 |   |
| Issuance of  restricted stock                                       |       | —                |       | 5              |       | —     |       | —      |       | —          |       | —                  |       | — |   | — |   |
| Restricted  shares withheld for payroll taxes                       |       | —                |       | —         |       | —     |       | —      |       | —          |       | 1                       |       | (13 | ) | (13 | ) |
| Conversion of  restricted common stock to unrestricted              |       | 6                     |       | (6             | )          | —     |       | —      |       | —          |       | —                  |       | — |   | — |   |
| Issuance of  shares of common stock upon exercises of stock options |       | 24                    |       | —         |       | —     |       | 110         |       | —          |       | —                  |       | — |   | 110 |   |
| Net loss                                                            |       | —                |       | —         |       | —     |       | —      |       | (89             | )          | —                  |       | — |   | (89 | ) |
| Balance at  October 31, 2006                                        |       | 24,835                |       | 776            |       | 256        |       | 114,611     |       | (53,010         | )          | 664                     |       | (3,388 | ) | 58,469 |   |

 

See accompanying notes.

5

----

 

**CARREKERCORPORATION**

**Condensed Consolidated Statements ofCash Flows**

**(Unaudited)**

**(In thousands)**
| ** **                                                                                   | ** ** | **Three Months Ended  October 31,** | ** ** | **Nine Months Ended  October 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2006**                                           | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Operating  Activities:**                                                                   | ** ** | ** **                                         | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income (loss)                                                                            |       | $                                                  | (89        | )                                                 | $          | (950 | ) | $ | 838 |   | $ | 602 |   |
| Adjustments to reconcile net income to net cash  provided by (used in) operating activities: |       |                                               |       |                                              |       |   |   |   |   |
| Depreciation and amortization of property and  equipment                                     |       | 818                                                |       | 793                                               |       | 2,304 |   | 2,391 |   |
| Amortization of capitalized software costs                                                   |       | 410                                                |       | 419                                               |       | 1,056 |   | 887 |   |
| Amortization of acquired developed technology                                                |       | 983                                                |       | 1,155                                             |       | 3,207 |   | 3,465 |   |
| Amortization of customer relationships                                                       |       | 350                                                |       | 350                                               |       | 1,050 |   | 1,050 |   |
| Amortization of deferred loan costs                                                          |       | —                                             |       | 68                                                |       | 136 |   | 203 |   |
| Stock based compensation                                                                     |       | 654                                                |       | 247                                               |       | 1,904 |   | 505 |   |
| Minority share of loss in Carretek LLC                                                       |       | (150                                               | )          | (269                                              | )          | (477 | ) | (799 | ) |
| Non-cash charge for merger costs                                                             |       | —                                             |       | —                                            |       | — |   | (32 | ) |
| Allowance for doubtful accounts                                                              |       | 98                                                 |       | 95                                                |       | 126 |   | 54 |   |
| Changes in operating assets and liabilities:                                                 |       |                                               |       |                                              |       |   |   |   |   |
| Accounts receivable                                                                          |       | 2,057                                              |       | 3,011                                             |       | (3,012 | ) | (2,194 | ) |
| Prepaid expenses and other assets                                                            |       | 190                                                |       | (147                                              | )          | 836 |   | (456 | ) |
| Accounts payable and accrued expenses                                                        |       | 398                                                |       | 708                                               |       | (245 | ) | (1,898 | ) |
| Income taxes payable                                                                         |       | 7                                                  |       | 107                                               |       | (136 | ) | (157 | ) |
| Deferred revenue                                                                             |       | (1,504                                             | )          | (3,401                                            | )          | (1,289 | ) | (5,221 | ) |
| Net cash  provided by (used in) operating activities                                         |       | 4,222                                              |       | 2,186                                             |       | 6,298 |   | (1,600 | ) |
|                                                                                         |       |                                               |       |                                              |       |   |   |   |   |
| **Investing  Activities:**                                                                   | ** ** | ** **                                         | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Purchases of property and equipment                                                          |       | (588                                               | )          | (523                                              | )          | (2,773 | ) | (1,809 | ) |
| Purchases of marketable securities                                                           |       | (10,265                                            | )          | —                                            |       | (13,765 | ) | (4,600 | ) |
| Sales of marketable securities                                                               |       | 3,200                                              |       | 100                                               |       | 5,500 |   | 100 |   |
| Software development costs capitalized                                                       |       | (265                                               | )          | —                                            |       | (1,509 | ) | (690 | ) |
| Net cash used in  investing activities                                                       |       | (7,918                                             | )          | (423                                              | )          | (12,547 | ) | (6,999 | ) |
|                                                                                         |       |                                               |       |                                              |       |   |   |   |   |
| **Financing  Activities:**                                                                   | ** ** | ** **                                         | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Proceeds from exercises of stock options                                                     |       | 110                                                |       | 276                                               |       | 393 |   | 542 |   |
| Purchase of treasury stock                                                                   |       | —                                             |       | (6                                                | )          | — |   | (3,228 | ) |
| Proceeds from minority shareholder equity  contributions to Carretek LLC                     |       | 220                                                |       | 380                                               |       | 420 |   | 931 |   |
| Net cash  provided by (used in) financing activities                                         |       | 330                                                |       | 650                                               |       | 813 |   | (1,755 | ) |
| Net increase  (decrease) in cash and cash equivalents                                        |       | (3,366                                             | )          | 2,413                                             |       | (5,436 | ) | (10,354 | ) |
| Cash and cash  equivalents at beginning of period                                            |       | 27,614                                             |       | 21,749                                            |       | 29,684 |   | 34,516 |   |
| Cash and cash  equivalents at end of period                                                  |       | $                                                  | 24,248     |                                              | $          | 24,162 |   | $ | 24,248 |   | $ | 24,162 |   |
|                                                                                         |       |                                               |       |                                              |       |   |   |   |   |
| Supplemental  disclosures of cash flow information:                                          |       |                                               |       |                                              |       |   |   |   |   |
| Cash paid for interest                                                                       |       | $                                                  | 13         |                                              | $          | 39 |   | $ | 89 |   | $ | 115 |   |
| Cash paid for  income taxes, net                                                             |       | $                                                  | 48         |                                              | $          | 16 |   | $ | 412 |   | $ | 443 |   |

 

See accompanying notes.

6

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**CarrekerCorporation**

**Notes to Condensed ConsolidatedUnaudited Financial StatementsFor the Three and Nine Months Ended October 31, 2006**

**1.****              Description ofBusiness**

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

**2.****              Summary ofSignificant Accounting Procedures**

**Principlesof Consolidation**

The condensedconsolidated unaudited financial statements include the accounts of the Companyand its wholly owned subsidiaries. All significant intercompany balances andtransactions have been eliminated in consolidation.

The condensedconsolidated unaudited financial statements also reflect the operations ofCarretek LLC, which is a 51% owned subsidiary.  The minority interest and minority share ofnet loss of Carretek LLC represent the 49% minority stockholder’s investmentand share of the loss of this consolidated subsidiary.  The minority interest is currently classifiedin other accrued expenses in the accompanying condensed consolidated unauditedbalance sheet and the minority share of net loss of Carretek LLC is recorded inother income in the accompanying condensed consolidated unaudited statements ofoperations.

The accompanyingcondensed consolidated unaudited financial statements and notes have beenprepared in accordance with the rules and regulations of the Securities andExchange Commission for Form 10-Q and include all of the information anddisclosures required by generally accepted accounting principles for interimfinancial reporting.  The accompanyingfinancial statements reflect all adjustments (consisting of normal recurringentries) which in the opinion of management are necessary for a fair presentationof the results for the interim periods presented.  The results of operations for the three andnine months ended October 31, 2006 are not necessarily indicative of full-yearresults.

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires the use of estimates and assumptionsthat affect the amounts reported in the financial statements and accompanyingnotes.  As discussed below, the Companymakes significant estimates and assumptions in the areas of accounts receivable,impairment of intangibles and revenue recognition.  Although the Company believes that theestimates and assumptions are reasonable, actual results may differ, and suchdifferences could be significant to the Company’s financial results.

**Cash andCash Equivalents**

The Company considers allhighly liquid investments with maturities of three months or less whenpurchased to be cash equivalents.  Cashand cash equivalents consist primarily of demand deposit accounts and demand moneymarket accounts with nationally recognized financial institutions, along withdomestic commercial paper.  The Companyutilizes a sweep service from a financial institution to invest daily inovernight repurchase agreements, typically in U.S. Treasury or agency issues.

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**Marketable Securities**

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

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

Marketable securities atOctober 31, 2006 consist of insured municipal bonds and guaranteed student loanbacked debt securities, treasury notes, agency notes and corporate notes with acost of $13.0 million, which approximates fair value.

Approximately $2.7million of original maturities of debt securities classified as available forsale at October 31, 2006 were due after 10 years.  All the debt securities are auction ratesecurities and the interest rates for these investments will adjust to currentmarket rates at each interest reset date, which is typically on at least amonthly basis.  The remainder of the debtsecurities have original maturities of less than two years.

**Comprehensive Income**

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

**ForeignCurrency Translation**

The Company considers theU.S. Dollar to be the functional currency for its internationalsubsidiaries.  All remeasurementadjustments are recorded in the consolidated statements of operations.

**AccountsReceivable****andConcentration of Credit Risk**

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

A significant portion ofthe Company’s business consists of providing consulting services and licensingsoftware to major domestic and international banks, which gives rise to aconcentration of credit risk in receivables. Because the Company’s accounts receivable are typically unsecured, theCompany periodically evaluates the collectibility of its accounts based on acombination of factors, including a particular customer’s ability to pay aswell as the age of receivables.  In caseswhere the evidence suggests a customer may not be able to satisfy itsobligation to the Company or if the collection of the receivable becomesdoubtful due to a dispute that arises subsequent to the delivery of the Company’sproducts and services, the Company sets up a reserve in an amount determinedappropriate for the perceived risk.  Mostof the Company’s contracts include multiple payment milestones, some of whichoccur in advance of revenue recognition, which mitigates the risk both in termsof collectibility and adjustments to recorded revenue.  During the three months ended October 31,2006, write-offs of receivables were $12,000. During the three months ended October 31, 2005, recoveries ofreceivables were $28,000.  During thenine months ended October 31, 2006 and 2005, write-offs of receivables, net ofrecoveries, were $31,000 and $14,000, respectively.

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

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**Propertyand Equipment**

Property and equipmentare stated at cost. Depreciation is calculated using the straight-line methodover the estimated useful lives of the respective assets, generally from two tofive years. Leasehold improvements are amortized using the straight-line methodover the shorter of the terms of the related leases or the respective usefullives of the assets.

The Company accounts forthe costs of computer software developed or obtained for internal use inaccordance with Statement of Position 98-1, *“Accountingfor the Costs of Computer Software Developed or Obtained for Internal Use”.*  The Company capitalizes software costsincurred after the preliminary project stage is complete, the Company has committedto the project and it is probable that the software will be used to perform thefunction intended.  Capitalized softwarecosts are amortized on an individual basis using the estimated economic life ofthe product on a straight-line basis, generally three to five years.  These capitalized software costs are includedin “Equipment and Software”.  Costsincurred during preliminary project and post-implementation stages are chargedto expense.

The components ofproperty and equipment are as follows (in thousands):
|                                                 | ** ** | **October 31,** | ** ** | **January 31,** | ** ** |
|-------------------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                      | ** ** | **2006**             | ** ** | **2006**             | ** ** |
| ** **                                      | ** ** | ** **           | ** ** | ** **           | ** ** |
| Furniture                                       |       | $                    | 5,052      |                 | $          | 5,070 |   |
| Equipment and  software                         |       | 25,032               |       | 22,643               |       |
| Leasehold  improvements                         |       | 1,316                |       | 1,284                |       |
| Total cost                                      |       | 31,400               |       | 28,997               |       |
|                                            |       |                 |       |                 |       |
| Less accumulated  depreciation and amortization |       | (25,037              | )          | (23,050              | )          |
| Net property and  equipment                     |       | $                    | 6,363      |                 | $          | 5,947 |   |

 

**LongLived Assets**

The Company accounts forgoodwill and other intangible assets in accordance with Statement of FinancialAccounting Standards No. 142, *“Goodwill andOther Intangible Assets”* (“SFAS 142”).  Under the provisions of SFAS 142, an annualassessment of goodwill impairment is performed. This assessment involves the use of estimates related to fair marketvalues of the Company’s reporting units with which the goodwill isassociated.  The assessment of goodwillimpairment in the future will be impacted if future operating cash flows of theCompany’s reporting units decline significantly, which could result indecreases in the related estimate of fair market value.  The Company performs its annual impairmentanalysis as of November 1st of each year andwhenever facts and circumstances indicate impairment may exist.

The Company accounts forlong lived assets in accordance with Statement of Financial Accounting StandardsNo. 144, *“Accounting for the Impairment orDisposal of Long-Lived Assets”* (“SFAS 144”).  Under the provisions of SFAS 144, long-livedassets, such as property, plant and equipment and purchased intangibles subjectto amortization are tested for recoverability whenever events or changes incircumstances indicate that the carrying amount of an asset may not berecoverable.  Recoverability of assets tobe held and used is measured by a comparison of the carrying amount of an assetto estimated undiscounted future cash flows expected to be generated by theasset.  If the carrying amount of anasset exceeds its estimated future cash flows, an impairment charge isrecognized by the amount by which the carrying amount of the asset exceeds theestimated fair value of the asset.

**Deferred Loan Costs**

Deferred loan costsconsist of loan closing costs associated with the Company’s revolving creditagreement.  The Company chose not torenew the revolving credit agreement which expired by its terms on July 31,2006.  These costs were amortized tointerest expense over the 36 month life of the revolving credit agreement andwere fully amortized at July 31, 2006.

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**CapitalizedSoftware Costs and Acquired Developed Technology**

The Company capitalizesthe development costs of software, other than internal-use software, inaccordance with Statement of Financial Accounting Standards No. 86, *“Accounting for Costs of Computer Software to beSold, Leased or Otherwise Marketed”* (“SFAS 86”).  The Company’s policy is to capitalize softwaredevelopment costs incurred in developing a product once technologicalfeasibility of the product has been established. Technological feasibility ofthe product is determined after completion of a detailed program design and adetermination has been made that any uncertainties related to high-riskdevelopment issues have been resolved. If the process of developing the productdoes not include a detail program design, technological feasibility isdetermined only after completion of a working model. All capitalized softwaredevelopment costs are amortized using an amount determined as the greater of:(1) the ratio that current gross revenues for a capitalized software productbears to the total of current and estimated future gross revenues for that projector (2) the straight-line method over the estimated remaining economic life ofthe product (generally three to five years). The Company capitalized $265,000and $0 in the three months ended October 31, 2006 and 2005, respectively.  The Company capitalized $1.5 million and$690,000 in the nine months ended October 31, 2006 and 2005, respectively.  The software development efforts in bothperiods were related to several new Cash and Risk solutions within the GlobalPayments Technologies business segment, along with two new offerings within theRevenue Enhancement business segment.

The Company recordedamortization relating to software development costs capitalized of $410,000 and$419,000 in the three months ended October 31, 2006 and 2005, respectively.  The Company recorded amortization relating tosoftware development costs capitalized of $1.1 million and $887,000 in the ninemonths ended October 31, 2006 and 2005, respectively.  Amortization expense is recorded as acomponent of cost of software license fees in the accompanying consolidatedstatements of operations.

Acquired developedtechnology includes purchased technology intangible assets associated withacquisitions.  These purchased technologyintangibles are initially recorded based on fair value assigned at the time ofacquisition.

Acquired developedtechnology with a useful life of 3-6 years is amortized on a straight-linebasis, resulting in amortization expense of $983,000 and $1.2 million for thethree months ended October 31, 2006 and 2005, respectively, and $3.2 millionand $3.5 million for the nine months ended October 31, 2006 and 2005.  Amortization expense is recorded as acomponent of cost of software license fees in the accompanying consolidated statementsof operations.

The following table setsforth the estimated amortization expense of capitalized software costs andacquired developed technology for the indicated fiscal years ending January 31(in thousands):
| Year               | ** ** | **Capitalized  Software  Costs** | ** ** | **Acquired  Developed  Technology** | ** ** |
|--------------------|------------|----------------------------------|------------|-------------------------------------|------------|
|               |       |                             |       |                                |       |
| Remainder of  2007 |       | $                                | 338        |                                | $          | 900 |   |
| 2008               |       | 1,170                            |       | 1,200                               |       |
| 2009               |       | 672                              |       | —                              |       |
| 2010               |       | 170                              |       | —                              |       |
|                    |            |                                  |            |                                     |            |  |  |

 

The table does notinclude the estimated amortization expense for $864,000 of capitalized softwareproducts that are currently being developed, and for which amortization has notcommenced.

The Company continuallymonitors the net realizable value of software capitalized and acquireddeveloped technology for factors that would indicate impairment such as adecline in demand or a loss of a significant customer.  During the quarterly period ended January 31,2006, the Company performed its annual formal evaluation for impairment anddetermined that the carrying amount of these assets was not impaired and hassubsequently noted no factors in the nine months ended October 31, 2006 thatwould indicate impairment.

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**RevenueRecognition**

The Company’s revenuerecognition policies are in accordance with Statement of Position (“SOP”) 97-2,*“Software Revenue Recognition,”* asamended by SOP 98-9, “*Modification of SOP 97-2,**Software Revenue Recognition with Respect toCertain Transactions,”* Staff Accounting Bulletin (“SAB”) No. 104,*“Revenue Recognition,”* and Emerging Issues Task Force (“EITF”) No.00-21,*“Revenue Arrangements with MultipleDeliverables.”* In the case ofsoftware arrangements that require significant production, modification, orcustomization of software, or the license agreement requires the Company toprovide implementation services that are determined to be essential to otherelements of the arrangement, the Company follows the guidance in SOP 81-1, *“Accounting for Performance of Construction–Type and Certain Production–TypeContracts.”*

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

*Consulting.*  The Company employs three primary pricingmethods in connection with its delivery of consulting services. First, theCompany may price its delivery of consulting services on the basis of time andmaterials, in which case the customer is charged agreed-upon daily rates forservices performed and out-of-pocket expenses. In this case, the Company isgenerally paid fees and related amounts usually on a monthly basis, and theCompany recognizes revenues as the services are performed. Second, the Companymay deliver consulting services on a fixed-price basis. In this case, theCompany is paid on a monthly basis or pursuant to an agreed upon paymentschedule, and the Company recognizes revenues on a proportionate performancebasis.  The Company believes that thismethod is appropriate because of its ability to determine performancemilestones and determine dependable estimates of its costs applicable to eachphase of a contract.  Because financialreporting of these contracts depends on estimates, which are assessedcontinually during the term of the contract, costs are subject to revisions asthe contract progresses.  Anticipatedlosses on fixed-price contracts are recognized when estimable.  Third, the Company may deliver consultingservices pursuant to a value-priced contract with the customer. In this case,the Company is paid, on an agreed upon basis with the customer, either aspecified percentage of (1) the projected increased revenues and/ordecreased costs that are expected to be derived by the customer generally overa period of up to twelve months following implementation of its solution or (2)the actual increased revenues and/or decreased costs experienced by thecustomer generally over a period of up to twelve months followingimplementation of its solution, subject in either case to a maximum, if any isagreed to, on the total amount of payments to be made to the Company.  The Company must first commit time andresources to develop projections associated with value-pricing contracts beforea customer will commit to purchase its solutions, and the Company thereforeassumes the risk of making these commitments with no assurance that thecustomer will purchase the solution. Costs associated with these value-pricing contracts are expensed asincurred.  These contracts typicallyinclude payments to be made to the Company pursuant to an agreed upon scheduleranging from one to twelve months in length. The Company recognizes revenues generated from consulting services inconnection with value-priced contracts once customer acknowledgement isobtained that confirms fees have become fixed and determinable.  In some cases, these acknowledgements containfuture deliverables or services, in which case the revenue from theseengagements is recognized on a proportionate performance basis based on effortsto be incurred following the customer acknowledgement.  In an effort to allow customers to moreclosely match expected benefits from services with payments to the Company, theCompany on occasion, may offer payment terms which extend beyond 12months.  When the Company enters into anagreement which has a significant component of the total amount payable underthe agreement due beyond 12 months or if it is determined payments are notfixed and determinable at the date the agreement was entered into, revenueunder the arrangement will be recognized as payments become due andpayable.  When fees are to be paid basedon a percentage of actual revenues and/or savings to customers, the Companyrecognizes revenues only upon completion of all services and as the amounts ofactual revenues or savings are confirmed by the customer with a fixed paymentdate.

Costs associated withtime and materials, fixed-priced and value-priced consulting fee arrangementsare expensed as incurred and are included as a component of the cost ofconsulting fees.

The Company expects thatvalue-pricing contracts will continue to account for a significant portion ofits revenues in the future. As a consequence of the use of value-pricingcontracts and due to the revenue recognition policy associated with thosecontracts, the Company’s results of operations will likely fluctuatesignificantly from period to period.

Regardless of the pricingmethod employed by the Company in a given contract, the Company is typicallyreimbursed on a monthly basis for out-of-pocket expenses incurred on behalf ofits customers.

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*Software License.*  A perpetual software license is sold eithertogether with implementation services or on a stand-alone basis.  The Company is usually paid software licensefees in one or more installments, as provided in the customer’s contract butnot to exceed twelve months.  The Companyrecognizes software license revenue upon execution of a contract and deliveryof the software, provided that the license fee is fixed and determinable, nosignificant production, modification or customization of the software isrequired and collection is considered probable by management.  When the software license arrangementrequires the Company to provide implementation services that are essential tothe functionality of the software or significant production, customization ormodification of the software is required, both the product license revenue andimplementation fees are recognized as services are performed.  A term software license is sold eithertogether with implementation services and/or with maintenance services.  These term licenses are usually paid inannual installments over the term of the license.  If the term software license is sold withoutessential implementation services, the revenue is recognized ratably over thenon-cancelable license term.  If the termlicense is sold with essential implementation services, the license revenue isrecognized as the lesser of the amount of license revenue recognized asservices are performed or on a ratable basis.

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

Software licenses areoften sold as part of a multiple element arrangement that may includemaintenance, implementation or consulting. The Company determines whether there is vendor specific objectiveevidence of fair value (“VSOEFV”) for each element identified in thearrangement to determine whether the total arrangement fees can be allocated toeach element.  If VSOEFV exists for eachelement, the total arrangement fee is allocated based on the relative fairvalue of each element.  In cases wherethere is not VSOEFV for each element, or if it is determined services areessential to the functionality of the software being delivered, or ifsignificant production, modification or customization of the software isrequired, the Company initially defers revenue recognition of the softwarelicense fees until VSOEFV is established or the services are performed.  However, if VSOEFV is determinable for all ofthe undelivered elements, and assuming the undelivered elements are not essentialto the delivered elements, the Company will defer recognition of the full fairvalue related to the undelivered elements and recognize the remaining portionof the arrangement value through application of the residual method.  Where VSOEFV has not been established forcertain undelivered elements, revenue for all elements is deferred until thoseelements have been delivered or their fair values have been determined.  Evidence of VSOEFV is determined for softwareproducts based on actual sales prices for the product sold to a similar classof customer and based on pricing strategies set forth in the Company’s pricebook.  Evidence of VSOEFV for services(implementation and consulting) is based upon standard billing rates and theestimated level of effort for individuals expected to perform the relatedservices.  The Company establishes VSOEFVfor maintenance agreements using the percentage method such that VSOEFV formaintenance is a percentage of the license fee charged annually for a specificsoftware product, which in most instances is 20% of the portion of arrangementfees allocated to the software license element.

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

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

*Software Implementation and OtherServices.*  Inconnection with the sale of a software license, a customer may elect topurchase software implementation services, including software enhancements andother software services. Most of the customers that purchase software licensesfrom the Company also purchase software implementation services.  The Company prices its implementationservices on a time-and-materials or on a fixed-price basis, and the Companyrecognizes the related revenues as services are performed.  Costs associated with these engagements areexpensed as incurred.

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*Outsourcing Services.*  We currently recognize revenue based on thenumber of items processed.  Theseservices are billed currently on a monthly basis.

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

**Royalties**

The Company is requiredto pay royalties in connection with software license, maintenance, andconsulting agreements entered into with certain customers under which theCompany acquired third party software technology or other intellectual propertyused in products and services sold to its customers.  Under these arrangements, the Companyrecognizes royalty expense when the associated revenue is recognized.  For current product offerings, the royaltypercentages generally range from 20% to 70% of the associated revenues.  Approximately $686,000 and $665,000 ofroyalty expense was recorded under these agreements in the three months endedOctober 31, 2006 and 2005, respectively, and $1.7 million and $1.4 million ofroyalty expense was recorded under these agreements in the nine months endedOctober 31, 2006 and 2005.  Royaltyexpense is primarily included as a component of the cost of software licenserevenues; however, certain amounts are also included in cost of consultingrevenues and cost of software maintenance revenues in the accompanyingconsolidated statements of operations.

**Deferred Revenue**

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

Deferred revenue consistsof the following (in thousands):
|                                                    | ** ** | **October 31,** | ** ** | **January 31,** | ** ** |
|----------------------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                         | ** ** | **2006**             | ** ** | **2006**             | ** ** |
|                                               |       |                 |       |                 |       |
| Deferred  software maintenance fees                |       | $                    | 20,484     |                 | $          | 39,343 |   |
| Deferred  software implementation and license fees |       | 11,321               |       | 15,769               |       |
|                                               |       | 31,805               |       | 55,112               |       |
| Less amounts not  yet collected                    |       | (13,943              | )          | (35,961              | )          |
| Net deferred revenue                               |       | $                    | 17,862     |                 | $          | 19,151 |   |

 

**Researchand Development Costs**

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

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**Otherincome (expense)**

Other income (expense) is comprised of the following(in thousands):
| ** **                                 | ** ** | **Three Months Ended  October 31,** | ** ** | **Nine Months Ended  October 31,** | ** ** |
|--------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                 | ** ** | **2006**                                           | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                       |       |                                               |       |                                              |       |   |   |   |   |
| Minority share of net loss of Carretek LLC |       | $                                                  | 150        |                                              | $          | 269 |   | $ | 477 |   | $ | 799 |   |
| Foreign exchange gains (losses)            |       | (18                                                | )          | 12                                                |       | 175 |   | (89 | ) |
| Other                                      |       | 2                                                  |       | 2                                                 |       | (3 | ) | 8 |   |
| Total                                      |       | $                                                  | 134        |                                              | $          | 283 |   | $ | 649 |   | $ | 718 |   |

 

**IncomeTaxes**

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

**EarningsPer Share**

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

**Stock-BasedCompensation**

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

On February 1, 2006, theCompany adopted, on a modified prospective basis, SFAS 123(R), “Share BasedPayment” (“SFAS 123(R)”).  SFAS123(R) requires all share-based payments to employees, including grants ofemployee stock options and shares purchased under an employee stock purchaseplan (if certain parameters are not met), to be recognized in the financialstatements based on their fair value.

Upon the adoption of SFAS123(R), the Company began recording compensation cost related to the continuedvesting of stock options that remained unvested as of February 1, 2006, as wellas for all new stock option grants after our adoption date.  The compensation cost to be recorded is basedon the fair value at the grant date.  Theadoption of SFAS 123(R) did not have an effect on our recognition ofcompensation expense relating to the vesting of restricted stock grants.

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

14

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

As a result of adopting SFAS 123(R) on February 1,2006, the Company’s net income for the three and nine months ended October 31,2006 is $351,000 and $1.1 million lower, respectively, than if it had continuedto account for share-based compensation under APB 25.  Basic earnings per share for the three andnine months ended October 31, 2006 are $0.01 and $0.05 lower, respectively, anddiluted earnings per share for the three and nine months ended October 31, 2006are $0.01 and $0.05 lower, respectively, than if the Company had continued toaccount for share-based compensation under APB 25.

Determining Fair Value

*Valuation and Amortization Method.*  The Company estimates the fair value ofshare-based awards granted using the Black-Scholes option valuation model.  The Company amortizes the fair value of allawards on a straight-line basis over the requisite service periods, which aregenerally the vesting periods.

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

*Expected Volatility.*  Using the Black-Scholes option valuationmodel, the Company estimates the volatility of its common stock at the date ofgrant based on the historical volatility of our common stock.

*Risk-Free Interest Rate.*  The Company bases the risk-free interest rateused in the Black-Scholes option valuation model on the implied yield currentlyavailable on U.S. Treasury zero-coupon issues with an equivalent remaining termequal to the expected life of the award.

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

*Expected Forfeitures.*  The Company uses historical data to estimatepre-vesting option forfeitures and records stock-based compensation only forthose awards that are expected to vest.

The fair value of eachoption grant is estimated on the date of grant using the Black-Scholes optionpricing model.  A summary of the weightedaverage assumptions and results for options granted during the three and ninemonths ended October 31, 2006 are as follows:
| ** **                                      | ** ** | **Three Months Ended  October 31,** | ** ** | **Nine Months Ended  October 31,** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                      | ** ** | **2006**                                           | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                            |       |                                               |       |                                              |       |   |   |   |   |
| Volatility                                      |       | 0.608                                              |       | 0.904                                             |       | 0.704 |   | 0.857 |   |
| Weighted-average  expected lives (years)        |       | 5.400                                              |       | 5.000                                             |       | 4.700 |   | 4.300 |   |
| Expected  dividend yields                       |       | —                                             |       | —                                            |       | — |   | — |   |
| Weighted-average  risk-free interest rates      |       | 5.07                                               | %          | 4.00                                              | %          | 5.03 | % | 3.94 | % |
| Weighted-average fair  value of options granted |       | $                                                  | 4.94       |                                              | $          | 4.63 |   | $ | 4.23 |   | $ | 3.93 |   |
|                                                 |            |                                                    |            |                                                   |            |  |  |  |  |  |  |  |  |

 

15

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Share-Based Compensation

The following tablesummarizes share-based compensation expense related to share-based awards underSFAS No. 123(R) for the three and nine months ended October 31, 2006 and 2005which is recorded in the statement of operations as follows (in thousands):
| ** **                                   | ** ** | **Three Months Ended  October 31, 2006** | ** ** | **Nine Months Ended  October 31, 2006** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                   | ** ** | **Unvested  Stock  Options**                                 | ** ** | **Unvested  Restricted  Common  Stock**                     | ** ** | **Total** | ** ** | **Unvested  Stock  Options** | ** ** | **Unvested  Restricted  Common  Stock** | ** ** | **Total** | ** ** |
|                                         |       |                                                         |       |                                                        |       |   |   |   |   |   |   |   |   |
| Cost of revenues                             |       | $                                                            | 41         |                                                        | $          | 101 |   | $ | 142 |   | $ | 175 |   | $ | 285 |   | $ | 460 |   |
| Selling, general  and administrative expense |       | 310                                                          |       | 188                                                         |       | 498 |   | 887 |   | 504 |   | 1,391 |   |
| Research and  development expense            |       | —                                                       |       | 14                                                          |       | 14 |   | 11 |   | 42 |   | 53 |   |
| Total share-based  compensation              |       | $                                                            | 351        |                                                        | $          | 303 |   | $ | 654 |   | $ | 1,073 |   | $ | 831 |   | $ | 1,904 |   |

 
| ** **                                   | ** ** | **Three Months Ended  October 31, 2005** | ** ** | **Nine Months Ended  October 31, 2005** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                   | ** ** | **Unvested  Stock  Options**                                 | ** ** | **Unvested  Restricted  Common  Stock**                     | ** ** | **Total** | ** ** | **Unvested  Stock  Options** | ** ** | **Unvested  Restricted  Common  Stock** | ** ** | **Total** | ** ** |
|                                         |       |                                                         |       |                                                        |       |   |   |   |   |   |   |   |   |
| Cost of revenues                             |       | $                                                            | —     |                                                        | $          | 81 |   | $ | 81 |   | $ | — |   | $ | 208 |   | $ | 208 |   |
| Selling, general  and administrative expense |       | —                                                       |       | 150                                                         |       | 150 |   | — |   | 267 |   | 267 |   |
| Research and  development expense            |       | —                                                       |       | 16                                                          |       | 16 |   | — |   | 30 |   | 30 |   |
| Total share-based  compensation              |       | $                                                            | —     |                                                        | $          | 247 |   | $ | 247 |   | $ | — |   | $ | 505 |   | $ | 505 |   |

 

At October 31, 2006, theCompany had unvested options to purchase 695,156 shares with a weighted averagegrant date fair value of $4.00. Additionally, the Company had 776,379 shares of unvested restrictedcommon stock with a weighted average fair value on the dates the awards weregranted of $6.22.

The unrecognizedcompensation costs are expected to be amortized over the following indicatedfiscal years ending January 31 (in thousands):
|                    | ** ** | **Unvested Stock  Options** | ** ** | **Unvested  Restricted  Common Stock** | ** ** | **Total** | ** ** |
|--------------------|------------|----------------------------------|------------|---------------------------------------------|------------|-----------|------------|
|               |       |                             |       |                                        |       |      |       |
| Remainder of  2007 |       | $                                | 340        |                                        | $          | 304       |       | $ | 644 |   |
| 2008               |       | 1,036                            |       | 1,215                                       |       | 2,251     |       |
| 2009               |       | 519                              |       | 1,125                                       |       | 1,644     |       |
| 2010               |       | 130                              |       | 851                                         |       | 981       |       |
| 2011               |       | —                           |       | 456                                         |       | 456       |       |
| 2012               |       | —                           |       | 78                                          |       | 78        |       |
| Total              |       | $                                | 2,025      |                                        | $          | 4,029     |       | $ | 6,054 |   |

 

16

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Stock Option Activity

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

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

Stock option transactionsduring the nine months ended October 31, 2006 were as follows (dollars andshare data in thousands):
|                                                                | ** ** | **Nine Months Ended October 31, 2006** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                                     | ** ** | **Number of  Shares**                                      | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Remaining  Contractual  Life (Years)** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|                                                           |       |                                                            |       |   |   |   |   |   |   |
| Stock options outstanding at the beginning of the period       |       | 3,781                                                           |       | $ | 8.44 |   | — |   | — |   |
| Granted                                                        |       | 394                                                             |       | 6.52 |   | — |   | — |   |
| Exercised                                                      |       | (87                                                             | )          | 4.55 |   | — |   | — |   |
| Forfeited                                                      |       | (95                                                             | )          | 8.93 |   | — |   | — |   |
| Stock options  outstanding at the end of the period            |       | 3,993                                                           |       | $ | 8.33 |   | 4.27 |   | $ | 3,593 |   |
|                                                           |       |                                                            |       |   |   |   |   |   |   |
| Stock options  vested and exercisable at the end of the period |       | 3,298                                                           |       | $ | 8.82 |   | 4.11 |   | $ | 2,605 |   |

 

Other information pertainingto option activity during the nine months ended October 31, 2006 was as follows(dollars in thousands, except per share data):
| Weighted average grant-date  fair value of options granted |   | $ | 4.23  |   |
|------------------------------------------------------------|--------|---|-------|--------|
| Total fair value  of stock options vested                  |   | $ | 1,665 |   |
| Total intrinsic  value of stock options exercised          |   | $ | 191   |   |

 

Information related to options outstanding at October31, 2006 is summarized below (option amounts in thousands):
| Range of Exercise  Price | ** ** | **Options  Outstanding at  October 31,  2006** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Remaining  Contractual Life** | ** ** | **Options Vested  and Exercisable  at  October 31, 2006** | ** ** | **Weighted Average  Exercise Price of  Vested and  Exercisable  Options** | ** ** |
|------------------------------------|------------|----------------------------------------------------------|------------|--------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|
| $3.00 to $4.97                     |       | 996                                                      |       | $                                          | 4.63       |                                                    | 4.05       |                                                                          | 818        |                                                                                          | $          | 4.68 |   |
| $5.00 to $7.79                     |       | 943                                                      |       | 6.38                                       |       | 5.75                                                    |       | 445                                                                           |       | 6.37                                                                                          |       |
| $8.00 to $9.88                     |       | 784                                                      |       | 8.63                                       |       | 3.81                                                    |       | 784                                                                           |       | 8.63                                                                                          |       |
| $10.00 to $25.44                   |       | 1,270                                                    |       | 12.49                                      |       | 3.63                                                    |       | 1,251                                                                         |       | 12.52                                                                                         |       |
|                               |       | 3,993                                                    |       | $                                          | 8.33       |                                                    | 4.27       |                                                                          | 3,298      |                                                                                          | $          | 8.82 |   |

 

17

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As of October 31, 2006,the Company has reserved for issuance under its stock-based compensation plans5,168,694 shares of common stock, of which 3,993,368 shares are subject tocurrently outstanding options to employees and directors, and 1,175,326 sharesare reserved for future awards.

Restricted Common StockActivity

For the stockcompensation expense related to the restricted common stock issued to employeesand officers, the Company is amortizing the compensation expense on a straightline basis over the period that the restrictions on the common stocklapse.  The Company recorded $303,000 and$247,000 of compensation expense related to the restricted common stock duringthe three months ended October 31, 2006 and 2005, respectively, and $831,000and $505,000 for the nine months ended October 31, 2006 and 2005,respectively.  Restricted common stocktransactions during the nine months ended October 31, 2006 were as follows(number of shares in thousands):
|                                                                  | ** ** | **Nine Months Ended  October 31, 2006** | ** ** |
|------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                                       | ** ** | **Number of  Shares**                                  | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|                                                             |       |                                                        |       |   |   |
| Restricted common stock unvested at the beginning of the  period |       | 732                                                         |       | $ | 6.14 |   |
|  Granted                                                    |       | 215                                                         |       | 6.35 |   |
|  Vested and released                                        |       | (152                                                        | )          | 5.99 |   |
|  Forfeited                                                  |       | (19                                                         | )          | 6.39 |   |
| Restricted common stock  unvested at the end of the period       |       | 776                                                         |       | $ | 6.22 |   |

 

Prior Period ProformaPresentations

Had compensation costfor stock-based compensation plans been determined based on the fair value atthe grant dates for awards under those plans in accordance with the provisionsof SFAS 123(R), net income and net income per share would have been as follows(in thousands, except per share data):
|                                                                            | ** ** | **Three Months  Ended**   | ** ** | **Nine Months  Ended**    | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------|------------|--------------------------------|------------|
| ** **                                                                 | ** ** | **October 31, 2005** | ** ** | **October 31, 2005** | ** ** |
|                                                                       |       |                           |       |                           |       |
| Net income  (loss), as reported                                            |       | $                              | (950       | )                              | $          | 602 |   |
| Stock compensation  expense recorded under the intrinsic value method      |       | 247                            |       | 505                            |       |
| Pro forma stock  compensation expense computed under the fair value method |       | (1,097                         | )          | (2,891                         | )          |
| Pro forma net  loss                                                        |       | $                              | (1,800     | )                              | $          | (1,784 | ) |
|                                                                       |       |                           |       |                           |       |
| Basic earnings  (loss) per common share, as reported                       |       | $                              | (0.04      | )                              | $          | 0.03 |   |
| Diluted earnings  (loss) per common share, as reported                     |       | $                              | (0.04      | )                              | $          | 0.03 |   |
| Pro forma basic  loss per common share                                     |       | $                              | (0.08      | )                              | $          | (0.07 | ) |
| Pro forma diluted loss  per common share                                   |       | $                              | (0.08      | )                              | $          | (0.07 | ) |

 

18

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**FinancialGuarantees**

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

Under the terms of themajority of the Company’s software license agreements with its customers, theCompany agrees that in the event the software sold infringes upon any patent,copyright, trademark, or any other proprietary right of a third party, it willindemnify its customer licensee against any loss, expense, or liability fromany damages that may be awarded against its customer.  The Company includes this infringementindemnification in most of its software license agreements.  In the event the customer cannot use thesoftware or service due to infringement and the Company cannot obtain the rightto use, replace or modify the license or service in a commercially feasiblemanner so that it no longer infringes, then the Company may generally terminatethe license and provide the customer a pro-rata refund of the fees paid by thecustomer for the infringing license or service. The Company has recorded no liability associated with thisindemnification, as it is not aware of any pending or threatened infringementactions that are probable losses.

The Company has agreed toindemnify members of the board of directors, officers and certain key employeesof the Company if they are made a party or are threatened to be made a party toany proceeding by reason of the fact that they are acting in their capacitieson behalf of the Company, or by reason of anything done or not done by them inany such capacities.  The indemnity isfor any and all expenses and liabilities of any type whatsoever (including butnot limited to, judgments, fines and amounts paid in settlement) actually andreasonably incurred by the directors, officers and key employees in connectionwith the investigation, defense, settlement or appeal of such proceeding,provided they acted in good faith.  TheCompany maintains insurance coverage for directors and officers liability (“D&Oinsurance”).  No maximum liability isstipulated in these agreements that include indemnifications of members of theboard of directors, officers and certain key employees of the Company.  The Company has recorded no liabilityassociated with these indemnifications as it is not aware of any pending orthreatened actions or claims against the members of its board of directors orofficers that are probable losses in excess of amounts covered by its D&Oinsurance.

**RecentlyIssued Accounting Standards**

InJune 2006, the Financial Accounting Standards Board (“FASB”) issuedInterpretation No. 48, “*Accounting for Uncertaintyin Income Taxes”* – an interpretation of FAS 109, *“Accounting for Income Taxes”* (“FIN 48”) to create a singlemodel to address accounting for uncertainty in tax positions.  FIN 48 clarifies the accounting for incometaxes, by prescribing a minimum recognition threshold a tax position isrequired to meet before being recognized in the financial statements.  FIN 48 also provides guidance onderecognition, measurement, classification, interest and penalties, accountingin interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006.  The Company will adopt FIN 48 as of February1, 2007, as required.  The cumulativeeffect of adopting FIN 48 will be recorded in retained earnings and otheraccounts as applicable.  The Company hasnot determined the effect, if any, that the adoption of FIN 48 will have on theCompany’s financial position and results of operations.

In September 2006, the FASB issued SFAS No. 157, *“Fair Value Measurements”* (SFAS 157) *,* which provides guidance on how tomeasure assets and liabilities that use fair value. SFAS 157 will applywhenever another US GAAP standard requires (or permits) assets or liabilitiesto be measured at fair value but does not expand the use of fair value to anynew circumstances. This standard also will require additional disclosures inboth annual and quarterly reports. SFAS 157 will be effective for financialstatements issued for fiscal years beginning after November 15, 2007, and willbe adopted by the Company on February 1, 2008. The Company is currentlyevaluating the potential impact this standard may have on its financialposition and results of operations, but do not believe the impact of theadoption will be material.

19

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**3.     Goodwilland Intangible Assets**

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

Customer relationships,obtained in the acquisition of Check Solutions in June 2001, with finite usefullives are amortized on a straight-line basis, which resulted in amortizationexpense of $350,000 during the three months ended October 31, 2006 and 2005,and $1.1 million during the nine months ended October 31, 2006 and 2005.

The following table setsforth the estimated amortization expense of customer relationships for theindicated fiscal years ending January 31 (in thousands):
| Year               | ** ** | **Amount** | ** ** |
|--------------------|------------|------------|------------|
|               |       |       |       |
| Remainder of  2007 |       | $          | 350        |   |
| 2008               |       | 467        |       |
|                    |            |            |            |  |

 

During the fourth quarterof the year ended January 31, 2006, the Company performed its annual evaluationfor goodwill impairment and determined that the carrying amount of goodwill wasnot impaired and subsequently has noted no factors that would indicateimpairment.

**4.     RevolvingCredit Agreement**

The Company had been aparty to a revolving credit agreement with a group of banks providing for acommitment amount of $30.0 million and a maturity date of July 31, 2006.  The Company chose not to renew the creditfacility, which expired by its terms on July 31, 2006, as current cash on hand,marketable securities and cash generated from operations are believed to besufficient to meet the Company’s cash requirements for the foreseeablefuture.  By not renewing the facility,the Company will be able to avoid certain fees and expenses associated withrenewing and maintaining a line of credit.

Interest expense,including the commitment fee and exclusive of the amortization of deferred loancosts on the credit agreement, was $0 and $54,000 for the three months endedOctober 31, 2006 and 2005, respectively, and $76,000 and $130,000 for the ninemonths ended October 31, 2006 and 2005, respectively.

**5.     Provisionfor Income Taxes**

The Company hasestablished a valuation allowance to reserve its net deferred tax assets atOctober 31, 2006 because of the Company’s inconsistent history of generatingprofitable operations and taxable income. The tax provision was computed based on actual results by jurisdictionwhich resulted in a foreign tax provision of $100,000 and $102,000 for thethree months ended October 31, 2006 and 2005, respectively, and $314,000 and$270,000 for the nine months ended October 31, 2006 and 2005,respectively.  In addition to theprovision for foreign taxes, the Company recorded $20,000 and $15,000 of U.S.Federal and State tax expense in the nine months ended October 31, 2006 and2005, respectively, for alternative minimum tax purposes.

20

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**6.     BenefitPlans**

**401(k)Plan**

The Company has adopted aplan pursuant to Section 401(k) of the Internal Revenue Code (“the Code”)whereby participants may contribute a percentage of compensation not in excessof the maximum allowed under the Code. Employer matching contributions amountedto $213,000 and $215,000 for the three months ended October 31, 2006 and 2005,respectively, and $756,000 and $820,000 for the nine months ended October 31,2006 and 2005, respectively. The Company may make additional contributions atthe discretion of the Board of Directors. No discretionary contributions were made during the three and nine monthsended October 31, 2006 and 2005.

**Incentive Compensation Plans**

The Carreker IncentiveBonus Plan (“CIBP”) awards employees bonuses based on the Company’s or theapplicable business unit’s operating results. Substantially all employees are eligible to receive cash awards underthe CIBP.  Awards from this plan are paidto employees subsequent to the end of the fiscal year.  The Company’s Compensation Committee of theBoard of Directors has the authority to determine the final amount of the bonusthat is ultimately paid to the officers of the Company.  In the three months ended October 31, 2006and 2005, the Company reversed expense under this plan of approximately $39,000and recorded expense of $364,000, respectively. In the nine months ended October 31, 2006 and 2005, the Company recordedexpense under this plan of approximately $465,000 and $627,000, respectively.

**7.     EarningsPer Share**

The following table sets forth the computation ofbasic and diluted earnings per share (in thousands, except per share amounts):
| ** **                                                                  | ** ** | **Three Months Ended  October 31,** | ** ** | **Nine Months Ended  October 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                  | ** ** | **2006**                                           | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                                        |       |                                               |       |                                              |       |   |   |   |   |
| Basic earnings  (loss) per share:                                           |       |                                               |       |                                              |       |   |   |   |   |
| Net income (loss)                                                           |       | $                                                  | (89        | )                                                 | $          | (950 | ) | $ | 838 |   | $ | 602 |   |
|                                                                        |       |                                               |       |                                              |       |   |   |   |   |
| Weighted average shares outstanding                                         |       | 24,159                                             |       | 23,906                                            |       | 24,029 |   | 24,152 |   |
|                                                                        |       |                                               |       |                                              |       |   |   |   |   |
| Basic earnings (loss) per share                                             |       | $                                                  | 0.00       |                                              | $          | (0.04 | ) | $ | 0.03 |   | $ | 0.03 |   |
|                                                                        |       |                                               |       |                                              |       |   |   |   |   |
| Diluted earnings  per share:                                                |       |                                               |       |                                              |       |   |   |   |   |
| Net income (loss)                                                           |       | $                                                  | (89        | )                                                 | $          | (950 | ) | $ | 838 |   | $ | 602 |   |
|                                                                        |       |                                               |       |                                              |       |   |   |   |   |
| Weighted average shares outstanding                                         |       | 24,159                                             |       | 23,906                                            |       | 24,029 |   | 24,152 |   |
| Assumed conversion of employee stock options and  unvested restricted stock |       | —                                             |       | —                                            |       | 427 |   | 401 |   |
| Shares used in diluted earnings (loss) per share  calculation               |       | 24,159                                             |       | 23,906                                            |       | 24,456 |   | 24,553 |   |
|                                                                        |       |                                               |       |                                              |       |   |   |   |   |
| Diluted earnings  (loss) per share                                          |       | $                                                  | 0.00       |                                              | $          | (0.04 | ) | $ | 0.03 |   | $ | 0.03 |   |

 

Options for 3,993,368shares and 3,870,944 shares for the three months ended October 31, 2006 and2005, respectively, and 2,532,374 shares and 2,608,263 shares for the ninemonths ended October 31, 2006 and 2005, respectively, have been excluded fromthe diluted earnings per share computation as the options were anti-dilutive.

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**8.     Commitmentsand Contingencies**

The Company isperiodically involved in litigation and claims which arise in the normal courseof business.  In management’s opinion, nopending proceeding is reasonably expected to have a material adverse effect onthe Company’s financial position or results of operations.

**9.     BusinessSegments and Revenue Concentration**

The tables below showrevenues and income (loss) from operations for the periods indicated for ourfour reportable business segments: Revenue Enhancement, Global PaymentsTechnologies, Global Payments Consulting and Business Process Outsourcing.  Certain prior year amounts have been reclassifiedto conform with the current year business segment presentation.  Our customer projects are sold on a solutionbasis, so it is necessary to break them down by segment and allocateaccordingly.  Included in “CorporateUnallocated” are costs related to selling and marketing, and certainunallocated corporate overhead expense such as executive management, finance,accounting, human resources, legal and certain IT and facility functions.  Business segment results, which include costsfor research and development as well as product royalty expense, theamortization and impairment of goodwill and intangible assets, the write-off ofcapitalized software costs and restructuring and other charges, were as follows(in thousands):
| ** **                                 | ** ** | **Three months ended October 31, 2006** | ** ** |
|--------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **Revenue  Enhancement**                                         | ** ** | **Global  Payments  Technologies** | ** ** | **Global  Payments  Consulting** | ** ** | **Business  Process  Outsourcing** | ** ** | **Corporate  Unallocated** | ** ** | **Total** | ** ** |
| Revenues                                   |       |                                                             |       |   |   |   |   |   |   |   |   |   |   |
| Consulting                                 |       | $                                                                | 8,001      |   | $ | 97 |   | $ | 841 |   | $ | — |   | $ | — |   | $ | 8,939 |   |
| Software license                           |       | 72                                                               |       | 2,759 |   | 33 |   | — |   | — |   | 2,864 |   |
| Software maintenance                       |       | 77                                                               |       | 10,903 |   | 218 |   | — |   | — |   | 11,198 |   |
| Software implementation and other services |       | 394                                                              |       | 3,201 |   | 281 |   | — |   | — |   | 3,876 |   |
| Outsourcing services                       |       | —                                                           |       | — |   | — |   | 511 |   | — |   | 511 |   |
| Out-of-pocket expense reimbursements       |       | 345                                                              |       | 455 |   | 87 |   | — |   | — |   | 887 |   |
| Total revenues                             |       | $                                                                | 8,889      |   | $ | 17,415 |   | $ | 1,460 |   | $ | 511 |   | $ | — |   | $ | 28,275 |   |
|                                       |       |                                                             |       |   |   |   |   |   |   |   |   |   |   |
| Income (loss) from  operations             |       | $                                                                | 3,125      |   | $ | 2,130 |   | $ | 147 |   | $ | (299 | ) | $ | (5,618 | ) | $ | (515 | ) |

 
| ** **                                 | ** ** | **Three months ended October 31, 2005** | ** ** |
|--------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **Revenue  Enhancement**                                         | ** ** | **Global  Payments  Technologies** | ** ** | **Global  Payments  Consulting** | ** ** | **Business  Process  Outsourcing** | ** ** | **Corporate  Unallocated** | ** ** | **Total** | ** ** |
| Revenues                                   |       |                                                             |       |   |   |   |   |   |   |   |   |   |   |
| Consulting                                 |       | $                                                                | 6,371      |   | $ | — |   | $ | 349 |   | $ | — |   | $ | — |   | $ | 6,720 |   |
| Software license                           |       | 235                                                              |       | 5,056 |   | 31 |   | — |   | — |   | 5,322 |   |
| Software maintenance                       |       | 286                                                              |       | 10,325 |   | 211 |   | — |   | — |   | 10,822 |   |
| Software implementation and other services |       | 811                                                              |       | 3,370 |   | 404 |   | — |   | — |   | 4,585 |   |
| Outsourcing services                       |       | —                                                           |       | — |   | — |   | 220 |   | — |   | 220 |   |
| Out-of-pocket expense reimbursements       |       | 326                                                              |       | 297 |   | 78 |   | — |   | — |   | 701 |   |
| Total revenues                             |       | $                                                                | 8,029      |   | $ | 19,048 |   | $ | 1,073 |   | $ | 220 |   | $ | — |   | $ | 28,370 |   |
|                                       |       |                                                             |       |   |   |   |   |   |   |   |   |   |   |
| Income (loss) from  operations             |       | $                                                                | 2,197      |   | $ | 2,412 |   | $ | (208 | ) | $ | (544 | ) | $ | (5,051 | ) | $ | (1,194 | ) |

 

22

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| ** **                                 | ** ** | **Nine months ended October 31, 2006** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                 | ** ** | **Revenue  Enhancement**                                        | ** ** | **Global  Payments  Technologies** | ** ** | **Global  Payments  Consulting** | ** ** | **Business  Process  Outsourcing** | ** ** | **Corporate  Unallocated** | ** ** | **Total** | ** ** |
| Revenues                                   |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |
| Consulting                                 |       | $                                                               | 21,770     |   | $ | 359 |   | $ | 2,207 |   | $ | — |   | $ | — |   | $ | 24,336 |   |
| Software license                           |       | 320                                                             |       | 10,289 |   | 305 |   | — |   | — |   | 10,914 |   |
| Software maintenance                       |       | 241                                                             |       | 31,928 |   | 680 |   | — |   | — |   | 32,849 |   |
| Software implementation and other services |       | 1,570                                                           |       | 9,805 |   | 885 |   | — |   | — |   | 12,260 |   |
| Outsourcing services                       |       | —                                                          |       | — |   | — |   | 1,551 |   | — |   | 1,551 |   |
| Out-of-pocket expense reimbursements       |       | 939                                                             |       | 1,153 |   | 321 |   | — |   | — |   | 2,413 |   |
| Total revenues                             |       | $                                                               | 24,840     |   | $ | 53,534 |   | $ | 4,398 |   | $ | 1,551 |   | $ | — |   | $ | 84,323 |   |
|                                       |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |
| Income (loss) from  operations             |       | $                                                               | 8,258      |   | $ | 8,312 |   | $ | 424 |   | $ | (951 | ) | $ | (16,379 | ) | $ | (336 | ) |

 
| ** **                                 | ** ** | **Nine months ended October 31, 2005** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                 | ** ** | **Revenue  Enhancement**                                        | ** ** | **Global  Payments  Technologies** | ** ** | **Global  Payments  Consulting** | ** ** | **Business  Process  Outsourcing** | ** ** | **Corporate  Unallocated** | ** ** | **Total** | ** ** |
| Revenues                                   |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |
| Consulting                                 |       | $                                                               | 22,925     |   | $ | 53 |   | $ | 1,562 |   | $ | — |   | $ | — |   | $ | 24,540 |   |
| Software license                           |       | 788                                                             |       | 11,528 |   | 147 |   | — |   | — |   | 12,463 |   |
| Software maintenance                       |       | 551                                                             |       | 31,506 |   | 653 |   | — |   | — |   | 32,710 |   |
| Software implementation and other services |       | 2,463                                                           |       | 10,442 |   | 706 |   | — |   | — |   | 13,611 |   |
| Outsourcing services                       |       | —                                                          |       | — |   | — |   | 718 |   | — |   | 718 |   |
| Out-of-pocket expense reimbursements       |       | 1,198                                                           |       | 968 |   | 280 |   | — |   | — |   | 2,446 |   |
| Total revenues                             |       | $                                                               | 27,925     |   | $ | 54,497 |   | $ | 3,348 |   | $ | 718 |   | $ | — |   | $ | 86,488 |   |
|                                       |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |
| Income (loss) from  operations             |       | $                                                               | 11,605     |   | $ | 6,175 |   | $ | (500 | ) | $ | (1,601 | ) | $ | (15,671 | ) | $ | 8 |   |

 

During the year endedJanuary 31, 2004, the Company formed Carretek LLC (Carretek), in which it ownsa 51% interest, to offer financial institutions offshore-centric outsourcing oftheir business processes and IT services needs. During July 2004, Carretek signed its first contract to performoutsourced services with a customer.

The 49% share relating tothe minority interest in the Carretek losses, which was $150,000 and $269,000for the three months ended October 31, 2006 and 2005, respectively, and$477,000 and $799,000 for the nine months ended October 31, 2006 and 2005,respectively, was recorded in other income in the accompanying consolidatedstatements of operations.  The Companyand its partner have funded Carretek to date in the aggregate amount of $5.4million of equity.  Carretek’s operationsare included in our business process outsourcing segment.

23

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The following tablesummarizes revenues, exclusive of out-of-pocket expense reimbursements, derivedfrom the Company’s largest customer and top five customers during the periodsindicated.
|                    | ** ** | **Three Months  Ended  October 31,** | ** ** | **Nine Months  Ended  October 31, ** | ** ** |
|--------------------|------------|------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **         | ** ** | **2006**                                       | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|               |       |                                           |       |                                                |       |   |   |   |   |
| Single customer    |       | 13.3                                           | %          | 13.0                                                | %          | 12.2 | % | 12.4 | % |
| Top five customers |       | 41.2                                           | %          | 41.3                                                | %          | 37.2 | % | 35.1 | % |

 

National City accountedfor approximately 13.3% of total revenues during the three months ended October31, 2006 and Wells Fargo accounted for approximately 13.0% of total revenuesduring the three months ended October 31, 2005. U.S. Bank accounted for approximately 12.2% of total revenues during thenine months ended October 31, 2006 and Wells Fargo accounted for approximately12.4% of total revenues during the nine months ended October 31, 2005.

The Company markets itssolutions in several foreign countries. Revenues, exclusive of out-of-pocket expense reimbursements, attributedto countries based on the location of the customers were as follows (inthousands):
|                | ** ** | **Three Months Ended** | ** ** |
|----------------|------------|----------------------------------|------------|
| ** **     | ** ** | **October 31,  2006**       | ** ** | **October 31,  2005** | ** ** |
| ** **     | ** ** | **Amount**                       | ** ** | **Percent of  total  revenues** | ** ** | **Amount** | ** ** | **Percent of  total  revenues** | ** ** |
| United States  |       | $                                | 21,624     |   | 79 | % | $ | 19,993 |   | 72 | % |
| Europe         |       | 1,450                            |       | 5 |   | 3,646 |   | 13 |   |
| Canada         |       | 2,617                            |       | 10 |   | 1,800 |   | 7 |   |
| Asia Pacific   |       | 1,177                            |       | 4 |   | 1,428 |   | 5 |   |
| South Africa   |       | 198                              |       | 1 |   | 142 |   | 1 |   |
| Other          |       | 322                              |       | 1 |   | 660 |   | 2 |   |
| Total revenues |       | $                                | 27,388     |   | 100 | % | $ | 27,669 |   | 100 | % |

 
|                | ** ** | **Nine Months Ended** | ** ** |
|----------------|------------|---------------------------------|------------|
| ** **     | ** ** | **October 31,  2006**      | ** ** | **October 31,  2005** | ** ** |
| ** **     | ** ** | **Amount**                      | ** ** | **Percent of  total  revenues** | ** ** | **Amount** | ** ** | **Percent of  total  revenues** | ** ** |
| United States  |       | $                               | 66,359     |   | 81 | % | $ | 60,838 |   | 72 | % |
| Europe         |       | 3,817                           |       | 5 |   | 7,113 |   | 9 |   |
| Canada         |       | 6,482                           |       | 8 |   | 5,223 |   | 6 |   |
| Asia Pacific   |       | 3,519                           |       | 4 |   | 4,227 |   | 5 |   |
| South Africa   |       | 551                             |       | 1 |   | 4,563 |   | 6 |   |
| Other          |       | 1,182                           |       | 1 |   | 2,078 |   | 2 |   |
| Total revenues |       | $                               | 81,910     |   | 100 | % | $ | 84,042 |   | 100 | % |

 

24

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**10.  Restructuringand Other Charges**

**There were no restructuring andother charges recorded during fiscal 2006. **However, in Q1 2005, the Company recorded$127,000 in restructuring and other charges, principally associated with theseparation of six employees. Additionally in Q1 2005, the Company also lowered its estimate by$32,000 for the costs associated with the discontinuance of one of our softwareofferings originally recorded in January 2004. In Q2 2005, the Company recorded $28,000 in restructuring and othercharges, principally associated with the separation of 2 employees.  Finally, in Q3 2005, the Company recorded$780,000 in restructuring and other charges, principally associated with theseparation of 29 employees primarily within the GPT business segment.

The activity related tothe accrued merger and restructuring costs during the three and nine monthsended October 31, 2006 is as follows (in thousands):
|                                      | ** ** | **Workforce  Reductions** | ** ** | **CheckFlow  Suite** | ** ** | **Other** | ** ** | **Total** | ** ** |
|--------------------------------------|------------|---------------------------|------------|----------------------|------------|-----------|------------|-----------|------------|
|                                 |       |                      |       |                 |       |      |       |      |       |
| Reserve balance  at January 31, 2006 |       | $                         | 87         |                 | $          | 200       |       | $         | 47         |   | $ | 334 |   |
| Cash paid                            |       | (87                       | )          | —               |       | (35       | )          | (122      | )          |
| Reserve balance at  October 31, 2006 |       | $                         | —     |                 | $          | 200       |       | $         | 12         |   | $ | 212 |   |

 

The Company expects to complete these existingobligations by the end of the fiscal year ending January 31, 2007.

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

All statements other thanstatements of historical fact contained in this report, including statements inthis “Management’s Discussion and Analysis of Financial Condition and Resultsof Operations” concerning our financial position and liquidity, results ofoperations, prospects for future growth, and other matters, are forward-lookingstatements.  Although we believe that theexpectations reflected in such forward-looking statements are reasonable, noassurance can be given that such expectations will prove correct.  Factors that could cause our results todiffer materially from the results discussed in, or contemplated by, suchforward-looking statements include the risks described under “Risk Factors”contained in our Form 10-K for the year ended January 31, 2006, as filed withthe Securities and Exchange Commission (“SEC”). Such risks include, without limitation: dependence on the bankingindustry, decline in check volumes, fluctuations in operating results,relatively fixed costs, product and service mix, lack of long-term agreements,dependence on key personnel, rapid technological change and dependence on newproducts, strategic alliances or acquisitions, focus on providing businessprocess outsourcing with a significant offshore component, ability to attractand retain qualified personnel, customer concentration, competition,proprietary rights, infringement claims, dependence on third parties fortechnology licenses, liability claims, defects in our software and solutions,our ability to protect our information technology infrastructure, internationaloperations, changing government and tax regulations, stock price fluctuations,impairment of goodwill or intangible assets, realization of revenue fromcontracted sales, potential sales, backlog and deferred revenue, anti-takeoverprovisions, the restatement of prior period financial statements and ourexploration of strategic alternatives. All forward-looking statements in this report are expressly qualified intheir entirety by the cautionary statements in this paragraph, in the “RiskFactors” included in our SEC filings and elsewhere in this report.

**Overview**

Since 1978, CarrekerCorporation has designed, developed, sold and delivered payments-relatedsoftware and consulting solutions to financial institutions and financialservice providers.  More recently, wehave introduced a business process outsourcing solution to our customers.  Our products and services address a broadspectrum of payment activities and are designed to help our clients enhance theperformance of their payments businesses; improve operational efficiency in paymentsprocessing; enhance revenue and profitability from payments-oriented productsand services; reduce losses associated with fraudulent payment transactions;facilitate compliance with risk-related laws and regulations; and/or maximizeclients’ customer income streams by aligning their customer interactions andproducts with customer needs.  Carrekeremployed a total of 495 employees at October 31, 2006.

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We are organized intofour business unit operating divisions: Global Payments Technologies (“GPT”),Revenue Enhancement (“RevE”), Global Payments Consulting (“GPC”) and a BusinessProcess Outsourcing business which is delivered through a majority-ownedsubsidiary named Carretek LLC (“Carretek”) to address the payments outsourcingarena.  These operating divisions areoperated in distinct yet increasingly synergistic ways to bring value to ourclients.

*GlobalPayments Technologies*. This division is responsible for design, development, sales, and supportof our technology solutions.  Thedivision has three lines of business with distinct solution offerings:  Risk solutions, Payments solutions and Cash& Logistics solutions.  Revenue isprimarily derived from license fees, implementation fees and maintenance fees.  As of October 31, 2006, GPT had 282employees.

*RevenueEnhancement*.  Thishighly specialized division provides consulting and software solutions focusedon increasing clients’ revenue streams. Areas of expertise include fee income, market segmentation, managementof customer price structures, account retention, account acquisition and profitability.  A majority of the revenue generated by thisdivision is through benefit-sharing agreements with our customers, recorded asconsulting revenue along with license fees, maintenance fees and implementationfees from our CVE software offering.  Asof October 31, 2006, RevE had 87 employees.

*GlobalPayments Consulting*. The objective of this professional services division is to provide ourclients with “applied thought leadership” related to the business ofpayments.  Revenue in the GPC division isprimarily derived through the delivery of consulting services offered primarilyon a time and materials basis to our clients, along with the license fees,maintenance fees and services fees associated with our Float Pricing Systemsoftware offering and Payments Clearing Model product offering.  As of October 31, 2006, GPC had 22 employees.

*BusinessProcess Outsourcing.*  In fiscal 2003 we formed Carretek.  Carretek is a transformational businessoutsourcer for information technology and payment and transaction processingjointly owned by Carreker Corporation and Majesco Software, Inc., the U.S.subsidiary of Mastek Limited, a leading Indian outsourcing company with globaloperations.  As of October 31, 2006, 2 ofthe Company’s U.S. based employees and 123 offshore personnel of Mastek Limitedwere seconded to Carretek on a contract basis.

*Cost ofRevenues and Gross Margins.* We strive to control our cost of revenues and thereby maintain orimprove our gross margins.  The majoritems impacting cost of consulting, cost of software maintenance and cost ofsoftware implementation are personnel, overhead and related expenses.  The major items impacting cost of softwarelicenses are amortization of both capitalized and acquired software and alsosoftware royalties for software from third parties.  While the amortization expense is relativelyfixed, the third party royalty expense can vary significantly based on therelative product mix.

*OperatingExpenses.*  Operatingexpenses, including selling, general and administrative and research anddevelopment, are substantially driven by personnel and overhead expenses.  Other significant operating expenses that wemonitor include professional fees, use of contractors, travel, insurance andoffice services expenses.  As of October31, 2006, the Corporate Account Relationship Management and Marketing staff had20 employees, and the Corporate staff which includes Executive Management,Legal, Finance and Accounting, Human Resources, Facilities and IT had 82employees.

*Liquidityand Cash Flows.*  Cashand cash equivalents at October 31, 2006 and January 31, 2006 totaled $24.2million and $29.7 million, respectively. In addition, we had $13.0 million of marketable debt securities atOctober 31, 2006, as compared to $4.7 million at January 31, 2006.  We did not renew our revolving creditagreement which expired by its terms on July 31, 2006 as current cash on hand,marketable securities and our cash projected to be generated from operationsare believed to be sufficient to meet our cash requirements for the foreseeablefuture.

26

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**Products and Services**

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

*Global Payments Technologies.*  Carreker’s technology solutions helpfinancial institutions address the needs of some critical payment services anddelivery functions that impact overall operating revenues and costs and riskmanagement.  These functions includepresentment of checks in paper and electronic form, identification andmitigation of fraudulent payments, handling irregular items such as checksreturned unpaid (exceptions), maintaining a record of past transactions(archiving), responding to related customer inquiries (research), andcorrecting any errors that are discovered (adjustments).  Global Payments Technologies (“GPT”)solutions address these and other key functions in the context of improving operationalefficiency and a gradual transition from paper to electronic-based paymentsystems.  GPT offers risk managementsolutions that mitigate depository account risk through profiling and advancedanalytics technology.  GPT riskmanagement solutions leverage transaction monitoring and filtering capabilitiesfor AML and OFAC compliance.  Finally, weoffer technology solutions that optimize the inventory management of a bank’scash stock levels and logistical service requirements, including managing how muchis needed, when it is needed and where it is needed.  Our solutions reduce the amount of cash banksneed to hold in reserve accounts and as cash-on-hand while ensuring a highlevel of customer service through timely replenishment of ATM cash supplies atminimal logistical services cost.

Specific solutions inthe GPT group include:
| **Solution**                                           | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   | ** ** | **Products Offered**                                                                                                                                                                                                                                                                                 |
|--------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                             | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | ** ** | ** **                                                                                                                                                                                                                                                                                           |
| **Risk  Solutions:**                                   | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | ** ** | ** **                                                                                                                                                                                                                                                                                           |
| ** **                                             | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | ** ** | ** **                                                                                                                                                                                                                                                                                           |
| Fraud Mitigation  and Anti-Money Laundering Compliance |       | Automated fraud detection and prevention solutions  that reduce incidents of check fraud, deposit fraud, check kiting, and  electronic fraud. Anti-money laundering solutions screen names and related  data against industry blacklists, local high-risk lists and other customized  databases. Information management solution aggregates fraud source  information and serves as a risk management dashboard. Multi-payment  transaction monitoring solution uses advanced analytics and rules to detect  suspicious activity. |       | FraudLink On-Us, FraudLink Deposit, FraudLink Deposit  – Branch Access Option, Kite, FraudLink Positive Pay, FraudLink eTracker,  FraudLink ACHeCK, FraudLink PC, Workflow Manager, AML Filter, Information  Manager, Fraud Manager On-Us, Deposit, Wires, AML, and Fraud Solutions  Consulting |
|                                                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                                                                 |
| **Payment  Solutions:**                                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                                                                 |
| ** **                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                                                                 |
| Exception  Management                                  |       | Products that bring new efficiencies to back-office  operations through leading-edge image, workflow, and RECO (character  recognition) technologies.                                                                                                                                                                                                                                                                                                                                                                             |       | Adjustments/Express, Exceptions/Express, Express  Capture, Express Decision, Input/Express, Inbound Returns/Express, and All  Transactions File                                                                                                                                                      |
|                                                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                                                                 |
| Remittance and  Payments Processing                    |       | Both host and client/server-based platforms for  improved productivity in processing retail and wholesale remittance  transactions for financial institutions and payments processing for a wide  variety of cross-industry applications.                                                                                                                                                                                                                                                                                         |       | NeXGen Remittance                                                                                                                                                                                                                                                                                    |
|                                                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                                                                 |
| Conventional  Check Capture                            |       | An extensive array of enhancement products that add  flexibility and usability to IBM’s Check Processing Control System (CPCS) and  the IBM 3890/XP series of Document Processors.                                                                                                                                                                                                                                                                                                                                           |       | Conventional Capture Products, CPCS Enhancements  Products, XP/Productivity Tools, Platform Emulation, NeXGen Settlement,  NeXGen Balancing, and LTA (Large Table Access)                                                                                                                            |

 

27

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| **Solution**                                     | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | ** ** | **Products Offered**                                                                                                                                                                                                                               |
|--------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                       | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                | ** ** | ** **                                                                                                                                                                                                                                         |
| Check Image  Capture                             |       | Products and services related to the centralized and  distributed capture, quality and inspection assurance, storage and delivery  of check images. Distributed capture solutions come in web-based thin client and  thick client. Distributed capture branch solution serves as a core component  to full bank branch image enablement.                                                                                                                                                                                                  |       | ALS & CIMS Products (MVS, AIX, Windows), NeXGen  Image Processor, Image Enhancement Products, Reject Repair, RECO Technology,  Image POD, Image Delivery Products, Delivery Express QAS Image Inspector,  NeXGen Capture, Source Capture Suite |
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                                                                                                                                                                                                                               |
| Check Image  Archive Management                  |       | Comprehensive array of check image archive  management products that may be tailored to a bank’s unique requirements based  on their operational environments and volumes. Carreker offers archive  technology for both in-house solutions and shared outsource providers.                                                                                                                                                                                                                                                           |       | Check Image Archive-AIX, Check Image Archive-MVS,  Check Image Archive Load                                                                                                                                                                        |
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                                                                                                                                                                                                                               |
| Other Check  Image Applications                  |       | An array of solutions that address revenue  enhancement, risk reduction, and expense reduction issues through the  application of image, workflow and RECO technologies.                                                                                                                                                                                                                                                                                                                                                                  |       | Image Statements, CDRom Delivery, Input/Express,  Express Capture, Payee Name Verification, and Amount Encoding Verification                                                                                                                       |
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                                                                                                                                                                                                                               |
| Electronic Check  Presentment and Image Exchange |       | Enables banks to transition from paper-based to  electronic payment systems by automating key elements of the processing  stream, creation of image replacement documents (“IRD”) and image quality and  usability checking.  Aided by Check 21 legislation, these solutions are designed to reduce and  eventually eliminate the movement of paper payments through the system,  improving productivity, reducing errors, increasing customer satisfaction and  reducing fraud.                                                |       | ExchgLink , IRD Create, IRD Author, Image Inspector,  CheckLink, CheckLink PC, Deposit Manager, Branch Truncation Manager and  Cnotes                                                                                                              |
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                                                                                                                                                                                                                               |
| **Cash  & Logistics Solutions:**             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                                                                                                                                                                                                                               |
| ** **                                       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                                                                                                                                                                                                                               |
| ATM Solutions                                    |       | Advanced ATM monitoring and management, improving  ATM availability and ensuring service levels are met. These solutions include  an automated ATM monitoring and dispatching system for maximizing network  availability; and a real-time Internet-based system for efficient handling of  ATM service requests and responses.                                                                                                                                                                                                           |       | eiManager, ATM Logix                                                                                                                                                                                                                               |
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                                                                                                                                                                                                                               |
| Cash Solutions                                   |       | A product suite, now optimized through Web-based  software solutions, that dramatically reduces the amount of cash banks,  financial institutions and companies need to hold as cash-on-hand throughout  vault, branch and ATM networks. These solutions also enable automation and  standardization of the cash ordering process, including the matching and  reconciliation of invoices and the optimization of transportation. Consulting  solutions can drive further efficiency and automation in vault, branch and  ATM operations. |       | iCom, ReserveLink, Matchpoint and Currency Supply  Chain Consulting                                                                                                                                                                                |

 

28

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| **Solution**         | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                            | ** ** | **Products Offered**                                    |
|----------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|
| ** **           | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                 | ** ** | ** **                                              |
| Enterprise  Tracking |       | An enterprise tracking solution designed to track  any object or virtual item from origination to final destination. Ability to  track accountable mail, branch bags, item volumes, ATM work, currency bags,  incoming domestic and international deposits, customer tapes and much more. Web-based  application with distributed deployment capabilities. |       | Receive Sentry, Trackpoint                              |
|                 |       |                                                                                                                                                                                                                                                                                                                                                       |       |                                                    |
| eMetrics             |       | Performance-measurement software suite that uses  historical data to generate key performance indicators, item processing  volume data, productivity statistics and quality control benchmarks.                                                                                                                                                            |       | Lumen, ProModel, eiMICR, eiStats, eiQuality,  eiPerform |

 

*Revenue Enhancement.*  Revenue Enhancement (“RevE”) is a highlyspecialized division that provides consulting services focused on tacticalmethods of increasing banks’ fee income. The scope and depth of this practicehas expanded throughout its 15 year history and now includes retail, smallbusiness, and commercial deposits, treasury management, consumer and commerciallending, credit card lending and trust and investment services. Our solutionsinvolve developing strategies that enable our clients to take advantage ofelectronification trends, often gaining first mover advantages for our clients.In addition to developing strategies, our business model ensures that wecontinue to translate those strategies into tactical implementations withmeasurable revenue streams. Our client base has continued to expand with veryhigh penetration rates in the markets in which we operate. Thus, we haveexperienced a trend of becoming longer term strategic partners with ourclients.

Another component of ourRevE offering is our CVE solutions that include software, proprietary salesmanagement methodologies and sales training programs. Our CVE solutions assistfinancial institutions in leveraging central intelligence with local insight,translating strategy into specific actions to achieve sustained organizationalperformance. This enables our clients to improve their identification of thosecustomers and prospects representing the greatest value or potential, whilealigning internal processes and behaviors with management’s focus. Our approachis unique and complementary to many CRM investments that banks have made inrecent years and is designed to focus their activities such that they canattain increased returns on these CRM investments.

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

·      Enterprisepayment rationalization (strategy through performance optimization)

·      Transaction/paymenttransformation services (research, planning, process design, implementationsupport, etc.)

·      Predictivefinancial and operational modeling of the implications of payment trends andstrategies

·                  Transactionclearing optimization solutions (transportation, float, clearing type, clearingpartners and funds availability optimization)

·      Consolidationand merger/integration planning

·      Paymentchannel risk mitigation

·      Imageexchange planning

·      StrategicSourcing evaluation

·      IssueRecovery Services

·      Managed Services for Float management /clearing optimization

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The GPC division alsocontains the license, maintenance and services revenue for the followingproduct areas:

·                          Float Management software products –Float Pricing System, Payments Clearing Model and Float and PricingProfitability application – for managing and reporting a bank’s floatprofitability through analysis and pricing of workflow, check clearingoperations and customer allocation methodologies.  These products also provide critical activitysummaries, aid in creating multiple availability and pricing schedules, andpinpoint the cost/profitability of transactions or relationships.

·                          Payments Modeling product – PaymentsLinkis an application that allows a bank to create an enterprise virtual profit andloss statement for the payments business as well as model business scenariosaround product and service pricing and transactional volume trends.

*Business Process Outsourcing*.  Carretek LLC is a transformational businessoutsourcer for information technology, payment and transaction processing forfinancial institutions jointly owned by Carreker Corporation (51%) and MajescoSoftware Inc. (49%), the U.S. subsidiary of Mastek Limited, a leading Indianoutsourcing company with global operations. Carretek was formed in fiscal 2003.

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

Initially, Carretek isfocused on offshoring payments-related business processes.  Through Carretek, financial institutions canleverage the global work force at this critical period when Check 21 and otherpayment electronification trends are pressuring financial institutions toreduce their payment per item costs beyond the power of traditional costmanagement practices.  Carretek hasdesigned and built specific product offerings targeted at payment andtransaction processing functions for this express purpose.  Within this area of expertise, the Carretekoffering includes a flexible array of offshore outsourcing services tofinancial institutions.

**Executive Summary**

***Comparisonof Three Months Ended October 31, 2006 (“Q3 2006”) to Three Months EndedOctober 31, 2005 (“Q3 2005”) and Nine Months Ended October 31, 2006 (“YTD 2006”)to Nine Months Ended October 31, 2005 (“YTD 2005”)***

Our consolidated revenues decreased $95,000, or 0.3%,to $28.3 million in Q3 2006 as compared to $28.4 million in Q3 2005, and ourrevenues declined $2.2 million, or 2.5%, to $84.3 million in YTD 2006 ascompared to $86.5 million in YTD 2005. Our net loss decreased $861,000 to a net loss of $89,000 in Q3 2006 ascompared to a net loss of $950,000 in Q3 2005 and our net income increased$236,000, or 39.2%, to $838,000 in YTD 2006 as compared to $602,000 in YTD2005.

The decrease in ourrevenue on a quarterly basis was primarily the result of a decline in softwarelicense revenue within our GPT business segment which was almost completelyoffset by increased domestic contingent fee revenue associated with our RevEbusiness segment, along with smaller revenue increases within both the GPC andBusiness Processing Outsourcing business segments.  The decline in our revenue on a YTD basis wasprimarily the result of declines in our international contingent fee revenuewithin our RevE business segment, along with a decline in software licenserevenue within our GPT business segment. These revenue declines were partially offset by increased revenue withinour GPC business segment and also increased transaction volume within ourBusiness Process Outsourcing business segment.

Our cost of revenuestotaled $14.8 million in each of Q3 2006 and Q3 2005.  On a YTD basis, our cost of revenues declined$216,000, or 0.5%, to $43.1 million in YTD 2006 as compared to $43.4 million inYTD 2005.  With relatively flat revenueand cost of revenues, gross profit decreased slightly to 47.5% in Q3 2006 ascompared to 47.8% in Q3 2005.  Due to thedecline in revenue in YTD 2006 as compared to YTD 2005, gross profit percentagedeclined to 48.8% as compared to 49.9%, respectively.

Total operating expensesdeclined $809,000, or 5.5%, to $14.0 million in Q3 2006 as compared to $14.8million in Q3 2005, and operating expenses declined $1.6 million, or 3.7%, to$41.5 million in YTD 2006 as compared to $43.1 million in YTD 2005.  On a quarterly basis, the decline in totaloperating costs and expenses was primarily associated with a $780,000restructuring charge which related to the severance and other personnel costsfor 29 employees terminated in Q3 2005 primarily within the GPT businesssegment.  On a YTD basis, the decline inoperating costs and expenses was primarily associated with a $903,000 declinein restructuring and other charges, along with lesser declines in both selling,general and administrative costs and research and development costs.

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Cash and cash equivalents, along with marketablesecurities, increased to $37.2 million at October 31, 2006 which is an increaseof $3.7 million and $2.8 million as compared to July 31, 2006 and January 31,2006, respectively.

# We expect that revenue and net income for Q42006 will be the highest of any quarter of the 2006 fiscal year though theincrease is not expected to be significant enough for us to achieve the 9 to16% Income from Operations goal that we had previously set for Q4 2006.  We anticipate achieving the target operatingrange in fiscal 2007.  Full year revenuefor fiscal 2006 is expected to be relatively flat compared to fiscal 2005 butwith improved profitability. We expect year over year sales backlog growth,which combined with current sales activity will position us for revenue growthand improved profitability in fiscal 2007.

### **Resultsof Operations**

***Comparisonof Three Months Ended October 31, 2006 (“Q3 2006”) to Three Months EndedOctober 31, 2005 (“Q3 2005”) and Nine Months Ended October 31, 2006 (“YTD 2006”)to Nine Months Ended October 31, 2005 (“YTD 2005”)***

***Revenues***

*Revenues by Segment ($ inthousands):*
| ** **                    | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|-------------------------------|------------|----------------------------------------------------|------------|--------------|------------|---------------------------------------------------|------------|--------------|------------|
| ** **                    | ** ** | **2006**                                           | ** ** | **2005**     | ** ** | **$**                                             | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|                          |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Revenue Enhancement           |       | $                                                  | 8,889      |         | $          | 8,029                                             |       | $            | 860        |   | 10.7 | % | $ | 24,840 |   | $ | 27,925 |   | $ | (3,085 | ) | (11.0 | )% |
| Global Payments  Technologies |       | 17,415                                             |       | 19,048       |       | (1,633                                            | )          | (8.6         | )          | 53,534 |   | 54,497 |   | (963 | ) | (1.8 | ) |
| Global Payments  Consulting   |       | 1,460                                              |       | 1,073        |       | 387                                               |       | 36.1         |       | 4,398 |   | 3,348 |   | 1,050 |   | 31.4 |   |
| Business Process  Outsourcing |       | 511                                                |       | 220          |       | 291                                               |       | 132.3        |       | 1,551 |   | 718 |   | 833 |   | 116.0 |   |
|                          |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Total Revenues                |       | $                                                  | 28,275     |         | $          | 28,370                                            |       | $            | (95        | ) | (0.3 | )% | $ | 84,323 |   | $ | 86,488 |   | $ | (2,165 | ) | (2.5 | )% |

 

Overall, total revenue decreased $95,000, or 0.3%, to$28.3 million in Q3 2006 as compared to $28.4 million in Q3 2005 and totalrevenue declined $2.2 million, or 2.5%, to $84.3 million in YTD 2006 ascompared to $86.5 million in YTD 2005.

Our RevE segment revenues increased $860,000, or10.7%, on a quarterly basis and has declined $3.1 million, or 11.0%, on a YTDbasis.  RevE’s traditional contingentconsulting revenues increased $1.6 million, or 25.6%, on a quarterly basis anddeclined $1.2 million, or 5.0%, on a YTD basis. The increase in revenue is primarily the result of an increase indomestic consulting revenue in Q3 2006. The decline on a YTD basis is primarily the result of lower salesactivity during fiscal 2005 in both our domestic and international markets,which negatively impacted the first two quarters of fiscal 2006 revenues.  In Q3 2006, approximately $3.2 million, or35.5%, and in YTD 2006 approximately $8.2 million, or 33.0%, of RevE’s totalrevenue was derived from a single consulting engagement.  Additionally, the software license, maintenance,implementation and other services revenue derived from RevE’s CVE proprietarysales management offering declined approximately $790,000, or 59.3%, to$543,000 in Q3 2006 as compared to $1.3 million in Q3 2005 and declinedapproximately $1.7 million, or 44.0%, to $2.1 million in YTD 2006 as comparedto $3.8 million in YTD 2005, due primarily to a decline in active engagements.

Our GPT segment revenue declined on a quarterly basis,primarily as the result of decreased software license revenue within all threeof GPT’s primary solution groups of Payments, Cash and Risk.  These declines were partially offset byincreased maintenance revenue, particularly within the Payments solutionsgroup.  On a YTD basis, the decline inrevenue is primarily related to a decrease in software license revenue withinour Cash and Risk solutions groups; however, this decline was partially offsetby an increase in software license revenue within the Payments solutionsgroup.  In Q2 2006, a single GPT customerexpanded its license for both the Check Image Archive and IRD Author solutionswithin the Payment Solutions group.  Theexpansion resulted in approximately $2.3 million of software license revenue inQ2 2006.

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Our GPC segment revenue increased on both a quarterlyand YTD basis.  GPC has intensified itssales focus as we completed the repositioning of this business to focus onenterprise-wide payment electronification strategies, image enablement planningand integration and risk mitigation.  Theprimarily driver of the increased revenue was related to renewed demand for ourFloat Management related consulting software and services solutions.  The demand for these products and serviceshas increased due to the rise in interest rates, along with the introduction ofnew managed Float service offerings. Additionally, GPC introduced a new Payments Modeling application infiscal 2006.

Our outsourcing revenue is derived through Carretek,our 51% owned business which offers outsourcing for information technology andpayment and transaction processing. Carretek was formed in fiscal 2003 and signed its first customeragreement in the second quarter of fiscal 2004. In 2005 and 2006, we increased staffing under our initial contract andexpanded our scope with this single customer to include a second and third setof transaction processing functions which has significantly increased revenueon both a quarterly and YTD basis in fiscal 2006 as compared to fiscal2005.  Future outsourcing revenue growthis contingent on increasing our scope with our existing customer or closingcontracts with additional customers.

*Consulting ($ in thousands):*
| ** ** | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|------------|------------|----------------------------------------------------|------------|--------------|------------|---------------------------------------------------|------------|--------------|------------|
| ** ** | ** ** | **2006**                                           | ** ** | **2005**     | ** ** | **$**                                             | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|       |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Consulting |       | $                                                  | 8,939      |         | $          | 6,720                                             |       | $            | 2,219      |   | 33.0 | % | $ | 24,336 |   | $ | 24,540 |   | $ | (204 | ) | (0.8 | )% |
|            |            |                                                    |            |              |            |                                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Most of our consulting revenues are derived from ourRevE business segment.  Consultingrevenues derived from our RevE segment increased $1.6 million, or 25.6%, to$8.0 million in Q3 2006 as compared to $6.4 million in Q3 2005, and declined$1.2 million, or 5.0%, to $21.8 million in YTD 2006 as compared to $22.9million in YTD 2005.  Within RevE, wecontinue to focus on maximizing the value to our existing customer base whileexpanding our expertise to new customers, both domestically andinternationally.  RevE is in the earlyphases of several large, long-term international engagements in which theconsulting revenue has yet to be realized.

Consulting revenues derived from our GPC segmentincreased $492,000, or 141.0%, to $841,000 in Q3 2006 as compared to $349,000in Q3 2005, and increased $645,000, or 41.3%, to $2.2 million in YTD 2006 ascompared to $1.6 million in YTD 2005. The increase can be attributed to renewed demand for our FloatManagement related consulting and service offerings.

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*Software License ($ in thousands):*
| ** **       | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|------------------|------------|----------------------------------------------------|------------|--------------|------------|---------------------------------------------------|------------|--------------|------------|
| ** **       | ** ** | **2006**                                           | ** ** | **2005**     | ** ** | **$**                                             | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|             |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Software License |       | $                                                  | 2,864      |         | $          | 5,322                                             |       | $            | (2,458     | ) | (46.2 | )% | $ | 10,914 |   | $ | 12,463 |   | $ | (1,549 | ) | (12.4 | )% |
|                  |            |                                                    |            |              |            |                                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Most of our software license revenues are derived fromour GPT business segment.  Softwarelicense revenues from our GPT business segment declined $2.3 million, or 45.4%,to $2.8 million in Q3 2006 as compared to $5.1 million in Q3 2005, and declined$1.2 million, or 10.7%, to $10.3 million in YTD 2006 as compared to $11.5million in YTD 2005.

Within GPT, the quarterly software license decreasewas spread among all three solutions: Payments, Cash and Risk.  Withinour Payments solutions suite of products, especially those products which weredesigned to address Check Image Exchange made possible by the Check 21legislation, we have continued to have isolated success with several of our keycustomers since these products were introduced in fiscal 2004 and fiscal 2005;new remote deposit capture products designed for branch, corporate and ATMdeposits have been introduced in fiscal 2006. While our sales prospects have increased in fiscal 2006, sales closureand revenue recognition have taken longer than expected.  Both Cash and Risk have recently introducedseveral new product offerings, such as Matchpoint, Trackpoint and Fraud Manager,and have had relatively good success within their markets; however, because ofour accounting policies for new products, along with contractual terms, thesoftware revenue from these products is deferred until the products areaccepted by the customers.  On a YTDbasis, the software license decreases within Cash and Risk have been partiallyoffset by an increase in Payments related software license revenue.  In Q2 2006, a single GPT customer expandedits license for both the Check Image Archive and IRD Author solutions withinthe Payment Solutions group.  Thisexpansion resulted in approximately $2.3 million of software license revenue inQ2 2006 as no software implementation or other services were required.

The GPC business segment software license revenueswere flat in Q3 2006 as compared to Q3 2005 and increased $158,000, or 107.5%,to $305,000 in YTD 2006 as compared to $147,000 in YTD 2005.  The YTD increase is primarily due to theintroduction of a new Payments Modeling application and renewed demand for ourFloat Management products.

The software license revenue derived from our CVEproduct offering within our RevE business segment declined $163,000, or 69.4%,to $72,000 in Q3 2006 as compared to $235,000 in Q3 2005, and declined$468,000, or 59.4%, to $320,000 in YTD 2006 as compared to $788,000 in YTD2005.  This decline is the result of lessactive engagements; however, RevE’s strategy changed in fiscal 2006 to focusless on marketing CVE’s traditional software licenses and putting more emphasison its consulting and other services, such as training.  We believe this change in strategy will leadto an expansion of our overall CVE offering revenues in the future.

*Software Maintenance ($ inthousands):*
| ** **           | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|----------------------|------------|----------------------------------------------------|------------|--------------|------------|---------------------------------------------------|------------|--------------|------------|
| ** **           | ** ** | **2006**                                           | ** ** | **2005**     | ** ** | **$**                                             | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|                 |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Software Maintenance |       | $                                                  | 11,198     |         | $          | 10,822                                            |       | $            | 376        |   | 3.5 | % | $ | 32,849 |   | $ | 32,710 |   | $ | 139 |   | 0.4 | % |
|                      |            |                                                    |            |              |            |                                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

As with software license fees, most of our maintenancefees are derived from our GPT business segment. Software maintenance fees are paid pursuant to annually renewableproduct and telephone support agreements with our software customers.  The annual maintenance fee is generally paidby the customer at the beginning of the maintenance period and we recognize thismaintenance revenue ratably over the term of the related contract.  If the annual maintenance fee is not paid atthe beginning of the maintenance period, we defer revenue recognition until thetime that the maintenance fee is collected. When the payment is received, maintenance revenue is recognized for theperiod that maintenance revenue was previously deferred.  Also, maintenance contracts usually carryannual maintenance fee escalation clauses typically based on an index, such asthe consumer price index.  Because ourrevenue recognition policy requires the collection of cash before revenue canbegin to be recognized, our software maintenance revenue will fluctuatequarter-to-quarter.  Typically, oursoftware maintenance revenue fluctuates between $10.0 million and $11.0 millionper quarter.

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*Software Implementation and OtherServices ($ in thousands):*
| ** **                                  | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|---------------------------------------------|------------|----------------------------------------------------|------------|--------------|------------|---------------------------------------------------|------------|--------------|------------|
| ** **                                  | ** ** | **2006**                                           | ** ** | **2005**     | ** ** | **$**                                             | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|                                        |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Software Implementation  and Other Services |       | $                                                  | 3,876      |         | $          | 4,585                                             |       | $            | (709       | ) | (15.5 | )% | $ | 12,260 |   | $ | 13,611 |   | $ | (1,351 | ) | (9.9 | )% |
|                                             |            |                                                    |            |              |            |                                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

In the majority of our software customer arrangements,installation services are provided to the customer.  Most of our software implementation fees arederived from our GPT business segment. The software implementation and other services revenue derived from GPTdeclined $169,000, or 5.0%, to $3.2 million in Q3 2006 as compared to $3.4million in Q3 2005, and declined $637,000, or 6.1%, to $9.8 million in YTD 2006as compared to $10.4 million in YTD 2005. The decline within GPT, on both a quarterly and YTD basis, was primarilywithin the Payments product offerings offset by increases within both Cash and Riskproduct offerings

RevE’s CVE software implementation and other servicesdeclined $417,000, or 51.4%, to $394,000 in Q3 2006 as compared to $811,000 inQ3 2005, and declined $893,000, or 36.2%, to $1.6 million in YTD 2006 ascompared to $2.5 million in YTD 2005. This decline is related to fewer CVE revenue producing engagements andCVE’s change in product strategy discussed under “Software License” above.

GPC’s software implementation and other servicesrevenue was relatively flat on both a quarterly and YTD basis.

*Outsourcing Services ($ in**thousands):*
| ** **           | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|----------------------|------------|----------------------------------------------------|------------|--------------|------------|---------------------------------------------------|------------|--------------|------------|
| ** **           | ** ** | **2006**                                           | ** ** | **2005**     | ** ** | **$**                                             | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|                 |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Outsourcing Services |       | $                                                  | 511        |         | $          | 220                                               |       | $            | 291        |   | 132.3 | % | $ | 1,551 |   | $ | 718 |   | $ | 833 |   | 116.0 | % |
|                      |            |                                                    |            |              |            |                                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Our outsourcing service revenue is derived throughCarretek, our 51% owned business which outsources information technology andpayment and transaction processing. Carretek was formed in fiscal 2003 and signed its first agreement in thesecond quarter of fiscal 2004.  In fiscal2005, we expanded our scope of business with this customer to include a secondand third set of transaction processing functions which resulted in increasedrevenue in fiscal 2006.  While wecontinue to pursue opportunities to expand the scope of the services we provideto our existing customer, we do not expect significant growth on an absolutedollar basis until additional outsourcing customers are obtained.

*Out-of-Pocket Expense Reimbursements($ in thousands)*:
| ** **                            | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|---------------------------------------|------------|----------------------------------------------------|------------|--------------|------------|---------------------------------------------------|------------|--------------|------------|
| ** **                            | ** ** | **2006**                                           | ** ** | **2005**     | ** ** | **$**                                             | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|                                  |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Out-of-Pocket Expense  Reimbursements |       | $                                                  | 887        |         | $          | 701                                               |       | $            | 186        |   | 26.5 | % | $ | 2,413 |   | $ | 2,446 |   | $ | (33 | ) | (1.3 | )% |
|                                       |            |                                                    |            |              |            |                                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

These reimbursements tend to fluctuate period toperiod and the increase in amount of out-of-pocket expense reimbursements on aquarterly basis is primarily the result of increased expenses within our GPTbusiness segment.

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***Cost of Revenues***

*Cost of Revenues by Segment ($ inthousands):*
| ** **                    | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|-------------------------------|------------|----------------------------------------------------|------------|--------------|------------|---------------------------------------------------|------------|--------------|------------|
| ** **                    | ** ** | **2006**                                           | ** ** | **2005**     | ** ** | **$**                                             | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|                          |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Revenue  Enhancement          |       | $                                                  | 5,120      |         | $          | 5,185                                             |       | $            | (65        | ) | (1.3 | )% | $ | 14,946 |   | $ | 14,566 |   | $ | 380 |   | 2.6 | % |
| % of revenue                  |       | 57.6                                               | %          | 64.6         | %          |                                              |       |         |       | 60.2 | % | 52.2 | % |   |   |   |   |
|                          |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Global Payments  Technologies |       | $                                                  | 8,370      |         | $          | 8,303                                             |       | $            | 67         |   | 0.8 | % | $ | 24,026 |   | $ | 24,694 |   | $ | (668 | ) | (2.7 | )% |
| % of revenue                  |       | 48.1                                               | %          | 43.6         | %          |                                              |       |         |       | 44.9 | % | 45.3 | % |   |   |   |   |
|                          |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Global Payments  Consulting   |       | $                                                  | 930        |         | $          | 887                                               |       | $            | 43         |   | 4.8 | % | $ | 2,766 |   | $ | 2,661 |   | $ | 105 |   | 3.9 | % |
| % of revenue                  |       | 63.7                                               | %          | 82.7         | %          |                                              |       |         |       | 62.9 | % | 79.5 | % |   |   |   |   |
|                          |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Business Process  Outsourcing |       | $                                                  | 414        |         | $          | 424                                               |       | $            | (10        | ) | (2.4 | )% | $ | 1,404 |   | $ | 1,437 |   | $ | (33 | ) | (2.3 | )% |
| % of revenue                  |       | 81.0                                               | %          | 192.7        | %          |                                              |       |         |       | 90.5 | % | 200.1 | % |   |   |   |   |
|                          |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Total Cost of  Revenues       |       | $                                                  | 14,834     |         | $          | 14,799                                            |       | $            | 35         |   | 0.2 | % | $ | 43,142 |   | $ | 43,358 |   | $ | (216 | ) | (0.5 | )% |
| % of revenue                  |       | 52.5                                               | %          | 52.2         | %          |                                              |       |         |       | 51.2 | % | 50.1 | % |   |   |   |   |

 

In total and by business segment, cost of revenues onan absolute dollar basis remained relatively flat for Q3 2006 and YTD 2006 ascompared to Q3 2005 and YTD 2005.  Thelargest decline on a YTD basis was within GPT and was primarily the result ofGPT reducing its workforce by 27 employees in Q3 2005.  RevE’s cost of revenues increased on a YTDbasis primarily within cost of consulting, as this group changed its focus andstrategy related to its CVE product offering discussed above.

On a quarterly basis, total revenues and total cost ofrevenues were relatively flat and correspondingly the total cost of revenues asa percentage of total revenue was also flat. On a YTD basis, the increase in the total cost of revenues as apercentage of total revenue was the result of the overall decline in totalrevenue exceeding the decline in total cost of revenues.

*Cost of Consulting ($ in thousands):*
| ** **              | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|-------------------------|------------|----------------------------------------------------|------------|--------------|------------|---------------------------------------------------|------------|--------------|------------|
| ** **              | ** ** | **2006**                                           | ** ** | **2005**     | ** ** | **$**                                             | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|                    |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Cost of  Consulting     |       | $                                                  | 5,154      |         | $          | 4,369                                             |       | $            | 785        |   | 18.0 | % | $ | 14,824 |   | $ | 12,887 |   | $ | 1,937 |   | 15.0 | % |
| % of consulting revenue |       | 57.7                                               | %          | 65.0         | %          |                                              |       |         |       | 60.9 | % | 52.5 | % |   |   |   |   |
|                         |            |                                                    |            |              |            |                                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The cost of consulting consists primarily of personnelcosts related to our consulting engagements within both our RevE and GPCbusiness segments.  The absolute dollarincrease in the cost of consulting on a quarterly and YTD basis is the resultof RevE’s change in focus and strategy for its CVE offering from traditionalsoftware license, software maintenance and software services offering toconsulting benchmarking and training offerings. A 25.6% increase in traditional RevE consulting revenue in Q3 2006, ascompared to Q3 2005, decreased the percentage of the cost of consulting as apercentage of consulting revenue in Q3 2006 as compared to Q3 2005; however, ona YTD basis, an increase in cost of consulting within RevE, without an increasein consulting revenue, has increased the cost of consulting as a percentage ofconsulting revenue.

35

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*Cost of Software Licenses ($ inthousands):*
| ** **                     | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|--------------------------------|------------|----------------------------------------------------|------------|--------------|------------|---------------------------------------------------|------------|--------------|------------|
| ** **                     | ** ** | **2006**                                           | ** ** | **2005**     | ** ** | **$**                                             | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|                           |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Cost of Software  Licenses     |       | $                                                  | 1,985      |         | $          | 2,155                                             |       | $            | (170       | ) | (7.9 | )% | $ | 5,710 |   | $ | 5,519 |   | $ | 191 |   | 3.5 | % |
| % of software  license revenue |       | 69.3                                               | %          | 40.5         | %          |                                              |       |         |       | 52.3 | % | 44.3 | % |   |   |   |   |
|                                |            |                                                    |            |              |            |                                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The cost of software licenses consists principally ofamortization of capitalized and acquired software costs along with royaltiespayable to third parties.  The cost ofsoftware licenses was relatively flat on a quarterly basis and increased on aYTD basis primarily as the result of increased royalty expense due to productmix.  The increase in the cost ofsoftware licenses as a percentage of software license revenue, on both aquarterly and YTD basis, is attributed to the decline in software license revenuewithin GPT discussed above.

In connection with certainsoftware license, maintenanceand consulting agreements entered into with some banks and purchase agreementswith vendors under which we acquire software technology used in products soldto our customers, we are required to pay royalties on sales of certain softwareproducts.  Under these arrangements, werecognize royalty expense when the associated revenue is recognized.  The royalty percentages generally range from20% to 70% of the associated revenue. Approximately $586,000 and $569,000 of royalty expense was recordedunder these agreements and charged to cost of software licenses in Q3 2006 andQ3 2005, respectively, and $1.4 million and $1.1 million in YTD 2006 and 2005,respectively.  Depending on our futureproduct mix, our margins from software license fees may be impacted byfluctuations in software royalty expense.

*Cost of Software Maintenance ($ inthousands):*
| ** **                         | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|------------------------------------|------------|----------------------------------------------------|------------|--------------|------------|---------------------------------------------------|------------|--------------|------------|
| ** **                         | ** ** | **2006**                                           | ** ** | **2005**     | ** ** | **$**                                             | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|                               |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Cost of Software  Maintenance      |       | $                                                  | 3,154      |         | $          | 3,588                                             |       | $            | (434       | ) | (12.1 | )% | $ | 9,515 |   | $ | 10,999 |   | $ | (1,484 | ) | (13.5 | )% |
| % of software  maintenance revenue |       | 28.2                                               | %          | 33.2         | %          |                                              |       |         |       | 29.0 | % | 33.6 | % |   |   |   |   |
|                                    |            |                                                    |            |              |            |                                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Cost of maintenance consists primarily of personneland facility costs to provide telephone support, product defect support andother enhancements to our existing products which are not significant enough toextend the product’s life cycle, or substantially increase itsmarketability.  These costs are primarilycontained within our GPT business segment. The decline in costs of maintenance in absolute dollars on a quarterlyand YTD basis is primarily the result of reduced personnel related costs andcontract labor costs within the GPT business segment which was the result ofthe personnel reductions carried out at the beginning of Q3 2005.

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

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*Cost of Software Implementation andOther Services ($ in thousands):*
| ** **                                               | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|----------------------------------------------------------|------------|----------------------------------------------------|------------|--------------|------------|---------------------------------------------------|------------|--------------|------------|
| ** **                                               | ** ** | **2006**                                           | ** ** | **2005**     | ** ** | **$**                                             | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|                                                     |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Cost of Software  Implementation and Other Services      |       | $                                                  | 3,167      |         | $          | 3,562                                             |       | $            | (395       | ) | (11.1 | )% | $ | 9,181 |   | $ | 10,217 |   | $ | (1,036 | ) | (10.1 | )% |
| % of software  implementation and other services revenue |       | 81.7                                               | %          | 77.7         | %          |                                              |       |         |       | 74.9 | % | 75.1 | % |   |   |   |   |
|                                                          |            |                                                    |            |              |            |                                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Cost of software implementation consists primarily ofpersonnel and facility costs to provide software implementation and projectmanagement support to customer software implementations primarily within ourGPT business segment and to a lesser degree our RevE business segment.  The decline in the cost of software implementationand other services on both a quarterly and YTD basis was primarily the resultof a decline in personnel costs within our RevE business segments due to theredeployment of CVE resources into consulting related activities.

*Cost of Outsourcing Services ($ in thousands):*
| ** **                         | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|------------------------------------|------------|----------------------------------------------------|------------|--------------|------------|---------------------------------------------------|------------|--------------|------------|
| ** **                         | ** ** | **2006**                                           | ** ** | **2005**     | ** ** | **$**                                             | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|                               |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Cost of  Outsourcing Services      |       | $                                                  | 414        |         | $          | 424                                               |       | $            | (10        | ) | (2.4 | )% | $ | 1,404 |   | $ | 1,437 |   | $ | (33 | ) | (2.3 | )% |
| % of outsourcing  services revenue |       | 81.0                                               | %          | 192.7        | %          |                                              |       |         |       | 90.5 | % | 200.1 | % |   |   |   |   |
|                                    |            |                                                    |            |              |            |                                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The cost of outsourcing services relates to theoperation of Carretek, our 51% owned business outsourcer for informationtechnology and payment and transaction processing.  To date, this business only has a single customerand our scope of business with this single customer includes outsourcing threebusiness functions.  The cost ofoutsourcing service on both a quarterly and YTD basis is relatively flat.  The decline in the percentage of cost ofoutsourcing service as a percentage of outsourcing services revenue isprimarily the result of increased revenue as two of the outsourced functionsramp up to full capacity on a relatively fixed cost structure.

*Out-of-Pocket Expenses ($ inthousands):*
| ** **                                 | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|--------------------------------------------|------------|----------------------------------------------------|------------|--------------|------------|---------------------------------------------------|------------|--------------|------------|
| ** **                                 | ** ** | **2006**                                           | ** ** | **2005**     | ** ** | **$**                                             | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|                                       |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Cost of  Out-of-Pocket Expenses            |       | $                                                  | 960        |         | $          | 701                                               |       | $            | 259        |   | 36.9 | % | $ | 2,508 |   | $ | 2,299 |   | $ | 209 |   | 9.1 | % |
| % of  out-of-pocket expense reimbursements |       | 108.2                                              | %          | 100.0        | %          |                                              |       |         |       | 103.9 | % | 94.0 | % |   |   |   |   |
|                                            |            |                                                    |            |              |            |                                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

These costs represent travel, meals and other sundryexpenses incurred by our employees. These costs are invoiced to the customer, without mark-up, usually on amonthly basis.  The costs have remainedrelatively flat on both a quarterly and YTD basis.  In addition, certain customer contractscontain expense maximums, so in certain cases not all expenses incurred can bepassed along to the customer without contractual revisions or the customer’sexpress written approval, which can increase the volatility of the cost ofout-of-pocket expense as a percentage of out-of-pocket expense reimbursements.

37

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***Operating Costs and Expenses:***

*Selling,General and Administrative Expenses ($ in thousands):*
| ** **                                    | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------|------------|--------------|------------|---------------------------------------------------|------------|--------------|------------|
| ** **                                    | ** ** | **2006**                                           | ** ** | **2005**     | ** ** | **$**                                             | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|                                          |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Selling, General  and Administrative Expenses |       | $                                                  | 11,087     |         | $          | 11,191                                            |       | $            | (104       | ) | (0.9 | )% | $ | 33,290 |   | $ | 33,688 |   | $ | (398 | ) | (1.2 | )% |
| % of total  revenue                           |       | 39.2                                               | %          | 39.4         | %          |                                              |       |         |       | 39.5 | % | 39.0 | % |   |   |   |   |
|                                               |            |                                                    |            |              |            |                                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Selling, general andadministrative expenses generally consist of personnel costs such as salaries, commissions and other incentivecompensation along with travel associated with selling, marketing, generalmanagement and software management. Additionally, the provision for doubtful accounts, insurance, includingdirectors and officers liability insurance, as well as professional services,such as legal and accounting expenses, and other related costs are classifiedwithin selling, general and administrative expense.  Our selling, general and administrativeexpenses were essentially flat in absolute dollars on both a quarterly and YTDbasis.  However, there were significantchanges within the underlying expense categories.  Corporate sales and marketing expensesdeclined $26,000 on a quarterly basis and $1.1 million on a YTD basis and ourbusiness segments also reduced their sales cost by $573,000 on a quarterlybasis and $2.0 million on a YTD basis. These declines were primarily achieved through reduced personnel andpersonnel related costs.  These costreductions were offset by increased general and administrative costs of$494,000 on a quarterly basis and $2.7 million on a YTD basis.  The increases in general and administrativecosts consist of increased professional fees including legal fees arising outof lawsuits in which we are the plaintiff, and to a lesser extent, increasedaccounting and other professional fees related to the restatement of ourfinancial statements that was announced in April 2006.  Additionally, in Q1 2006, we began to expensestock-based compensation related to stock options and approximately $249,000 ona quarterly basis and $674,000 YTD 2006 was charged to general andadministrative expense.

Selling, general andadministrative costs as a percentage of total revenue decreased on a quarterly basis due to both a slightdecline in selling, general and administrative expenses along with a slightincrease in total revenue.  Selling,general and administrative expense as a percentage of total revenue increasedslightly on a YTD basis, primarily as a result of the decrease in revenueexceeding the decline in selling, general and administrative expenses.

*Researchand Development ($ in thousands):*
| ** **                                           | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------|------------|--------------|------------|---------------------------------------------------|------------|--------------|------------|
| ** **                                           | ** ** | **2006**                                           | ** ** | **2005**     | ** ** | **$**                                             | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|                                                 |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Research and  Development    Expenses |       | $                                                  | 2,519      |         | $          | 2,444                                             |       | $            | 75         |   | 3.1 | % | $ | 7,177 |   | $ | 7,481 |   | $ | (304 | ) | (4.1 | )% |
| % of total revenue                                   |       | 8.9                                                | %          | 8.6          | %          |                                              |       |         |       | 8.5 | % | 8.6 | % |   |   |   |   |
|                                                      |            |                                                    |            |              |            |                                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Research and developmentexpenses consist primarily ofpersonnel, contract labor, travel and facilities expenses.  Research and development costs are typicallylimited to development of new software products, or enhancements to existingsoftware products, which extend the product’s life cycle and/or substantiallyincrease its marketability.  The majorityof research and development costs were related to new product developmentwithin our GPT business segment.

In accordance with SFAS No. 86, “*Accounting for Costs of Software**to be Sold, Leased or Otherwise Marketed,”*we capitalized $265,000 and $0 in Q3 2006 and Q3 2005, respectively, and $1.5million and $690,000 in YTD 2006 and YTD 2005, respectively.  Software development costs of a product arecapitalized from the time technological feasibility is reached until thegeneral release of the product.  Weestablish technological feasibility through the process of creating a detailedprogram design and reviewing the detailed program design for any high riskdevelopment issues or through the creation of a working model.  Capitalization only occurs if we believecosts capitalized are recoverable through future sales of the software productunder development.  At October 31, 2006,we had four projects underway for which costs were capitalized in Q3 2006.  Two of these projects are within Risksolutions and two are RevE solutions. All current capitalized development projects are scheduled to becompleted by the end of Q1 2007.

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*Amortization of Customer Relationships:*  Amortization of customer relationships was$350,000 in both Q3 2006 and Q3 2005, and$1.1 million for YTD 2006 and YTD 2005. The amortization results from the periodic recognition of amortizationexpense of intangible customer relationships acquired in the Check Solutionsacquisition in fiscal 2001, and this amortization will continue until May 2007.

***Restructuring and Other Charges:***  Therewere no restructuring and other charges recorded to date in fiscal 2006.  However, in Q1 2005,we recorded $127,000 in restructuring and other charges, principally associatedwith the separation of six employees. Additionally in Q1 2005, we also lowered our estimate by $32,000 for thecosts associated with the discontinuance of one of our software offeringsoriginally recorded in January 2004.  InQ2 2005, we recorded $28,000 in restructuring and other charges, principallyassociated with the separation of 2 employees. Finally, in Q3 2005, we recorded $780,000 in restructuring and othercharges, principally associated with the separation of 29 employees primarilywithin the GPT business segment.

Theactivity related to the accrued merger and restructuring costs to date infiscal 2006 is as follows (in thousands):
|                                      | ** ** | **Workforce  Reductions** | ** ** | **CheckFlow  Suite** | ** ** | **Other** | ** ** | **Total** | ** ** |
|--------------------------------------|------------|---------------------------|------------|----------------------|------------|-----------|------------|-----------|------------|
|                                 |       |                      |       |                 |       |      |       |      |       |
| Reserve balance at  January 31, 2006 |       | $                         | 87         |                 | $          | 200       |       | $         | 47         |   | $ | 334 |   |
| Cash paid                            |       | (87                       | )          | —               |       | (35       | )          | (122      | )          |
| Reserve balance at  October 31, 2006 |       | $                         | —     |                 | $          | 200       |       | $         | 12         |   | $ | 212 |   |

 

We expect to complete these existing obligations bythe end of fiscal 2006.

***Other Income(Expense):***

*Interest Income ($ in thousands):*
| ** **      | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|-----------------|------------|----------------------------------------------------|------------|--------------|------------|---------------------------------------------------|------------|--------------|------------|
| ** **      | ** ** | **2006**                                           | ** ** | **2005**     | ** ** | **$**                                             | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|            |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Interest Income |       | $                                                  | 392        |         | $          | 185                                               |       | $            | 207        |   | 111.9 | % | $ | 1,070 |   | $ | 495 |   | $ | 575 |   | 116.2 | % |
|                 |            |                                                    |            |              |            |                                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Interest income consists of interest earned onmarketable securities and cash and cash equivalents.  The increase in interest income on both aquarterly and YTD basis is primarily the result of higher average investedbalances in fiscal 2006 and higher yields on these investments.

*Interest Expense ($ in thousands):*
| ** **       | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|------------------|------------|----------------------------------------------------|------------|--------------|------------|---------------------------------------------------|------------|--------------|------------|
| ** **       | ** ** | **2006**                                           | ** ** | **2005**     | ** ** | **$**                                             | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|             |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Interest Expense |       | $                                                  | —     |         | $          | 122                                               |       | $            | (122       | ) | (100.0 | )% | $ | 211 |   | $ | 334 |   | $ | (123 | ) | (36.8 | )% |
|                  |            |                                                    |            |              |            |                                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Interest expense is primarily the result of thecommitment fees associated with the maintenance of our $30.0 million revolvingcredit agreement.  As discussed below in “Liquidityand Capital Resources,” we did not renew our credit facility following itsexpiration on July 31, 2006. Additionally, the amortization of the deferred loan costs is alsoincluded in interest expense and this amortization concluded on July 31, 2006.

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*Other income (expense) ($ inthousands):*
| ** **                                        | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|---------------------------------------------------|------------|----------------------------------------------------|------------|--------------|------------|---------------------------------------------------|------------|--------------|------------|
| ** **                                        | ** ** | **2006**                                           | ** ** | **2005**     | ** ** | **$**                                             | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|                                              |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Minority share  of net loss of  Carretek LLC |       | 150                                                |       | 269          |       | (119                                              | )          | (44.2        | )%         | 477 |   | 799 |   | (322 | ) | (40.3 | )% |
| Foreign exchange  gains (losses)                  |       | (18                                                | )          | 12           |       | (30                                               | )          | 250.0        | %          | 175 |   | (89 | ) | 264 |   | 296.6 | % |
| Other                                             |       | 2                                                  |       | 2            |       | —                                            |       | —       | %          | (3 | ) | 8 |   | (11 | ) | (137.5 | )% |
|                                              |       |                                               |       |         |       |                                              |       |         |       |   |   |   |   |   |   |   |   |
| Total                                             |       | $                                                  | 134        |         | $          | 283                                               |       | $            | (149       | ) | (52.7 | )% | $ | 649 |   | $ | 718 |   | $ | (69 | ) | (9.6 | )% |
|                                                   |            |                                                    |            |              |            |                                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

We own a 51% interest in Carretek LLC (“Carretek”),through which we offer financial institutions offshore-centric outsourcing oftheir business processes.  Carretekgenerated approximately $307,000 and $549,000 of losses in Q3 2006 and Q3 2005,respectively, and $974,000 and $1.6 million of losses in YTD 2006 and YTD 2005,respectively.  Accordingly, the 49% shareof these losses relating to the minority interest held by Majesco Software,Inc., or $150,000 and $269,000 in Q3 2006 and Q2 2005, respectively, and$477,000 and $799,000 in YTD 2006 and 2005, respectively, was recorded in otherincome (expense). Foreign exchange gains and losses fluctuated primarily as theresult of changing exchange rates and our mix of engagements denominated in aforeign currency.

*Provisionfor Income Taxes:*  We have established a valuationallowance to reserve our net deferred tax assets at October 31, 2006 because ofour inconsistent history of generating profitable operations and taxableincome.  The tax provision was computedbased on actual results by jurisdiction, which resulted in a foreign taxprovision of $100,000 and $102,000 for the three months ended October 31, 2006and 2005, respectively, and $314,000 and $270,000 for the nine months endedOctober 31, 2006 and 2005, respectively. In addition to the provision for foreign taxes, we recorded $20,000 and$15,000 of U.S. Federal and State tax expense in the nine months ended October31, 2006 and 2005, respectively, for alternative minimum tax purposes.

40

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**Liquidity and Capital Resources**

Historically, we have funded our operations and cashexpenditures primarily with cash generated from operating activities.  At October 31, 2006, we had working capitalof $24.6 million compared to $17.9 million at January 31, 2006.  We had $24.2 million in cash and cashequivalents at October 31, 2006, a decrease of $5.5 million from $29.7 millionin cash and cash equivalents at January 31, 2006.  However, we also had $13.0 million of “availablefor sale” marketable securities at October 31, 2006, compared to $4.7 millionat January 31, 2006.  We expect thatexisting cash and cash equivalents, marketable securities and our cashprojected to be generated from operating activities will be sufficient to meetour presently anticipated liquidity requirements for the foreseeable future.

Cash provided by operating activities was $4.2 millionfor Q3 2006 compared to cash provided by operating activities of $2.2 millionin Q3 2005.  Cash provided by operatingactivities was $6.3 million in YTD 2006 as compared to cash used in operatingactivities of $1.6 million in YTD 2005. The increase in cash provided by operating activities on a quarterlybasis is primarily the result of increased net income in Q3 2006 as compared toQ3 2005.  On a YTD basis, the increase incash provided by operating activities is primarily related to increased levelsof deferred revenue and accounts payable, along with increased amounts ofnon-cash stock compensation expense related to the adoption of FAS 123(R) onFebruary 1, 2006.

Average days’ sales outstandingfluctuate for a variety of reasons, including the timing of billings specifiedby contractual agreement, and receivables for expense reimbursements.  Because we defer recognition of maintenancerevenue until the maintenance fee is paid by the customer, no unpaidmaintenance renewals nor related deferred revenue are reflected on ourquarterly consolidated balance sheet. Therefore, the following tables contain the quarterly days’ salesoutstanding (DSO) calculations both with and without maintenance revenue:
| Quarter ended | ** ** | **DSO, including maintenance  revenue** | ** ** | **DSO, excluding maintenance  revenue** | ** ** |
|--------------------|------------|---------------------------------------------------|------------|---------------------------------------------------|------------|
|               |       |                                              |       |                                              |       |
| October 31, 2006   |       | 48                                                |       | 80                                                |       |
| July 31, 2006      |       | 54                                                |       | 87                                                |       |
| April 30, 2006     |       | 33                                                |       | 54                                                |       |
| January 31, 2006   |       | 37                                                |       | 54                                                |       |
| October 31, 2005   |       | 42                                                |       | 68                                                |       |

 

The general increase in DSO in the quarters ended July31, 2006 and October 31, 2006 over the previous quarters is primarily theresult of our RevE business segment providing payment terms for several largecontracts recorded in Q1 and Q2 2006 which extended into Q3 and Q4 2006.

Cash used in investing activities increased to $7.9million in Q3 2006 as compared to $423,000 in Q3 2005 and increased to $12.5million in YTD 2006 as compared to $7.0 million in YTD 2005.  The increase in both the quarterly and YTDperiods reflects the purchase of additional marketable securities and increasedlevels of software development costs capitalized and purchases of property andequipment in both periods.

Financing activities provided cash of$330,000 in Q3 2006 as compared to cash provided of $650,000 in Q3 2005.  Financing activities provided cash of$813,000 in YTD 2006 as compared to a use of cash of $1.8 million in YTD 2005.  The cash provided by financing activities inQ3 2006, Q3 2005 and YTD 2006 was related to proceeds from stock optionexercises along with a minority shareholder cash investment in CarretekLLC.  The cash used in financingactivities in YTD 2005 was related to $3.2 million of treasury stock purchasesin YTD 2005.  These common stockpurchases were performed under a program to purchase up to $5.0 million of theCompany’s outstanding common stock during the period April 18, 2005 throughOctober 15, 2005.

We were a party to a revolving creditagreement with a group of banks providing for a commitment amount of $30.0million which was allowed to expire by its terms on July 31, 2006.  There had been no borrowings outstandingunder the credit facility since Q1 2004 and we believe our current cash andcash equivalents, marketable securities and our cash projected to be generatedfrom operations to be sufficient to meet our cash requirements for theforeseeable future.

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The following summarizes our contractual obligationsat October 31, 2006 and the effect these contractual obligations are expectedto have on our liquidity and cash flows in future periods (in thousands):
| ** **       | ** ** | **Payments Due by Period** | ** ** |
|------------------|------------|----------------------------|------------|
| ** **       | ** ** | **Total**                  | ** ** | **1 Year  or Less** | ** ** | **Years 2-3** | ** ** | **Years 4-5** | ** ** | **After  5 Years** | ** ** |
|             |       |                       |       |   |   |   |   |   |   |   |   |
| Operating leases |       | $                          | 11,065     |   | $ | 3,281 |   | $ | 5,821 |   | $ | 1,665 |   | $ | 298 |   |
|             |       | $                          | 11,065     |   | $ | 3,281 |   | $ | 5,821 |   | $ | 1,665 |   | $ | 298 |   |

 

We believe that current cash and cashequivalents, marketable securities and expected future cash flows will besufficient to meet our anticipated cash needs for working capital and routinecapital expenditures during fiscal 2006. However, if current sources are not sufficient to meet our needs, we mayseek new equity or debt financing.  Therecan be no assurance that additional financing would be available on acceptableterms, if at all.  Further, we may in thefuture pursue acquisitions of businesses, products or technologies that couldcomplement or expand our business and product offerings, and change ourfinancing needs.  Our forecast of theperiod of time through which our financial resources will be adequate tosupport our operations is a forward looking statement that involves risks anduncertainties, and actual results could vary. The failure to secure new financing when needed could have a materialadverse effect on our business, financial condition and results of operations.

**Critical Accounting Policies**

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

Revenue Recognition

The Company’s revenue recognition policies are inaccordance with Statement of Position (“SOP”) 97-2, *“SoftwareRevenue Recognition,”* as amended by SOP 98-9, “*Modificationof SOP 97-2,**Software RevenueRecognition with Respect to Certain Transactions,”* Staff AccountingBulletin (“SAB”) No. 104,*“Revenue Recognition,”* and Emerging Issues Task Force (“EITF”) No.00-21,*“Revenue Arrangements with MultipleDeliverables.”* In the case ofsoftware arrangements that require significant production, modification, orcustomization of software, or the license agreement requires the Company toprovide implementation services that are determined to be essential to otherelements of the arrangement, the Company follows the guidance in SOP 81-1, *“Accounting for Performance of Construction – Type and CertainProduction – Type Contracts.”*

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

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*Consulting.*  TheCompany employs three primary pricingmethods in connection with its delivery of consulting services. First, theCompany may price its delivery of consultingservices on the basis of time and materials, in which case the customer ischarged agreed-upon daily rates for services performed and out-of-pocketexpenses. In this case, the Company isgenerally paid fees and related amounts usually on a monthly basis, and theCompany recognizes revenues as the servicesare performed. Second, the Company maydeliver consulting services on a fixed-price basis. In this case, theCompany is paid on a monthly basis orpursuant to an agreed upon payment schedule, and the Company recognizes revenues on a proportionate performancebasis.  The Company believes that this method is appropriate becauseof its ability to determine performance milestones and determine dependableestimates of its costs applicable to each phase of a contract.  Because financial reporting of thesecontracts depends on estimates, which are assessed continually during the termof the contract, costs are subject to revisions as the contract progresses.  Anticipated losses on fixed-price contractsare recognized when estimable.  Third, theCompany may deliver consulting servicespursuant to a value-priced contract with the customer. In this case, theCompany is paid, on an agreed upon basis with the customer, either a specifiedpercentage of (1) the projected increased revenues and/or decreased coststhat are expected to be derived by the customer generally over a period of upto twelve months following implementation of its solution or (2) the actualincreased revenues and/or decreased costs experienced by the customer generallyover a period of up to twelve months following implementation of its solution,subject in either case to a maximum, if any is agreed to, on the total amountof payments to be made to the Company. The Company must first commit time and resources to develop projectionsassociated with value-pricing contracts before a customer will commit topurchase its solutions, and the Company therefore assumes the risk of makingthese commitments with no assurance that the customer will purchase the solution.  Costs associated with these value-pricingcontracts are expensed as incurred. These contracts typically include payments to be made to the Companypursuant to an agreed upon schedule ranging from one to twelve months inlength.  The Company recognizes revenues generated from consultingservices in connection with value-priced contracts once customeracknowledgement is obtained that confirms fees have become fixed anddeterminable.  In some cases, theseacknowledgements contain future deliverables or services, in which case therevenue from these engagements is recognized on a proportionate performancebasis based on the efforts to be incurred following the customeracknowledgement.  In an effort to allowcustomers to more closely match expected benefits from services with paymentsto the Company, the Company onoccasion, may offer payment terms whichextend beyond 12 months.  When theCompany enters into an agreement which has a significant component of the totalamount payable under the agreement due beyond 12 months or if it is determinedpayments are not fixed and determinable at the date the agreement was enteredinto, revenue under the arrangement will be recognized as payments become dueand payable.  When fees are to be paidbased on a percentage of actual revenues and/or savings to customers, theCompany recognizes revenues only uponcompletion of all services and as the amounts of actual revenues or savings areconfirmed by the customer with a fixed payment date.

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

The Company expectsthat value-pricing contracts will continue to account for a significantportion of its revenues in the future. As a consequence of the use of value-pricingcontracts and due to the revenue recognition policy associated with thosecontracts, the Company’s results ofoperations will likely fluctuate significantly from period to period.

Regardless of the pricing methodemployed by the Company in a givencontract, the Company is typicallyreimbursed on a monthly basis for out-of-pocket expenses incurredon behalf of its customers.

*Software License.*  Aperpetual software license is sold either together with implementation servicesor on a stand-alone basis.  TheCompany is usually paid software licensefees in one or more installments, as provided in the customer’s contract butnot to exceed twelve months.  The Companyrecognizes software license revenue upon execution of a contract and deliveryof the software, provided that the license fee is fixed and determinable, nosignificant production, modification or customization of the software isrequired and collection is considered probable by management.  When the software license arrangementrequires the Company to provide implementation services that are essential tothe functionality of the software or significant production, customization ormodification of the software is required, both the product license revenue andimplementation fees are recognized as services are performed.  A term software license is sold eithertogether with implementation services and/or with maintenance services.  These term licenses are usually paid inannual installments over the term of the license.  If the term software license is sold withoutessential implementation services, the revenue is recognized ratably over thenon-cancelable license term.  If the termlicense is sold with essential implementation services, the license revenue isrecognized as the lesser of the amount of license revenue recognized asservices are performed or on a ratable basis.

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

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Software licenses are often soldas part of a multiple element arrangement that may include maintenance, implementationor consulting.  The Company determineswhether there is vendor specific objective evidence of fair value (“VSOEFV”)for each element identified in the arrangement to determine whether the totalarrangement fees can be allocated to each element.  If VSOEFV exists for each element, the totalarrangement fee is allocated based on the relative fair value of eachelement.  In cases where there is notVSOEFV for each element, or if it is determined services are essential to thefunctionality of the software being delivered, or if significant production,modification or customization of the software is required, the Companyinitially defers revenue recognition of the software license fees until VSOEFVis established or the services are performed. However, if VSOEFV is determinable for all of the undelivered elements,and assuming the undelivered elements are not essential to the deliveredelements, the Company will defer recognition of the full fair value related tothe undelivered elements and recognize the remaining portion of the arrangementvalue through application of the residual method.  Where VSOEFV has not been established forcertain undelivered elements, revenue for all elements is deferred until thoseelements have been delivered or their fair values have been determined.  Evidence of VSOEFV is determined for softwareproducts based on actual sales prices for the product sold to a similar classof customer and based on pricing strategies set forth in the Company’s pricebook.  Evidence of VSOEFV for services(implementation and consulting) is based upon standard billing rates and theestimated level of effort for individuals expected to perform the relatedservices.  The Company establishes VSOEFVfor maintenance agreements using the percentage method such that VSOEFV formaintenance is a percentage of the license fee charged annually for a specificsoftware product, which in most instances is 20% of the portion of arrangementfees allocated to the software license element.

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

*Software Maintenance.*  Inconnection with the sale of a software license, a customer may elect topurchase software maintenance services. Most of the customers that purchasesoftware licenses from the Company alsopurchase software maintenance services, which typically are renewedannually.  The Company charges an annual maintenance fee, which istypically a percentage of the initial software license fee. The annualmaintenance fee generally is paid to the Company at the beginning of the maintenance period, and the Company recognizes these revenues ratably over the term ofthe related contract.  If the annualmaintenance fee is not paid at the beginning of the maintenance period, theCompany defers revenue recognition until the time that the maintenance fee ispaid by the customer.  The Companynormally continues to provide maintenance service while awaiting payment fromcustomers.  When the payment is received,revenue is recognized for the period that revenue was previously deferred.  This may result in volatility in softwaremaintenance revenue from period to period.

*Software Implementation and OtherServices.*  In connection with the sale of a softwarelicense, a customer may elect to purchase software implementation services,including software enhancements and other software services. Most of thecustomers that purchase software licenses from the Company also purchase software implementationservices.  The Company prices its implementation services on a time-and-materialsor on a fixed-price basis, and the Company recognizes the related revenues as services are performed.  Costs associated with these engagements areexpensed as incurred.

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

*Return Provisions.*  TheCompany’s contracts typically do not includeright of return clauses, and as a result, the Company does not record aprovision for returns.

Royalties

We are required to pay royalties inconnection with software license, maintenance and consulting agreements enteredinto with certain customers under which we acquired third party softwaretechnology or other intellectual property used in products and services sold toour customers.  Under these arrangements,we accrue royalty expense when the associated revenue is recognized.  For current product offerings, the royaltypercentages generally range from 20%-70% of the associated revenues.  Royalty expense is primarily included as acomponent of the cost of software license revenues; however, certain amountsare also included in cost of consulting and cost of software maintenance in theaccompanying consolidated statements of operations.

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Allowance for Doubtful Accounts

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

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

Software costs capitalized include developedtechnology acquired in acquisitions and costs incurred by us in developing ourproducts that qualify for capitalization. We capitalize our software development costs, other than costs forinternal-use software, in accordance with Statement of Financial AccountingStandards No. 86, “*Accounting for Costs ofComputer Software to be Sold, Leased or Otherwise Marketed”* (“SFAS86”).  Our policy is to capitalizesoftware development costs incurred in developing a product once technologicalfeasibility of the product has been established.  Software development costs capitalized alsoinclude amounts paid for purchased software on products that have reachedtechnological feasibility. Technological feasibility of the product isdetermined after completion of a detailed program design and a determinationhas been made that any uncertainties related to high-risk development issueshave been resolved. If the process of developing the product does not include adetailed program design, technological feasibility is determined only aftercompletion of a working model. All capitalized software development costs areamortized using an amount determined as the greater of: (1) the ratio thatcurrent gross revenues for a capitalized software project bears to the total ofcurrent and future projected gross revenues for that project or (2) thestraight-line method over the estimated remaining economic life of the product(generally three to six years).  Wecontinually monitor the net realizable value of the software capitalized andacquired developed technology for factors that would indicate impairment, suchas a decline in the demand or loss of a significant customer.  During the quarterly period ended January 31,2006, we performed our annual formal evaluation for impairment and determinedthat the carrying amount of these assets was not impaired and have noted nosubsequent factors that would indicate impairment.

Goodwill is assessed on an annual basis for impairmentat the reporting unit level by applying a fair value based test utilizing theresults of a third party appraisal.  Weperform an annual impairment assessment on November 1st of each year or when factors indicate thatgoodwill should be evaluated for possible impairment.  During the quarterly period ended January 31,2006, we performed our annual evaluation for goodwill impairment and determinedthat the carrying amount of goodwill was not impaired and have not noted anyfactors subsequent that would indicate impairment.  Goodwill at October 31, 2006 totaled $20.8million.  Any deterioration in marketconditions, increases in interest rates and changes in our projections withrespect to the Global Payments Technologies reporting unit to which goodwill isallocated would result in additional impairment charges in the future.

Restructuringand Other Charges

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

Contingencies

We are subject to proceedings, lawsuits and otherclaims.  We are required to assess thelikelihood of any adverse judgments or outcomes to these matters as well aspotential ranges of probable losses.  Adetermination of the amount or reserves required, if any, for thesecontingencies is made after careful analysis of each individual issue.  The required reserves may change in thefuture due to new developments in each matter or changes in insurance coverageor approach such as a change in settlement strategy.

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IncomeTaxes

Werecognize deferred tax assets or liabilities for the expected future taxconsequences of temporary differences between the book and tax basis of assetsand liabilities.  We review our deferredtax assets for recoverability and establish a valuation allowance based onhistorical taxable income, projected future taxable income and the expectedtiming of the reversals of existing temporary differences.  As a result of our recent history ofinconsistent profitability, we have provided a full valuation allowance againstour net deferred tax assets.  Inaddition, we expect to provide a full valuation allowance of any future taxbenefits until we can sustain a level of profitability that demonstrates ourability to utilize these assets.

**Recently Issued AccountingStandards**

In June 2006, the Financial Accounting StandardsBoard (“FASB”) issued Interpretation No. 48, “*Accountingfor Uncertainty in Income Taxes”* – an interpretation of FAS 109, *“Accounting for Income Taxes”* (“FIN 48”) to create a singlemodel to address accounting for uncertainty in tax positions.  FIN 48 clarifies the accounting for incometaxes, by prescribing a minimum recognition threshold a tax position isrequired to meet before being recognized in the financial statements.  FIN 48 also provides guidance onderecognition, measurement, classification, interest and penalties, accountingin interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15,2006.  We will adopt FIN 48 as of February1, 2007, as required.  The cumulativeeffect of adopting FIN 48 will be recorded in retained earnings and otheraccounts as applicable.  We have notdetermined the effect, if any, that the adoption of FIN 48 will have on ourfinancial position and results of operations.

In September 2006, theFASB issued SFAS No. 157, *“Fair ValueMeasurements”* (SFAS 157), which provides guidance on how to measureassets and liabilities that use fair value. SFAS 157 will apply wheneveranother US GAAP standard requires (or permits) assets or liabilities to bemeasured at fair value but does not expand the use of fair value to any newcircumstances. This standard also will require additional disclosures in bothannual and quarterly reports. SFAS 157 will be effective for financialstatements issued for fiscal years beginning after November 15, 2007, and willbe adopted by us February 1, 2008. We are currently evaluating the potentialimpact this standard may have on our financial position and results ofoperations, but do not believe the impact of the adoption will be material.

**Item 3. ****Quantitative and Qualitative Disclosures aboutMarket Risk**

**Interest Rate Risk**

We invest our cash in a variety of financialinstruments.  The vast majority of theseinvestments is denominated in U.S. dollars and maintained with nationallyrecognized financial institutions.

Investments in bothfixed rate and floating rate interest earning instruments carry a degree ofinterest rate risk.  Fixed ratesecurities may have their fair market value adversely impacted due to a rise ininterest rates, while floating rate securities may produce less income thanexpected if interest rates fall.  Due inpart to these factors, our future investment income may fall short ofexpectations due to changes in interest rates, or we may suffer losses inprincipal if forced to sell securities which have seen a decline in marketvalue due to various factors including changes in interest rates.  At October 31, 2006, we held $13.0 million ofmarketable securities of which $2.7 million were auction rate securities.  The interest rate for these auction ratesecurities will adjust to the current market interest rate at each interestreset date, which is typically on at least a monthly basis.

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**Foreign Currency Risk**

We currently have sales and marketing operations inseveral international locations including Canada, United Kingdom, South Africaand Australia.  As a result, we haveassets and liabilities outside the United States that are subject tofluctuations in foreign currency exchange rates.  Due to the nature of these operations, wecurrently utilize the U.S. Dollar as the functional currency for allinternational operations.  WithinCarretek LLC, our 51% owned subsidiary which offers financial institutionsoffshore-centric outsourcing of their business processes, the majority of thelabor costs is denominated in Indian Rupees while the revenues from thisoperation are denominated in U.S. Dollars. As our operations increase, fluctuating labor costs may increase ourforeign currency risk.

Less than 10%of our accounts receivable balance at October 31, 2006 includes amountsdenominated in a foreign currency.  We donot currently hedge our foreign currency exposure; however, we do try to limitour foreign currency exposure by negotiating these foreign contracts in U.S.Dollars.  In the future we may changethis practice.  We will continue toevaluate the need to adopt a hedge strategy in the future and may implement aformal strategy in future periods.

Foreignexchange losses were $18,000 for the three months ended October 31, 2006 and foreign exchange gainswere $12,000 in the three monthsended October 31, 2005.  Foreign exchangegains were $175,000 in YTD 2006 and foreign exchange losses were $89,000 in YTD2005.  These gains/losses were primarilythe result of remeasurement of accounts receivable denominated in the BritishPound and the Euro.

**Item 4.  Controls andProcedures**

*Disclosure Controls and Procedures*

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

Our management, under the supervision and with theparticipation of our Chief Executive Officer and Chief Financial Officer, hasevaluated the effectiveness of our disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act).  As of October 31, 2006, they carried out anevaluation of our disclosure controls and procedures, and the Chief Executiveand Chief Financial Officers believe that these disclosure****controlsand procedures are effective to ensure that we are able to collect, process anddisclose the information we are required to disclose in the reports we filewith the SEC within the required time periods.

In designing and evaluating the disclosure controlsand procedures, management recognizes that any controls and procedures, nomatter how well designed and operated, can provide only reasonable assurance ofachieving the desired control objectives, and management necessarily isrequired to apply its judgment in evaluating the cost-benefit relationship ofpossible controls and procedures.

*Changes in Internal Control over Financial Reporting*

We upgraded ourcurrent accounting system during Q3 2006, which impacted our internal controlover financial reporting.  Managementbelieves that the conversion to the upgraded system was adequately tested toprovide reasonable assurance that our internal control over financial reportingwas not materially affected or is reasonably likely to be materially affectedin the future.

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#### **PART II:  OTHER INFORMATION**

**ITEM 1.          LEGAL PROCEEDINGS**

We are periodically involved inlitigation and claims which arise in the normal course of business.  In management’s opinion, no pendingproceeding is reasonably expected to have a material adverse effect on ourfinancial position or results of operations.

**ITEM 1A.       RISK FACTORS**

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

*We are exploring a range ofstrategic alternatives that we may or may not pursue and that may yieldunforeseen results.*

On June 12, 2006, weannounced that our Board of Directors had authorized that we explore variousstrategic alternatives designed to increase our scale and capabilities in themarketplace.  These strategic alternatives include, but are not limitedto, a merger with a strategic partner, a sale of the company and other possibletransactions.  There can be no assurance that any particular strategicalternative will be pursued or that any transaction will occur, or on whatterms.  If we choose to continue to execute our operating plan instead ofpursuing a strategic alternative, our stock price could decline.  Inaddition, we may be unsuccessful in implementing an alternative that is chosenby our Board of Directors or we may implement an alternative that yieldsunexpected results.  The process of continuing to review, and potentiallyexecuting, strategic alternatives is likely to be costly and time-consuming andmay distract our management and otherwise disrupt our operations, which couldhave a material adverse effect on our business, financial condition and resultsof operations.

**ITEM 2.          UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

None.

**ITEM 3.          DEFAULTS UPON SENIOR SECURITIES**

None.

**ITEM 4.          SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

None.

**ITEM 5.          OTHERINFORMATION**

None.

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**ITEM 6.          EXHIBITS**
| Number | ** ** | **Exhibit Description**                                                                                                                                                                                                                             |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |       |                                                                                                                                                                                                                                                |
| 10.1   |       | Amended and Restated Employment Agreement dated October  11, 2006 between the Company and Suzette L. Massie                                                                                                                                         |
|   |       |                                                                                                                                                                                                                                                |
| 10.2   |       | Amended and Restated Employment Agreement dated  October 11, 2006 between the Company and Lisa K. Peterson                                                                                                                                          |
|   |       |                                                                                                                                                                                                                                                |
| 10.3   |       | First Amendment to Employment Agreement dated August  10, 2006 between the Company and John D. Carreker, III (incorporated by  reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for  the quarter ended July 31, 2006.) |
|   |       |                                                                                                                                                                                                                                                |
| 31.1   |       | Certification Pursuant to Section 302(a) of the  Sarbanes-Oxley Act of 2002                                                                                                                                                                         |
|   |       |                                                                                                                                                                                                                                                |
| 31.2   |       | Certification Pursuant to Section 302(a) of the  Sarbanes-Oxley Act of 2002                                                                                                                                                                         |
|   |       |                                                                                                                                                                                                                                                |
| 32.1   |       | Certification Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                             |
|   |       |                                                                                                                                                                                                                                                |
| 32.2   |       | Certification Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                             |

 

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**SIGNATURES**

Pursuant to the requirements of the Securities Act of1934, the Registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.
| CARREKER CORPORATION |
|----------------------|
|                 |   |   |
|                 |   |   |
| By:                  |   /s/  John D. Carreker, Jr. |   | Date: |  December 7, 2006 |   |
|                 | John D. Carreker, Jr. |   |   |
|                 | Chairman of the Board and |   |   |
|                 | Chief Executive Officer |   |   |
|                 |   |   |   |
|                 |   |   |   |
| By:                  |   /s/  Lisa K. Peterson |   | Date: |  December 7, 2006 |   |
|                 | Lisa K. Peterson |   |   |
|                 | Chief Financial Officer |   |   |
|                      |  |  |  |  |  |  |

 

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