**UnitedStatesSecurities and Exchange Commission**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 

| **ý****Quarterly Report  Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934**                                                                                                                                                                                                                                      |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **for the Period Ended October 31, 2003.**                                                                                                                                                                                                                                                                                                  |
|                                                                                                                                                                                                                                                                                                                                             |
| **o****Transition Report  Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934**                                                                                                                                                                                                                                          |
| **for the Transition Period from                            to                          .** |
|                                                                                                                                                                                                                                                                                                                                             |
| **Commission file  number       0-24201**                                                                                                                                                                                                                                                                     |

 

**CarrekerCorporation**

(Exact name of registrant asspecified in its charter)

 

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

 

**(972)458-1981**

(Registrant’s telephone number,including area code)

 

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

 

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

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act).

Yes ý        Noo

 

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

 

Common Stock, $.01 par value — 23,873,099 shares as ofNovember 28, 2003.

 

 

----

 

**CARREKER CORPORATION**

 

**Index**

 
| **PART 1:**    | **FINANCIAL  INFORMATION**                                                                                                     |   |
|----------------|--------------------------------------------------------------------------------------------------------------------------------|--------|
|           |                                                                                                                           |   |
| **Item 1.**    | **Financial  Statements (unaudited)**                                                                                          |   |
|           |                                                                                                                           |   |
|           | **Condensed Consolidated Balance Sheets at  October 31, 2003 and January 31, 2003**                                  |   |
|           |                                                                                                                           |   |
|           | **Condensed Consolidated Statements of  Operations for the three and nine months ended October 31, 2003 and 2002**        |   |
|           |                                                                                                                           |   |
|           | **Condensed Consolidated Statements of  Stockholders’ Equity for the three and nine months ended October 31,  2003** |   |
|           |                                                                                                                           |   |
|           | **Condensed Consolidated Statements of Cash  Flows for the three and nine months ended October 31, 2003 and 2002**        |   |
|           |                                                                                                                           |   |
|           | **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 2.**    | **Changes in 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 and Reports on Form 8-K**                                                                                           |   |
|           |                                                                                                                           |   |
| **SIGNATURES** |                                                                                                                           |   |
|           |                                                                                                                           |   |
| **EXHIBITS**   |                                                                                                                           |   |

 

2

----

 

**PART I****:  FINANCIAL INFORMATION**

 

**Item1****.  Financial Statements**

 

**CARREKERCORPORATION**

**CondensedConsolidated Balance Sheets**

**(Unaudited)**

**(Inthousands, except per share amounts)**

 
|                                                                                                                                                        |   | **October 31,  2003** |       | **January 31,  2003** |       |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------|------------|----------------------------|------------|
| **ASSETS**                                                                                                                                                  |   |                       |       |                       |       |
| Current  assets                                                                                                                                             |   |                       |       |                       |       |
| Cash and  cash equivalents                                                                                                                                  |   | $                          | 21,160     |                       | $          | 26,986 |   |
| Accounts  receivable, net of allowance of $1,462 and $1,761 at October 31, 2003  and January 31, 2003, respectively                               |   | 19,488                     |       | 22,759                     |       |
| Prepaid  expenses and other current assets                                                                                                                  |   | 3,933                      |       | 3,380                      |       |
| Total  current assets                                                                                                                                       |   | 44,581                     |       | 53,125                     |       |
|                                                                                                                                                        |   |                       |       |                       |       |
| Property and  equipment, net of accumulated depreciation of $16,288 and $14,704 at  October 31, 2003 and January 31, 2003, respectively           |   | 7,236                      |       | 8,975                      |       |
| Capitalized  software costs, net of accumulated amortization of $10,811 and $10,025 at  October 31, 2003 and January 31, 2003, respectively       |   | 1,428                      |       | 2,010                      |       |
| Acquired  developed technology, net of accumulated amortization of $9,998 and $6,867 at  October 31, 2003 and January 31, 2003, respectively      |   | 15,702                     |       | 17,333                     |       |
| Goodwill,  net of accumulated amortization of $3,405 at October 31, 2003 and  January 31, 2003                                                    |   | 21,193                     |       | 21,193                     |       |
| Customer  relationships, net of accumulated amortization of $3,383 and $2,333 at  October 31, 2003 and January 31, 2003, respectively             |   | 5,017                      |       | 6,067                      |       |
| Deferred  loan costs, net of accumulated amortization of $960 and $676 at  October 31, 2003 and January 31, 2003, respectively                    |   | 748                        |       | 576                        |       |
| Other assets                                                                                                                                                |   | 986                        |       | 829                        |       |
| Total assets                                                                                                                                                |   | $                          | 96,891     |                       | $          | 110,108 |   |
|                                                                                                                                                        |   |                       | ** ** |                       | ** ** |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                               |   |                       | ** ** |                       | ** ** |
| Current  liabilities                                                                                                                                        |   |                       |       |                       |       |
| Accounts  payable                                                                                                                                           |   | $                          | 1,228      |                       | $          | 725 |   |
| Accrued  compensation and benefits                                                                                                                          |   | 7,724                      |       | 7,603                      |       |
| Other  accrued expenses                                                                                                                                     |   | 3,837                      |       | 6,030                      |       |
| Income tax  payable                                                                                                                                         |   | 111                        |       | —                     |       |
| Deferred  revenue                                                                                                                                           |   | 18,177                     |       | 17,600                     |       |
| Accrued  merger and restructuring costs                                                                                                                     |   | 1,846                      |       | 3,735                      |       |
| Total  current liabilities                                                                                                                                  |   | 32,923                     |       | 35,693                     |       |
| Long-term  debt                                                                                                                                             |   | 12,500                     |       | 25,000                     |       |
| Deferred  revenue                                                                                                                                           |   | —                     |       | 817                        |       |
| Other  long-term liabilities                                                                                                                                |   | 49                         |       | —                     |       |
| Total  liabilities                                                                                                                                          |   | 45,472                     |       | 61,510                     |       |
|                                                                                                                                                        |   |                       |       |                       |       |
| Minority interest                                                                                                                                           |   | 49                         |       | —                     |       |
|                                                                                                                                                        |   |                       |       |                       |       |
| 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; 23,860 and 23,574 shares  issued at October 31, 2003 and January 31, 2003, respectively |   | 239                        |       | 236                        |       |
| Additional  paid-in capital                                                                                                                                 |   | 105,219                    |       | 105,263                    |       |
| Accumulated  deficit                                                                                                                                        |   | (54,085                    | )          | (56,386                    | )          |
| Less  treasury stock, at cost:  1 and 27  common shares at October 31, 2003 and January 31, 2003,  respectively                              |   | (3                         | )          | (515                       | )          |
| Total  stockholders’ equity                                                                                                                            |   | 51,370                     |       | 48,598                     |       |
| Total  liabilities and stockholders’ equity                                                                                                            |   | $                          | 96,891     |                       | $          | 110,108 |   |

 

See accompanying notes.

 

3

----

 

**CARREKERCORPORATION**

**Condensed Consolidated Statements ofOperations**

**(Unaudited)**

**(In thousands, except per share amounts)**

 
|                                                 |   | **Three  Months Ended****October 31,** |   | **Nine  Months Ended****October 31,** |   |
|------------------------------------------------------|--------|---------------------------------------------|--------|--------------------------------------------|--------|
|                                                 |   | **2003**                                    |   | **2002**                                   |   | **2003** |   | **2002** |   |
|                                                 |   |                                        |   |                                       |   |   |   |   |   |
| **Revenues:**                                        |   |                                        |   |                                       |   |   |   |   |   |
| Consulting  fees                                     |   | $                                           | 6,396  |                                       | $      | 8,136 |   | $ | 21,349 |   | $ | 30,677 |   |
| Software  license fees                               |   | 7,026                                       |   | 6,330                                      |   | 21,955 |   | 32,430 |   |
| Software  maintenance fees                           |   | 11,770                                      |   | 11,624                                     |   | 34,764 |   | 33,381 |   |
| Software  implementation fees                        |   | 4,983                                       |   | 6,589                                      |   | 14,385 |   | 19,481 |   |
| Out-of-pocket  expense reimbursements                |   | 1,228                                       |   | 1,498                                      |   | 3,367 |   | 5,356 |   |
| Total  revenues                                      |   | 31,403                                      |   | 34,177                                     |   | 95,820 |   | 121,325 |   |
|                                                 |   |                                        |   |                                       |   |   |   |   |   |
| **Cost of revenues:**                                |   |                                        |   |                                       |   |   |   |   |   |
| Consulting  fees                                     |   | 4,936                                       |   | 5,650                                      |   | 15,193 |   | 19,623 |   |
| Software  license fees                               |   | 2,037                                       |   | 1,864                                      |   | 5,662 |   | 5,625 |   |
| Software  maintenance fees                           |   | 3,458                                       |   | 2,486                                      |   | 9,644 |   | 7,730 |   |
| Software  implementation fees                        |   | 4,413                                       |   | 4,651                                      |   | 14,264 |   | 14,480 |   |
| Out-of-pocket  expenses                              |   | 1,122                                       |   | 1,582                                      |   | 3,413 |   | 5,858 |   |
| Total cost  of revenues                              |   | 15,966                                      |   | 16,233                                     |   | 48,176 |   | 53,316 |   |
| Gross profit                                         |   | 15,437                                      |   | 17,944                                     |   | 47,644 |   | 68,009 |   |
|                                                 |   |                                        |   |                                       |   |   |   |   |   |
| **Operating costs and expenses:**                    |   |                                        |   |                                       |   |   |   |   |   |
| Selling,  general and administrative                 |   | 12,153                                      |   | 12,573                                     |   | 36,933 |   | 37,977 |   |
| Research and  development                            |   | 1,734                                       |   | 3,226                                      |   | 5,256 |   | 9,387 |   |
| Amortization  of intangible assets                   |   | 350                                         |   | 350                                        |   | 1,050 |   | 1,050 |   |
| Restructuring  and other charges                     |   | (229                                        | )      | —                                     |   | 1,233 |   | — |   |
| Total  operating costs and expenses                  |   | 14,008                                      |   | 16,149                                     |   | 44,472 |   | 48,414 |   |
| Income from  operations                              |   | 1,429                                       |   | 1,795                                      |   | 3,172 |   | 19,595 |   |
|                                                 |   |                                        |   |                                       |   |   |   |   |   |
| **Other income (expense):**                          |   |                                        |   |                                       |   |   |   |   |   |
| Interest  income                                     |   | 69                                          |   | 138                                        |   | 223 |   | 331 |   |
| Interest  expense                                    |   | (234                                        | )      | (605                                       | )      | (991 | ) | (2,086 | ) |
| Other income  (expense)                              |   | 219                                         |   | 53                                         |   | 269 |   | 91 |   |
| Total other  income (expense)                        |   | 54                                          |   | (414                                       | )      | (499 | ) | (1,664 | ) |
| Income  before provision (benefit) for income taxes  |   | 1,483                                       |   | 1,381                                      |   | 2,673 |   | 17,931 |   |
| Provision  (benefit) for income taxes                |   | 146                                         |   | 392                                        |   | 372 |   | (666 | ) |
| Net income                                           |   | $                                           | 1,337  |                                       | $      | 989 |   | $ | 2,301 |   | $ | 18,597 |   |
| Basic earnings  per share                            |   | $                                           | 0.06   |                                       | $      | 0.04 |   | $ | 0.10 |   | $ | 0.81 |   |
| Diluted earnings per share                           |   | $                                           | 0.05   |                                       | $      | 0.04 |   | $ | 0.10 |   | $ | 0.79 |   |
| Shares used in computing basic earnings per  share   |   | 23,812                                      |   | 23,544                                     |   | 23,635 |   | 23,081 |   |
| Shares used in computing diluted earnings  per share |   | 24,645                                      |   | 23,907                                     |   | 23,820 |   | 23,674 |   |

 

See accompanying notes.

 

4

----

 

**CARREKER CORPORATION**

**CondensedConsolidated Statements of Stockholders’ Equity**

**(Unaudited)**

**(Inthousands)**

 
|                                                                |               |       |       | **Additional  Paid-In  Capital** |       | **Accumulated  Deficit** |   |    |   | **Total  Stockholders’  Equity** |    |
|---------------------------------------------------------------------|--------------------|------------|------------|----------------------------------|------------|--------------------------|--------|---------|--------|---------------------------------------|---------|
| **Common Stock**                                                    | **Treasury Stock** |
| **Shares**                                                          |               | **Amount** | **Shares** |                             | **Amount** |
| Balance at  January 31, 2003                                   |               | 23,574     |       | $                                | 236        |                     | $      | 105,263 |   | $                                     | (56,386 | ) | 27 |   | $ | (515 | ) | $ | 48,598 |   |
|                                                                |               |       |       |                             |       |                     |   |    |   |                                  |    |   |   |   |   |
| Net loss                                                            |               | —     |       | —                           |       | —                   |   | (2,967  | )      | —                                |    | — |   | (2,967 | ) |
| Balance at  April 30, 2003                                     |               | 23,574     |       | 236                              |       | 105,263                  |   | (59,353 | )      | 27                                    |    | (515 | ) | 45,631 |   |
|                                                                |               |       |       |                             |       |                     |   |    |   |                                  |    |   |   |   |   |
| Reissuance  of treasury stock as restricted stock                   |               | —     |       | —                           |       | (512                     | )      | —  |   | (26                                   | )       | 512 |   | — |   |
| Compensation  expense related to issuance of restricted stock       |               | 218        |       | 2                                |       | 33                       |   | —  |   | —                                |    | — |   | 35 |   |
| Net income                                                          |               | —     |       | —                           |       | —                   |   | 3,931   |   | —                                |    | — |   | 3,931 |   |
| Balance at  July 31, 2003                                      |               | 23,792     |       | 238                              |       | 104,784                  |   | (55,422 | )      | 1                                     |    | (3 | ) | 49,597 |   |
|                                                                |               |       |       |                             |       |                     |   |    |   |                                  |    |   |   |   |   |
| Cancellation  of restricted stock                                   |               | (5         | )          | —                           |       | —                   |   | —  |   | —                                |    | — |   | — |   |
| Compensation  expense related to issuance of restricted stock       |               | —     |       | —                           |       | 52                       |   | —  |   | —                                |    | — |   | 52 |   |
| Issuance of  shares of common stock upon exercises of stock options |               | 73         |       | 1                                |       | 383                      |   | —  |   | —                                |    | — |   | 384 |   |
| Net income                                                          |               | —     |       | —                           |       | —                   |   | 1,337   |   | —                                |    | — |   | 1,337 |   |
| Balance at  October 31, 2003                                   |               | 23,860     |       | $                                | 239        |                     | $      | 105,219 |   | $                                     | (54,085 | ) | 1 |   | $ | (3 | ) | $ | 51,370 |   |

 

See accompanying notes.

 

5

----

 

**CARREKER CORPORATION**

**CondensedConsolidated Statements of Cash Flows**

**(Unaudited)**

**(In thousands)**

 
|                                                                                          |   | **Three  Months Ended****October 31,** |   | **Nine Months  Ended****October 31,** |   |
|-----------------------------------------------------------------------------------------------|--------|---------------------------------------------|--------|--------------------------------------------|--------|
|                                                                                          |   | **2003**                                    |   | **2002**                                   |   | **2003** |   | **2002** |   |
| **Operating Activities:**                                                                     |   |                                        |   |                                       |   |   |   |   |   |
| Net income                                                                                    |   | $                                           | 1,337  |                                       | $      | 989 |   | $ | 2,301 |   | $ | 18,597 |   |
| Adjustments  to reconcile net income to net cash provided by (used in) operating  activities: |   |                                        |   |                                       |   |   |   |   |   |
| Depreciation  and amortization of property and equipment                                      |   | 882                                         |   | 1,115                                      |   | 2,588 |   | 3,456 |   |
| Amortization  of capitalized software costs and acquired developed technology                 |   | 1,311                                       |   | 1,513                                      |   | 3,917 |   | 4,391 |   |
| Amortization  of customer relationships                                                       |   | 350                                         |   | 350                                        |   | 1,050 |   | 1,050 |   |
| Provision  for doubtful accounts                                                              |   | (91                                         | )      | 72                                         |   | (118 | ) | 588 |   |
| Amortization  of deferred loan costs                                                          |   | 68                                          |   | 108                                        |   | 284 |   | 324 |   |
| Compensation  earned under restricted stock plan                                              |   | 52                                          |   | —                                     |   | 87 |   | — |   |
| Change in  estimate related to restructuring and other charges                                |   | (540                                        | )      | —                                     |   | (540 | ) | — |   |
| Changes in  operating assets and liabilities:                                                 |   |                                        |   |                                       |   |   |   |   |   |
| Accounts  receivable                                                                          |   | (2,332                                      | )      | (1,716                                     | )      | 3,389 |   | (280 | ) |
| Prepaid  expenses and other assets                                                            |   | (1,574                                      | )      | (457                                       | )      | (710 | ) | 102 |   |
| Accounts  payable and accrued expenses                                                        |   | 164                                         |   | (3,228                                     | )      | (2,918 | ) | (23,695 | ) |
| Income taxes  payable/receivable                                                              |   | 11                                          |   | 7,189                                      |   | 111 |   | 5,475 |   |
| Deferred  revenue                                                                             |   | (4,437                                      | )      | (5,772                                     | )      | (240 | ) | (2,192 | ) |
| Net cash  provided by (used in) operating activities                                          |   | (4,799                                      | )      | 163                                        |   | 9,201 |   | 7,816 |   |
| **Investing Activities:**                                                                     |   |                                        |   |                                       |   |   |   |   |   |
| Purchases of  property and equipment                                                          |   | (279                                        | )      | (1,553                                     | )      | (849 | ) | (3,351 | ) |
| Computer  software costs capitalized                                                          |   | (204                                        | )      | —                                     |   | (204 | ) | (103 | ) |
| Purchase of  acquired developed software                                                      |   | (1,500                                      | )      | —                                     |   | (1,500 | ) | — |   |
| Proceeds  from disposition of assets                                                          |   | —                                      |   | 3                                          |   | — |   | 3 |   |
| Net cash  used in investing activities                                                        |   | (1,983                                      | )      | (1,550                                     | )      | (2,553 | ) | (3,451 | ) |
| **Financing Activities:**                                                                     |   |                                        |   |                                       |   |   |   |   |   |
| Payments on  long-term debt                                                                   |   | —                                      |   | (7,000                                     | )      | (12,500 | ) | (16,000 | ) |
| Payment of  deferred loan costs                                                               |   | —                                      |   | —                                     |   | (456 | ) | — |   |
| Proceeds  from exercises of stock options                                                     |   | 384                                         |   | 36                                         |   | 384 |   | 2,277 |   |
| Minority  interest and minority shareholder loan to Carretek LLC                              |   | 98                                          |   | —                                     |   | 98 |   | — |   |
| Proceeds  from sale of common stock                                                           |   | —                                      |   | —                                     |   | — |   | 9,323 |   |
| Net cash  provided by (used in) financing activities                                          |   | 482                                         |   | (6,964                                     | )      | (12,474 | ) | (4,400 | ) |
| Net decrease  in cash and cash equivalents                                                    |   | (6,300                                      | )      | (8,351                                     | )      | (5,826 | ) | (35 | ) |
| Cash and  cash equivalents at beginning of period                                             |   | 27,460                                      |   | 33,990                                     |   | 26,986 |   | 25,674 |   |
| Cash and  cash equivalents at end of period                                                   |   | $                                           | 21,160 |                                       | $      | 25,639 |   | $ | 21,160 |   | $ | 25,639 |   |
|                                                                                          |   |                                        |   |                                       |   |   |   |   |   |
| Supplemental  disclosures of cash flow information:                                           |   |                                        |   |                                       |   |   |   |   |   |
| Cash paid  for interest                                                                       |   | $                                           | 79     |                                       | $      | 526 |   | $ | 748 |   | $ | 1,755 |   |
| Cash paid  (received) for income taxes, net                                                   |   | $                                           | 118    |                                       | $      | (6,796 | ) | $ | 248 |   | $ | (6,140 | ) |

 

See accompanying notes.

 

6

----

 

**Carreker Corporation**

**Notes to Condensed Consolidated Unaudited FinancialStatementsFor the Three and Nine Months Ended October 31, 2003 and 2002**

 

**1.****              Descriptionof Business**

 

CarrekerCorporation (“the Company,” “Carreker,” “our,” “we”) provides payments-relatedsoftware and consulting solutions to financial institutions and financialservice providers.  These solutions helpthe Company’s customers improve operational efficiency in how payments areprocessed; enhance revenue and profitability from payments-oriented productsand services; reduce losses associated with fraudulent payment transactions;and evolve toward next-generation payment practices and technologies.

 

**2.****              Summaryof Significant Accounting Procedures**

 

**Principles of Consolidation and Presentation**

 

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.

 

Certainprepaid expenses, other assets, accounts payable and other accrued expensesamounts at January 31, 2003 have been reclassified to conform to thecurrent presentation.

 

The accompanying condensed consolidatedunaudited financial statements and notes have been prepared in accordance withthe rules and regulations of the Securities and Exchange Commission for Form10-Q and include all of the information and disclosures required by generallyaccepted accounting principles for interim financial reporting.  The results of operations, for the three andnine months ended October 31, 2003, are not necessarily indicative offull-year results.

 

These financial statements should be read inconjunction with the financial statements, accounting policies and financialnotes included in the Company’s Annual Report on Form 10-K for the fiscal yearended January 31, 2003, filed with the Securities and ExchangeCommission.  In the opinion ofmanagement, the accompanying condensed consolidated unaudited financialstatements reflect all adjustments (consisting only of normal recurringadjustments) that are necessary for a fair representation of financial resultsfor the interim periods presented.

 

We restatedour audited financial statements for the years ended January 31, 2002,2001, 2000 and 1999, and our unaudited financial statements for each of thequarters in the year ended January 31, 2002 and for the quarters endedApril 30, 2002 and July 31, 2002. Refer to the Company’s Form 10-K for the year ended January 31,2003 for details of the restatement as well as the impact of the restatement onthe years and quarters previously reported.

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States requires the use of estimates andassumptions that affect the amounts reported in the financial statements andaccompanying notes.  As discussed below,the Company makes significant estimates and assumptions in the areas ofaccounts 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 and Cash Equivalents**

 

The Companyconsiders all highly liquid investments with maturities of three months or lesswhen purchased to be cash equivalents. Cash and cash equivalents primarilyconsist of demand deposit accounts and shares in a demand money market accountcomprised of domestic and foreign commercial paper, certificates of deposit andU.S. government obligations that are maintained with nationally recognizedfinancial institutions.

 

7

----

 

**Accounts Receivable****and Concentration of Credit Risk**

 

Financialinstruments, which potentially subject the Company to concentration of creditrisk, consist principally of temporary cash investments and accountsreceivable.  The Company placestemporary cash investments with financial institutions and limits its exposurewith any one financial institution.

 

A significantportion of the Company’s business consists of providing consulting services andlicensing software to major domestic and international banks, which gives riseto a concentration of credit risk in receivables. The Company performs on-goingcredit evaluations of its customers’ financial condition and generally requiresno collateral. Because the Company’s accounts receivable are typicallyunsecured, the Company periodically evaluates the collectibility of itsaccounts based on a combination of factors, including a particular customer’sability to pay as well as the age of receivables.  To evaluate a specific customer’s ability to pay, the Companyanalyzes financial statements, payment history, and various information ordisclosures by the customer or other publicly available information.  In cases where the evidence suggests acustomer may not be able to satisfy its obligation to the Company or if thecollection of the receivable becomes doubtful due to a dispute that arisessubsequent to the delivery of the Company’s products and services, the Companysets up a reserve in an amount determined appropriate for the perceivedrisk.  Most of the Company’s contractsinclude multiple payment milestones, some of which occur in advance of revenuerecognition, which mitigates the risk both in terms of collectibility andadjustments to recorded revenue.

 

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

 

Accountsreceivable, net of allowances, consist of the following (in thousands):

 
|                                  |   | **October 31,  2003** |   | **January 31,  2003** |   |
|---------------------------------------|--------|----------------------------|--------|----------------------------|--------|
|                                  |   |                       |   |                       |   |
| Gross  accounts receivable            |   | $                          | 54,097 |                       | $      | 74,918 |   |
| Less amounts  in deferred revenue     |   | (33,147                    | )      | (50,398                    | )      |
| Less allowance  for doubtful accounts |   | (1,462                     | )      | (1,761                     | )      |
| Net accounts  receivable              |   | $                          | 19,488 |                       | $      | 22,759 |   |

 

**Property and Equipment**

 

Property andequipment are stated at cost. Depreciation is calculated using thestraight-line method over the estimated useful lives of the respective assets,generally from three to five years. Leasehold improvements are amortized usingthe straight-line method over the shorter of the terms of the related leases orthe respective useful lives of the assets.  The components of property and equipment are as follows (in thousands):

 
|                                            |   | **October 31,  2003** |   | **January 31,  2003** |   |
|-------------------------------------------------|--------|----------------------------|--------|----------------------------|--------|
| Furniture                                       |   | $                          | 5,070  |                       | $      | 5,071 |   |
| Equipment  and software                         |   | 17,380                     |   | 17,406                     |   |
| Leasehold  improvements                         |   | 1,074                      |   | 1,202                      |   |
| Total cost                                      |   | 23,524                     |   | 23,679                     |   |
|                                            |   |                       |   |                       |   |
| Less  accumulated depreciation and amortization |   | (16,288                    | )      | (14,704                    | )      |
| Net property  and equipment                     |   | $                          | 7,236  |                       | $      | 8,975 |   |

 

The Companyaccounts for the costs of computer software developed or obtained for internaluse in accordance with Statement of Position No. 98-1, “*Accounting for the Costs of Computer SoftwareDeveloped or Obtained for Internal Use,”* (“SOP 98-1”)*.* The Company capitalizes costs of consultants, as well as payroll andpayroll-related costs for employees incurred in developing internal-usecomputer software.  These costs areincluded in “Equipment and Software”. Costs incurred during preliminary project and post-implementation stagesare charged to expense.

 

8

----

 

**Long Lived Assets**

 

The Company accounts for goodwill and otherintangible assets in accordance with Statement of Financial AccountingStandards No. 142, *“Goodwill and OtherIntangible Assets,”* (SFAS 142). Under the provisions of SFAS 142, an annual assessment of goodwillimpairment is performed.  Thisassessment involves the use of estimates related to fair market values of theCompany’s reporting units with which the goodwill is associated.  The assessment of goodwill impairment in thefuture will be impacted if future operating cash flows of the Company’sreporting units decline, which would result in decreases in the relatedestimate of fair market value.  TheCompany performs its annual impairment analysis as of November 1stof each year and whenever facts and circumstances indicate impairment may exist.  Intangible assets not subject toamortization are tested annually for impairment, and are tested for impairmentmore frequently if events and circumstances indicate that an asset might beimpaired.  An impairment loss isrecognized to the extent that the carrying amount exceeds the asset’s fairvalue.

 

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

 

**Deferred Loan Costs**

 

Deferred loan costs consist of loan closingcosts and other administrative expenses associated with the Revolving CreditAgreement.  On July 31, 2003, theRevolving Credit Agreement was amended as described in Note 5.  In connection with this amendment, theCompany incurred approximately $450,000 of deferred loan costs.  These costs, along with the net book valueof the original deferred loan costs, are being amortized to interest expenseover the 36 month life of the Revolving Credit Agreement.

 

**CapitalizedSoftware Costs and Acquired Developed Technology**

 

The Company capitalizes the development costsof software, other than internal-use software, in accordance with Statement ofFinancial Accounting Standards No. 86, “*Accountingfor Costs of Computer Software to be Sold, Leased or Otherwise Marketed,”*(“SFAS 86”).  The Company’s policy is tocapitalize software development costs incurred in developing a product, oncetechnological feasibility of the product has been established.  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 adetail program design, technological feasibility is determined only after completionof a working model which has been beta tested. All software development costscapitalized are amortized using an amount determined as the greater of: (1) theratio that current gross revenues for a capitalized software project bears tothe total of current and estimated future gross revenues for that project or(2) the straight-line method over the remaining economic life of the product(generally three to six years). The Company capitalized $204,000 of softwarecosts for the three months ended October 31, 2003 and did not capitalizeany software costs for the three months ended October 31, 2002.  The Company capitalized $204,000 and$103,000 of software costs during the nine months ended October 31, 2003and 2002, respectively.  The Company isdeveloping software for sending and receiving check images.  The product reached technologicalfeasibility in October 2003, and accordingly certain costs subsequentlyincurred were capitalized under SFAS 86.

 

The Company recorded amortization related tocapitalized software costs of $239,000 and $484,000 for the three months endedOctober 31, 2003 and 2002, respectively. The Company recorded amortization related to capitalized software costsof $781,000 and $1.3 million for the nine months ended October 31, 2003and 2002, respectively.  Amortizationexpense is recorded as a component of cost of software license fees in theaccompanying condensed consolidated unaudited statements of operations.

 

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

 

9

----

 

In October 2003, the Company purchasedan anti-money laundering software solution designed to help banks protect boththeir customers and their corporate reputations from the growing risk offinancial fraud and to comply with a growing number of laws and regulations.  The $1.5 million purchase price was recordedin acquired developed technology in the accompanying condensed consolidatedbalance sheets and will be amortized over a 3-year period.

 

Acquired developed technology with a usefullife of 3-6 years is amortized on a straight-line basis, resulting inamortization expense of $1.1 million and $1.0 million for the three monthsended October 31, 2003 and 2002, respectively, and $3.1 million for eachof the nine-month periods ended October 31, 2003 and 2002.  Amortization expense is recorded as acomponent of cost of software license fees in the accompanying unauditedcondensed consolidated statement of operations.

 

The following table sets forth the estimatedamortization expense of capitalized software costs and acquired developedtechnology for the indicated fiscal years ending January 31 (inthousands):

 
| **Year** |   | **Capitalized  Software  Costs** |   | **Acquired  Developed  Technology** |   |
|----------|--------|----------------------------------|--------|-------------------------------------|--------|
| 2004     |   | $                                | 1,021  |                                | $      | 4,287 |   |
| 2005     |   | 837                              |   | 4,620                               |   |
| 2006     |   | 148                              |   | 4,620                               |   |
| 2007     |   | —                           |   | 4,107                               |   |
| 2008     |   | —                           |   | 1,200                               |   |
|          |        |                                  |        |                                     |        |  |  |

 

**RevenueRecognition**

 

The Company’s revenue recognition policiesare in accordance with Statement of Position (“SOP”) 97-2, *“Software Revenue Recognition,”*as amended by SOP 98-9, “*Modification of SOP 97-2,**SoftwareRevenue Recognition with Respect to Certain Transactions,”* and StaffAccounting Bulletin (“SAB”) No. 101, *“Revenue Recognition in Financial Statements.”*  In the case of software arrangements thatrequire significant production, modification, or customization of software, orthe license agreement requires the Company to provide implementation servicesthat are determined to be essential to other elements of the arrangement, theCompany follows the guidance in SOP 81-1, *“Accounting for Performance of Construction – Typeand Certain Production – Type Contracts.”*

 

*Consulting Fees.*  The Company employs three primary pricing methods in connectionwith its delivery of consulting services. First, the Company may price itsdelivery of consulting services on the basis of time and materials, in whichcase the customer is charged agreed-upon daily rates for services performed andout-of-pocket expenses. In this case, the Company is generally paid fees andrelated amounts on a monthly basis, and the Company recognizes revenues as theservices are performed. Second, the Company may deliver consulting services ona fixed-price basis. In this case, the Company is paid on a monthly basis orpursuant to an agreed upon payment schedule, and the Company recognizesrevenues on a percentage-of-completion basis. The Company believes that this method is appropriate because of itsability to determine performance milestones and determine dependable estimatesof its costs applicable to each phase of a contract.  Because financial reporting of these contracts depends onestimates, which are assessed continually during the term of the contract,costs are subject to revisions as the contract progresses.  Anticipated losses on fixed-price contractsare recognized when estimatable.  Third,the Company may deliver consulting services pursuant to a value-priced contractwith the customer. In this case, the Company is paid, on an agreed upon basiswith the customer, either a specified percentage of (1) the projectedincreased revenues and/or decreased costs that are expected to be derived by thecustomer generally over a period of up to twelve months followingimplementation of its solution or (2) the actual increased revenues and/ordecreased costs experienced by the customer generally over a period of up totwelve months following implementation of its solution, subject in either caseto a maximum, if any is agreed to, on the total amount of payments to be madeto the Company.  The Company must firstcommit time and resources to develop projections associated with value-pricingcontracts before a bank will commit to purchase its solutions, and the Companytherefore assumes the risk of making these commitments with no assurance thatthe bank 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 uponschedule ranging from one to twelve months in length.  The Company recognizes revenues generatedfrom consulting services in connection with value-priced contracts based uponprojected results only upon completion of all services and agreement upon theactual fee to be paid (even though billings for these services may be delayedby mutual agreement for periods not to exceed twelve months). In an effort toallow customers to more closely match expected benefits from services withpayments to the Company, the Company on occasion, 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

 

10

----

 

will be recognized as payments become due and payable.  When fees are to be paid based on apercentage 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 with time and materials,fixed-priced and value-priced consulting fee arrangements are expensed asincurred and are included as a component of the cost of consulting fees.

 

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

 

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

 

*Software License Fees.*  A software license is sold either togetherwith 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.  Under SOP97-2, the Company recognizes software license revenue upon execution of acontract and delivery of the software, provided that the license fee is fixedand determinable, no significant production, modification or customization ofthe software is required and collection is considered probable bymanagement.  When the software licensearrangement requires the Company to provide implementation services that areessential to the functionality of the software or significant production,customization or modification of the software is required, both the productlicense revenue and implementation fees are recognized as services areperformed.

 

Software licenses are often sold as part of amultiple element arrangement that may include maintenance, implementation orconsulting.  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 total arrangement fee isallocated based on the relative fair value of each element.  In cases where there is not VSOEFV for eachelement, or if it is determined services are essential to the functionality ofthe software being delivered, or if significant production, modification orcustomization of the software is required, the Company defers revenuerecognition of the software license fees. 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 as set forth in SOP 98-9.  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 forsoftware products based on actual sales prices for the product sold to asimilar class of customer and based on pricing strategies set forth in theCompany’s price book.  Evidence ofVSOEFV for services (implementation and consulting) is based upon standardbilling rates and the estimated level of effort for individuals expected toperform the related services.  TheCompany establishes VSOEFV for maintenance agreements using the percentagemethod such that VSOEFV for maintenance is a percentage of the license feecharged annually for a specific software product, which in most instances is20% of the portion of arrangement fees allocated to the software licenseelement.

 

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

 

*Software Maintenance Fees.*  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 isreceived, revenue is recognized for the period that revenue was previouslydeferred.  This may result in volatilityin software maintenance revenue from period to period.

 

*Software Implementation Fees.*  In connection with the sale of a softwarelicense, a customer may elect to purchase software implementation services,including software enhancements, patches and other software support services.Most of the customers that purchase software licenses from the Company alsopurchase software implementation services. The Company prices its implementation services on a time-and-materialsor on a fixed-price basis, and the Company recognizes the related revenues asservices are performed.  Costsassociated with these engagements are expensed as incurred.

 

11

----

 

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

 

**Royalties**

 

In connection with software license andmaintenance agreements entered into with certain banks and purchase agreementswith vendors under which the Company acquired software technology used inproducts sold to its customers, the Company is required to pay royalties onsales of certain software products. Under these arrangements, the Company accrues royalty expense when theassociated revenue is recognized.  Forcurrent product offerings, the royalty percentages generally range from 20% to30% of the associated revenues. Approximately $718,000 and $384,000 of royalty expense was recordedunder these agreements for the three months ended October 31, 2003 and2002, respectively, and $1.7 million and $1.8 million for the nine months endedOctober 31, 2003 and 2002, respectively. Royalty expense is included as a component of the cost of softwarelicense fees and cost of software maintenance fees in the accompanying condensedconsolidated statements of operations.

 

**DeferredRevenue**

 

Deferred revenue represents amounts paid by customersunder terms specified in consulting, software licensing, and maintenancecontracts for which completion of contractual terms or delivery of the softwarehas not occurred.  Non-current deferredrevenue represents amounts for maintenance to be provided beginning in periodsin excess of one year.

 

Deferred revenue and advance payments fromcustomers consist of the following (in thousands)

 
|                                                   |   | **October 31,  2003** |   | **January 31,  2003** |   |
|--------------------------------------------------------|--------|----------------------------|--------|----------------------------|--------|
| Current:                                               |   |                       |   |                       |   |
| Deferred  software maintenance fees                    |   | $                          | 30,949 |                       | $      | 38,764 |   |
| Deferred  software implementation and license fees     |   | 20,375                     |   | 29,234                     |   |
|                                                   |   | 51,324                     |   | 67,998                     |   |
| Less amounts  in accounts receivable                   |   | (33,147                    | )      | (50,398                    | )      |
| Net deferred  revenue and advance payments             |   | $                          | 18,177 |                       | $      | 17,600 |   |
|                                                   |   |                       |   |                       |   |
| Non-current:                                           |   |                       |   |                       |   |
| Deferred  software maintenance fees                    |   | $                          | — |                       | $      | 817 |   |
|                                                   |   |                       |   |                       |   |
| Less amount  in accounts receivable                    |   | —                     |   | —                     |   |
| Net  non-current deferred revenue and advance payments |   | $                          | — |                       | $      | 817 |   |

 

**Researchand Development Costs**

 

Research and development costs, that are notsubject to capitalization under Statement of Financial Accounting Standards No.86, “*Accounting for the Cost of ComputerSoftware to be Sold, Leased, or Otherwise Marketed,”* (“SFAS 86”) areexpensed as incurred and relate mainly to the development of new products, newapplications, new features or significant enhancements for existing products orapplications.

 

**Income Taxes**

 

The Company accounts for income taxes usingthe liability method, whereby deferred tax assets and liabilities aredetermined based on differences between financial reporting and tax basis ofassets and liabilities measured using enacted tax rates and laws that will bein 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 share is computed usingthe weighted average number of shares of common stock outstanding during eachperiod. Diluted earnings per share is computed using the weighted averagenumber of shares of common stock outstanding during each period and common equivalentshares consisting of stock options (using the treasury stock method).

 

12

----

 

**Stock-BasedCompensation**

 

The Company has elected to follow AccountingPrinciples Board (“APB”), Opinion No. 25, “*Accountingfor Stock Issued to Employees*,” in accounting for its employees anddirector stock options.  Under APB 25,if the exercise price of a stock option equals or exceeds the market price ofthe underlying stock on the date of grant, no compensation expense is recognized.  The Company accounts for stock-basedcompensation for non-employees under the fair value method prescribed by SFAS123, “*Accounting for Stock-BasedCompensation”* (“SFAS 123”). Through October 31, 2003, there have been no significant grants tonon-employees.

 

On June 20, 2003, the Company issued245,000 shares of restricted common stock to several employees.  The market price of the stock was$4.35.  The stock vests one-third onJune 20, 2006, one-third on June 20, 2007 and one-third onJune 20, 2008.  The Company isamortizing the resulting compensation expense on a straight-line basis from thedate of issuance through June 20, 2008, and any forfeitures will beaccounted for in the period the forfeiture takes place.

 

Pursuant to the Director Stock Option Plan,each outside director on August 1st is granted a number ofoptions with an aggregate Black-Scholes valuation of $60,000.  On August 1, 2003, each outsidedirector received 8,871 options under the Director Stock Option Plan with aBlack-Scholes Valuation of $28,210.  Asthere were no further options available for grant under the Director StockOption Plan, on August 27, 2003, each outside director received anadditional 8,662 options from the 1994 Incentive Stock Option Plan with theremaining Black-Scholes valuation of $31,790.

 

Although SFAS 123 allows APB 25 guidelines to beapplied in accounting for stock options, the Company is required to disclosepro forma net income (loss) and net income (loss) per share as if they hadadopted SFAS 123.  The following tablesets forth the pro forma information as if the provisions of SFAS 123 had beenapplied to account for stock based compensation (in thousands, except per sharedata):

 
|                                                                                             |   | **Three  Months Ended****October 31,** |   | **Nine  Months Ended****October 31,** |   |
|--------------------------------------------------------------------------------------------------|--------|---------------------------------------------|--------|--------------------------------------------|--------|
|                                                                                             |   | **2003**                                    |   | **2002**                                   |   | **2003** |   | **2002** |   |
|                                                                                             |   |                                        |   |                                       |   |   |   |   |   |
| Net income,  as reported                                                                         |   | $                                           | 1,337  |                                       | $      | 989 |   | $ | 2,301 |   | $ | 18,597 |   |
| Pro forma  stock compensation expense computed under the fair value method, net of  income taxes |   | 669                                         |   | 744                                        |   | 2,049 |   | 2,231 |   |
| Pro forma  net income                                                                            |   | $                                           | 668    |                                       | $      | 245 |   | $ | 252 |   | $ | 16,366 |   |
|                                                                                             |   |                                        |   |                                       |   |   |   |   |   |
| Basic  earnings per common share, as reported                                                    |   | $                                           | 0.06   |                                       | $      | 0.04 |   | $ | 0.10 |   | $ | 0.81 |   |
| Diluted  earnings per common share, as reported                                                  |   | $                                           | 0.05   |                                       | $      | 0.04 |   | $ | 0.10 |   | $ | 0.79 |   |
| Pro forma  basic earnings per common share                                                       |   | $                                           | 0.03   |                                       | $      | 0.01 |   | $ | 0.01 |   | $ | 0.71 |   |
| Pro forma  diluted earnings per common share                                                     |   | $                                           | 0.03   |                                       | $      | 0.01 |   | $ | 0.01 |   | $ | 0.69 |   |

 

**Risksand Uncertainties**

 

The Company’s future results of operationsand financial condition could be impacted by the following factors, amongothers: dependence on the banking industry, decline in check volumes,fluctuations in operating results, use of fixed-price or value-pricedarrangements, lack of long-term agreements, ability to manage growth,dependence on key personnel, product liability, rapid technological change anddependence on new products, dependence on third-party providers and theInternet, new focus on providing business process outsourcing with significantoffshore component, ability to attract and retain qualified personnel, customerconcentration, indebtedness, competition, potential strategic alliances andacquisitions, proprietary rights, infringement claims and legal proceedings,dependence on third parties for technology licenses, liability claims, classaction lawsuits, stock price fluctuations, continued NASDAQ listing,international operations, use of independent contractors, changing governmentand tax regulations, anti-takeover provisions in the Company’s charter andimpairment of goodwill, capitalized software costs, acquired developedtechnology or intangible assets. Negative trends in the Company’s operating results could result innoncompliance of financial covenants related to its revolving credit agreement,which could impair the Company’s liquidity. See description of the Company’s revolving credit agreement and relatedfinancial covenants in Note 5.

 

13

----

 

**Recently IssuedAccounting Standards**

 

In November 2002, the EITF reached aconsensus on Issue 00-21, *“MultipleDeliverable Revenue Arrangements.”* EITF 00-21 addresses certain aspects of the accounting by a vendor forarrangements under which it will perform multiple revenue-generatingactivities.  It also addresses when andhow an arrangement involving multiple deliverables should be divided intoseparate units of accounting.  Theguidance in EITF 00-21 is effective for revenue arrangements entered into infiscal periods beginning after June 15, 2003, with early applicationpermitted.  Companies may elect toreport the change in accounting as a cumulative effect of a change inaccounting principle in accordance with APB Opinion 20, *“Accounting Changes” and SFAS 3, “ReportingAccounting Changes in Interim Financial Statements (an amendment of APB OpinionNo. 28).”*  The adoption ofEITF 00-21 did not have a significant impact on our accounting for multipleelement arrangements.

 

In June 2003, the FASB issuedInterpretation No. 46, “Consolidation of Variable Interest Entities.”  Interpretation No. 46 clarifies theapplication of Accounting Research Bulletin No. 51 and applies immediately toany variable interest entities created after January 31, 2003 and tovariable interest entities in which an interest is obtained after that date.  This Interpretation is applicable to theCompany in the quarter ending October 31, 2003, for interests acquired invariable interest entities prior to February 1, 2003.  This Interpretation requires variableinterest entities to be consolidated if the equity investment at risk is notsufficient to permit an entity to finance its activities without support fromother parties or the equity investors lack specified characteristics.  The adoption of the Interpretation did notto have a material impact on the Company’s financial statements.

 

**3.****              BusinessCombinations**

 

On June 6, 2001, the Company completedthe acquisition of Check Solutions Company, a New York general partnership(“Check Solutions”), for $110.2 million in cash, plus an additional $2.0million of direct acquisition costs. Check Solutions is a check and image processing software andinstallation business that services the payment-processing sector of thefinancial industry.  The operating resultsof Check Solutions are reported as part of the Business Segments and Revenue Concentrationfootnote in the Global Payments Technologies segment.  The Company funded the acquisition with $65.2 million in cash andfunded the remaining $45.0 million from proceeds under the revolving creditagreement as described in Note 5.

 

The acquisition was accounted for by thepurchase method of accounting, and accordingly, the statements of operationsinclude the results of Check Solutions beginning June 6, 2001.  The assets acquired and liabilities assumedwere recorded at estimated fair values determined by the Company’s management,based on information currently available and on current assumptions aboutfuture operations.  The Company hasobtained an independent appraisal of the fair values of the identifiedintangible assets, which are being amortized on a straight-line basis.

 

A summary of the assets acquired andliabilities assumed in the acquisition follows (in thousands):

 
| Net assets  of Check Solutions                                          |   | $      | 6,702   |
|-------------------------------------------------------------------------|--------|--------|---------|
| Current  technology and software products (estimated life of 5-6 years) |   | 24,200 |
| Customer  relationships (estimated life of 6 years)                     |   | 8,400  |
| Assembled  workforce                                                    |   | 5,600  |
| Goodwill                                                                |   | 64,998 |
| In-process  research and development                                    |   | 2,300  |
| Total  purchase price                                                   |   | $      | 112,200 |
|                                                                    |   |   |    |

 

In connection with the acquisition of CheckSolutions, a portion of the purchase price was allocated to acquired in-processresearch and development (“IPR&D”). The $2.3 million attributed to IPR&D was expensed on the date of theacquisition as the IPR&D projects had not reached technological feasibilitynor had any alternative future use.  Thecharge was included in merger, restructuring and other charges in the statementof operations.

 

14

----

 

**4.****              Goodwilland Intangible Assets**

 

The Company adopted SFAS No. 142, *“Goodwill and Other Intangible Assets,”*effective February 1, 2002.  UnderSFAS 142, goodwill and intangible assets deemed to have indefinite lives are nolonger amortized but are subject to annual impairment tests in accordance withthis statement.  Customer relationshipswill continue to be amortized over their useful lives.

 

The Company performed an evaluation of its existinggoodwill and intangible assets effective November 1, 2002 in accordancewith its policy, utilizing various assumptions and factors to estimate futurecash flows to determine the fair value of the business.  Due to a decline in the estimated fair valueof the reporting unit to which goodwill has been assigned subsequent to theannual assessment date, the Company determined goodwill was impaired during thequarterly period ended January 31, 2003 and the Company recorded a chargeof $46.0 million during that period to reflect the impairment of goodwill andintangible assets based on declines in the estimated fair value of the GlobalPayments Technologies segment to which goodwill is allocated.  Fair value was determined considering anumber of fair value estimation techniques, including a discounted cash flowanalysis and consideration of the market price of the Company’s stock.

 

Customer relationships with definite usefullives are amortized on a straight-lined basis, resulting in amortizationexpense of $350,000 for the three month periods ended October 31, 2003 and2002, respectively, and $1.1 million for the nine month periods ended October 31,2003 and 2002, respectively.

 

The following table sets forth the estimatedamortization expense of customer relationships for the indicated fiscal yearsending January 31 (in thousands):

 
| **Year** |   | **Customer  Relationships** |   |
|----------|--------|-----------------------------|--------|
| 2004     |   | $                           | 1,400  |   |
| 2005     |   | 1,400                       |   |
| 2006     |   | 1,400                       |   |
| 2007     |   | 1,400                       |   |
| 2008     |   | 467                         |   |
|          |        |                             |        |  |

 

**5.****              RevolvingCredit Agreement**

 

On June 6, 2001, the Company enteredinto a three-year revolving credit agreement with a group of banks in an amountnot to exceed $60.0 million to fund the acquisition of Check Solutions.  On July 31, 2003, the revolving creditwas amended to reduce the commitment amount to $30.0 million, and to extend thematurity date of outstanding borrowings to July 31, 2006.  Borrowings under the credit agreement, asamended, currently bear interest equal to either the greater of prime orfederal funds rate plus a margin ranging from 1.25% to 2.25% depending on theCompany’s ratio of funded debt to Earnings before Interest, Taxes, Depreciationand Amortization (“EBITDA”), or LIBOR plus a margin equal to 2.75% to 3.75%depending on the Company’s ratio of funded debt to EBITDA.  Interest payments are due quarterly.  The Company is required to pay a commitmentfee equal to 0.50% on the unused amount of the revolving credit agreement.  The revolving credit agreement containscustomary affirmative and negative covenants, including financial covenantsrequiring the maintenance of specified interest coverage, ratio of EBITDA tofunded debt, and ratio of 80% of accounts receivable, cash and short-terminvestments to funded debt.  Theinterest coverage covenant was amended on July 31, 2003 to be morefavorable to the Company.  Additionally,the payment of dividends is precluded except upon approval of the banks.  Substantially all of the Company’s assetscollateralize the revolving credit agreement. As of October 31, 2003, the Company is in compliance with thecovenants of the revolving credit agreement, as amended.

 

At October 31, 2003, the Company had$12.5 million outstanding under the credit agreement.  At October 31, 2003, the interest rate on the debt was4.375% on 50% of the outstanding borrowings and 4.50% on the remaining50%.  Because the interest on the debtis variable, the carrying value approximates the fair value.  Interest expense, exclusive of the amortizationof deferred loan costs, on the credit agreement was $166,000 and $496,000 forthe three months ended October 31, 2003 and 2002, respectively, and$707,000 and $1.7 million for the nine months ended October 31, 2003 andOctober 31, 2002, respectively.

 

15

----

 

**6.****              CommonStock Offering**

 

On April 5, 2002, the Company sold1,282,214 shares to a group of institutional investors in a privatetransaction.  In connection with thistransaction, the Company filed a registration statement on Form S-3 followingthe filing of its annual report on Form 10-K for the year endedJanuary 31, 2002, to register the resale of such shares.  The Form S-3 was deemed effective on May 15,2002.  On April 5, 2002, theCompany utilized the net proceeds of approximately $9.3 million received fromthe sale to satisfy remaining obligations due certain employees of CheckSolutions described in Note 13 below, with the remainder used for workingcapital.

 

**7.****              Provision(Benefit) for Income Taxes**

 

The Company has established a valuationallowance to reserve its net deferred tax assets at October 31, 2003because the more likely than not criteria for future realization of theCompany’s net deferred tax assets specified in Statements of FinancialAccounting Standards No. 109, “*Accountingfor Income Taxes,”* (“SFAS No. 109”) were not met.

 

The net tax provision of $146,000 and$372,000 for the three and nine months ended October 31, 2003,respectively, consists of a provision for state and foreign taxes.  The effective tax rate varies from thefederal statutory rate in 2003 primarily due to the expected utilization of netoperating loss carryforwards.  The nettax provision of $392,000 for the three months ended October 31, 2002consists of a provision for state and foreign taxes based on the estimatedannual effective rate for the year ended January 31, 2002.  The net tax benefit of $666,000 for the ninemonths ended October 31, 2002 consists of a $1.9 million tax benefitgenerated by additional tax loss carrybacks available to the Company as aresult of the Job Creation and Workers Assistance Act of 2002, offset by a $1.2million provision for state and foreign taxes based on the estimated annualeffective tax rate for the year ending January 31, 2002.  The estimated annual effective tax rate in2002 was lower than the statutory federal and state rates as a result of thebenefits from carryforward of net operating losses expected to be utilized.

 

**8.****              IncentiveCompensation Plans**

 

In 2002, the Company introduced two newincentive programs to employees.  Thevariable compensation plan awards employees based on quarterly Companyoperating results.  At October 31,2003, substantially all employees are eligible to participate in the variablecompensation plan.  The Company did notrecord any expense under this plan for the three months ended October 31,2003 and October 31, 2002.  TheCompany did not record any expense under this plan for the nine months endedOctober 31, 2003 and recorded $1.5 million in the nine months endedOctober 31, 2002.

 

The incentive bonus plan awards employeesbased on the Company’s and the applicable business unit’s operatingresults.  Substantially, all employeesare eligible to receive cash awards under the incentive bonus plan.  Awards from this plan are paid to employeessubsequent to the end of the fiscal year. The Company recorded expense under this plan of $509,000 in the threemonths ended October 31, 2003. During the three months ended October 31, 2002, corporate operatingresults declined resulting in a reversal of approximately $881,000 of accruedincentive bonus expense.  The Companyrecorded expense under this plan of $1.6 million and $1.5 million in the ninemonths ended October 31, 2003 and 2002, respectively.

 

16

----

 

**9.****              EarningsPer Share**

 

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

 
|                                                   |   | **Three  Months Ended****October 31,** |   | **Nine  Months Ended****October 31,** |   |
|--------------------------------------------------------|--------|---------------------------------------------|--------|--------------------------------------------|--------|
|                                                   |   | **2003**                                    |   | **2002**                                   |   | **2003** |   | **2002** |   |
|                                                   |   |                                        |   |                                       |   |   |   |   |   |
| Basic  earnings per share:                             |   |                                        |   |                                       |   |   |   |   |   |
| Net income                                             |   | $                                           | 1,337  |                                       | $      | 989 |   | $ | 2,301 |   | $ | 18,597 |   |
|                                                   |   |                                        |   |                                       |   |   |   |   |   |
| Weighted  average shares outstanding                   |   | 23,812                                      |   | 23,544                                     |   | 23,635 |   | 23,081 |   |
|                                                   |   |                                        |   |                                       |   |   |   |   |   |
| Basic  earnings per share                              |   | $                                           | 0.06   |                                       | $      | 0.04 |   | $ | 0.10 |   | $ | 0.81 |   |
|                                                   |   |                                        |   |                                       |   |   |   |   |   |
| Diluted  earnings per share:                           |   |                                        |   |                                       |   |   |   |   |   |
| Net income                                             |   | $                                           | 1,337  |                                       | $      | 989 |   | $ | 2,301 |   | $ | 18,597 |   |
|                                                   |   |                                        |   |                                       |   |   |   |   |   |
| Weighted  average shares outstanding                   |   | 23,812                                      |   | 23,544                                     |   | 23,635 |   | 23,081 |   |
| Assumed  conversion of employee stock options          |   | 833                                         |   | 363                                        |   | 185 |   | 593 |   |
| Shares used  in diluted earnings per share calculation |   | 24,645                                      |   | 23,907                                     |   | 23,820 |   | 23,674 |   |
|                                                   |   |                                        |   |                                       |   |   |   |   |   |
| Diluted  earnings per share                            |   | $                                           | 0.05   |                                       | $      | 0.04 |   | $ | 0.10 |   | $ | 0.79 |   |

 

17

----

 

**10.****       Contingencies**

 

On June 2, 2003, in the District Court,Dallas County, Texas, Walter Evans brought a shareholders’ derivative action,for the benefit of Nominal Defendant Carreker Corporation against James D. Carreker,John D. Carreker, Jr., James R. Erwin, James L. Fischer, Michael D. Hansen,Donald L. House, Richard R. Lee, Jr., David K. Sias, Ronald G. Steinhart, andErnst & Young, LLP and Carreker Corporation, Nominal Defendant (Cause No.0305505). The complaint alleges that the director defendants breached theirfiduciary duty to the company. In addition the complaint makes certainallegations against the company’s independent auditors Ernst & Young, LLP.The complaint seeks unspecified amounts of compensatory damages, as well asinterest and costs, including legal fees from the director defendants.

 

On May 29, 2003, in the United StatesDistrict Court for the Northern District of Texas, Dallas Division, Barbara I.Smith brought a shareholders’ derivative action pursuant to Rule 23.1,Fed.R.Civ.P, for the benefit of Nominal Defendant Carreker Corporation againstcertain of its current officers and directors, i.e., John D. Carreker, Jr.,James D. Carreker, Richard R. Lee, Jr., James L. Fischer, Donald L. House, DavidK. Sias and Terry L. Gage (Civil Action No. 303CV1211-D), seeking to remedytheir individual breaches of fiduciary duty, including their knowing violationsof Generally Accepted Accounting Principles (“GAAP”), knowing violations offederal and state securities laws, acts of bad faith and other breaches offiduciary duty.  The plaintiff seeksredress (in the form of, among others, unspecified amounts of compensatorydamages, interests and costs, including legal fees) for injuries to the Companyand its shareholders caused by Defendants’ misfeasance and/or malfeasanceduring the period from May 20, 1998 through December 10, 2002.  On November 20, 2003 the parties tothis action filed a joint motion with the Court requesting that the Courtdismiss the action without prejudice. This is a voluntary dismissal by the plaintiff and there is nocompensation being given by or on behalf of the Company or the individualdefendants.  The Court has ordered theplaintiffs to publish, no later than December 22, 2003, a notice of theparties' intent to voluntarily dismiss this action.

 

On April 16, 2003 the United StatesDistrict Court for the Northern District of Texas, Dallas Division, issued anorder consolidating a number of purported class action lawsuits against theCompany, John D. Carreker Jr. and Terry L. Gage into a Consolidated Actionstyled In re Carreker Corporation Securities Litigation, Civil Action No.303CV0250-M.  Also, on March 3,2003, Claude Alton Coulter filed a purported class action lawsuit (Civil Action No.503-CV-5-Q) against the Company, John D. Carreker Jr. and Terry L. Gage in theUnited States District Court for the Eastern District of Texas, TexarkanaDivision.  These complaints, filed onbehalf of purchasers of the Company’s common stock between May 20, 1998and December 10, 2002, inclusive, allege violations of Section 10(b)of the Securities Exchange Act of 1934 and Rule 10b-5 against all defendantsand violations of Section 20(a) of the Exchange Act against the individualdefendants.  These complaints alsoallege, among other things, that defendants artificially inflated the value ofthe Company’s stock by knowingly or recklessly misrepresenting the Company’sfinancial results during the purported class period.  The plaintiffs are seeking unspecified amounts of compensatorydamages, interests and costs, including legal fees.

 

Earnings Performance Group (“EPG”) filed acomplaint on or about September 16, 1998 in the Superior Court of NewJersey, Law Division, Essex County seeking to enjoin and restrain the Companyfrom using any EPG confidential or proprietary information or trade secrets andfrom employing any former EPG employee in such a manner that disclosure or useof an EPG confidential or proprietary information or trade secret would belikely.  EPG also seeks (a) anaccounting of any profits realized from or attributable to the use of any EPGconfidential or proprietary information or trade secret, (b) compensatory andexemplary damages, plus interest and (c) attorneys’ fees and costs ofsuit.  On October 14, 1998, theCompany removed the case to the United States District Court for the Districtof New Jersey.  The Company answered thecomplaint on November 4, 1998, essentially denying the allegations andsetting forth various affirmative defenses. On November 20, 1998, the Company filed an Amended Answer, SeparateDefenses and Counterclaim.  In theCounterclaim the Company asserts claims for (a) restraint of trade, (b)tortuous interference with contractual relationships, (c) unfair competitionand (d) interference with prospective economic advantage.

 

The Company and individual defendants denythe allegations in these complaints and intend to defend themselvesvigorously.  It is not possible at thistime to predict whether the Company will incur any liability or to estimate thedamages, or the range of damages, if any, that the Company might incur inconnection with these lawsuits.

 

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

 

18

----

 

**11.****       BusinessSegments and Revenue Concentration**

 

The tables below show revenues and income(loss) from operations for the periods indicated for the Company’s threereportable business segments: Revenue Enhancement, Global Payments Technologiesand Global Payments Consulting. Customer projects are sold on a solution basis, so it is necessary tobreak them down by segment and allocate accordingly.  Included in “Corporate Unallocated” are costs related to sellingand marketing, unallocated corporate overhead expense and general softwaremanagement.  Business segment resultsincluding costs for research and development, as well as product royaltyexpense, the amortization of intangible assets, the write-off of capitalizedsoftware costs and restructuring and other charges were as follows (inthousands):

 
|                                                                  |   | **Three  Months ended October 31, 2003** |   |
|-----------------------------------------------------------------------|--------|-----------------------------------------------|--------|
|                                                                  |   | **Revenue  Enhancement**                      |   | **Global  Payments  Technologies** |   | **Global  Payments  Consulting** |   | **Corporate  Unallocated** |   | **Total** |   |
| Revenues:                                                             |   |                                          |   |   |   |   |   |   |   |   |   |
| Consulting  fees                                                      |   | $                                             | 6,151  |   | $ | 35 |   | $ | 210 |   | $ | — |   | $ | 6,396 |   |
| Software  license fees                                                |   | 646                                           |   | 6,380 |   | — |   | — |   | 7,026 |   |
| Software  maintenance fees                                            |   | 410                                           |   | 11,360 |   | — |   | — |   | 11,770 |   |
| Software  implementation fees                                         |   | 301                                           |   | 4,459 |   | 223 |   | — |   | 4,983 |   |
| Out-of-pocket  expense reimbursements                                 |   | 378                                           |   | 762 |   | 88 |   | — |   | 1,228 |   |
| Intercompany  revenue                                                 |   | —                                        |   | (126 | ) | 126 |   | — |   | — |   |
| Total  revenues                                                       |   | $                                             | 7,886  |   | $ | 22,870 |   | $ | 647 |   | $ | — |   | $ | 31,403 |   |
|                                                                  |   |                                          |   |   |   |   |   |   |   |   |   |
| Income  (loss) from operations before restructuring and other charges |   | $                                             | 2,985  |   | $ | 5,794 |   | $ | (971 | ) | $ | (6,608 | ) | $ | 1,200 |   |
|                                                                  |   |                                          |   |   |   |   |   |   |   |   |   |
| Restructuring  and other charges                                      |   | —                                        |   | (540 | ) | — |   | 311 |   | (229 | ) |
| Income  (loss) from operations                                        |   | $                                             | 2,985  |   | $ | 6,334 |   | $ | (971 | ) | $ | (6,919 | ) | $ | 1,429 |   |

 
|                                                                  |   | **Three  Months ended October 31, 2002** |   |
|-----------------------------------------------------------------------|--------|-----------------------------------------------|--------|
|                                                                  |   | **Revenue  Enhancement**                      |   | **Global  Payments  Technologies** |   | **Global  Payments  Consulting** |   | **Corporate  Unallocated** |   | **Total** |   |
| Revenues:                                                             |   |                                          |   |   |   |   |   |   |   |   |   |
| Consulting  fees                                                      |   | $                                             | 6,807  |   | $ | 1 |   | $ | 1,328 |   | $ | — |   | $ | 8,136 |   |
| Software  license fees                                                |   | 70                                            |   | 6,260 |   | — |   | — |   | 6,330 |   |
| Software  maintenance fees                                            |   | 228                                           |   | 11,396 |   | — |   | — |   | 11,624 |   |
| Software  implementation fees                                         |   | 118                                           |   | 6,267 |   | 204 |   | — |   | 6,589 |   |
| Out-of-pocket  expense reimbursements                                 |   | 378                                           |   | 652 |   | 468 |   | — |   | 1,498 |   |
| Intercompany  revenue                                                 |   | —                                        |   | (139 | ) | 139 |   | — |   | — |   |
| Total  revenues                                                       |   | $                                             | 7,601  |   | $ | 24,437 |   | $ | 2,139 |   | $ | — |   | $ | 34,177 |   |
|                                                                  |   |                                          |   |   |   |   |   |   |   |   |   |
| Income  (loss) from operations before restructuring and other charges |   | $                                             | 3,333  |   | $ | 6,818 |   | $ | (709 | ) | $ | (7,647 | ) | $ | 1,795 |   |
|                                                                  |   |                                          |   |   |   |   |   |   |   |   |   |
| Restructuring  and other charges                                      |   | —                                        |   | — |   | — |   | — |   | — |   |
| Income  (loss) from operations                                        |   | $                                             | 3,333  |   | $ | 6,818 |   | $ | (709 | ) | $ | (7,647 | ) | $ | 1,795 |   |

 

19

----

 
|                                                                  |   | **Nine  Months ended October 31, 2003** |   |
|-----------------------------------------------------------------------|--------|----------------------------------------------|--------|
|                                                                  |   | **Revenue  Enhancement**                     |   | **Global  Payments  Technologies** |   | **Global  Payments  Consulting** |   | **Corporate  Unallocated** |   | **Total** |   |
| Revenues:                                                             |   |                                         |   |   |   |   |   |   |   |   |   |
| Consulting  fees                                                      |   | $                                            | 20,032 |   | $ | 164 |   | $ | 1,153 |   | $ | — |   | $ | 21,349 |   |
| Software  license fees                                                |   | 2,368                                        |   | 19,587 |   | — |   | — |   | 21,955 |   |
| Software  maintenance fees                                            |   | 879                                          |   | 33,885 |   | — |   | — |   | 34,764 |   |
| Software  implementation fees                                         |   | 722                                          |   | 13,220 |   | 443 |   | — |   | 14,385 |   |
| Out-of-pocket  expense reimbursements                                 |   | 1,242                                        |   | 1,748 |   | 377 |   | — |   | 3,367 |   |
| Intercompany  revenue                                                 |   | —                                       |   | (165 | ) | 165 |   | — |   | — |   |
| Total  revenues                                                       |   | $                                            | 25,243 |   | $ | 68,439 |   | $ | 2,138 |   | $ | — |   | $ | 95,820 |   |
|                                                                  |   |                                         |   |   |   |   |   |   |   |   |   |
| Income  (loss) from operations before restructuring and other charges |   | $                                            | 10,412 |   | $ | 18,918 |   | $ | (2,887 | ) | $ | (22,038 | ) | $ | 4,405 |   |
|                                                                  |   |                                         |   |   |   |   |   |   |   |   |   |
| Restructuring  and other charges                                      |   | —                                       |   | (476 | ) | 293 |   | 1,416 |   | 1,233 |   |
| Income  (loss) from operations                                        |   | $                                            | 10,412 |   | $ | 19,394 |   | $ | (3,180 | ) | $ | (23,454 | ) | $ | 3,172 |   |

 
|                                                                  |   | **Nine  Months ended October 31, 2002** |   |
|-----------------------------------------------------------------------|--------|----------------------------------------------|--------|
|                                                                  |   | **Revenue  Enhancement**                     |   | **Global  Payments  Technologies** |   | **Global  Payments  Consulting** |   | **Corporate  Unallocated** |   | **Total** |   |
| Revenues:                                                             |   |                                         |   |   |   |   |   |   |   |   |   |
| Consulting  fees                                                      |   | $                                            | 24,955 |   | $ | 243 |   | $ | 5,479 |   | $ | — |   | $ | 30,677 |   |
| Software  license fees                                                |   | 524                                          |   | 31,906 |   | — |   | — |   | 32,430 |   |
| Software  maintenance fees                                            |   | 429                                          |   | 32,952 |   | — |   | — |   | 33,381 |   |
| Software  implementation fees                                         |   | 1,394                                        |   | 17,731 |   | 356 |   | — |   | 19,481 |   |
| Out-of-pocket  expense reimbursements                                 |   | 1,570                                        |   | 2,315 |   | 1,471 |   | — |   | 5,356 |   |
| Intercompany  revenue                                                 |   | —                                       |   | (419 | ) | 419 |   | — |   | — |   |
| Total  revenues                                                       |   | $                                            | 28,872 |   | $ | 84,728 |   | $ | 7,725 |   | $ | — |   | $ | 121,325 |   |
|                                                                  |   |                                         |   |   |   |   |   |   |   |   |   |
| Income  (loss) from operations before restructuring and other charges |   | $                                            | 13,258 |   | $ | 30,143 |   | $ | (1,724 | ) | $ | (22,082 | ) | $ | 19,595 |   |
|                                                                  |   |                                         |   |   |   |   |   |   |   |   |   |
| Restructuring  and other charges                                      |   | —                                       |   | — |   | — |   | — |   | — |   |
| Income  (loss) from operations                                        |   | $                                            | 13,258 |   | $ | 30,143 |   | $ | (1,724 | ) | $ | (22,082 | ) | $ | 19,595 |   |

 

During the three months ended July 31, 2003, the Company formedCarretek LLC (Carretek), a 51% jointly owned company to offer financialinstitutions offshore-centric outsourcing of their business processes and ITservices needs.  As this outsourcingbusiness is in the development phase and its operations immaterial, thefinancial results for the three and nine months ended October 31, 2003 arecontained in the Corporate-Unallocated business segment in the tables above.

 

During the three months ended October 31, 2003, the Company andits partner funded Carretek with an aggregate amount of $200,000 from both partners.  $100,000 was in equity and another $100,000in the form of a note payable.  The$49,000 of minority interest in equity and the $49,000 minority interest in thenote payable are reflected as long-term liabilities in the accompanyingcondensed consolidated balance sheets.

 

Effective during the three months ended October 31, 2003, certaingeneral and administrative functions such as accounting, human resources andoffice services classified within the Global Payments Technologies segment wereconsolidated with the traditional corporation functions and hence these costswere reclassified to the corporate unallocated segment, for all periodspresented above.

 

20

----

 

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

 
|                |   | **Three  Months Ended****October 31,** |   | **Nine  Months Ended****October 31,** |   |
|---------------------|--------|---------------------------------------------|--------|--------------------------------------------|--------|
|                |   | **2003**                                    |   | **2002**                                   |   | **2003** |   | **2002** |   |
|                |   |                                        |   |                                       |   |   |   |   |   |
| Single  customer    |   | 10.5                                        | %      | 13.5                                       | %      | 9.6 | % | 10.1 | % |
| Top five  customers |   | 33.5                                        | %      | 34.6                                       | %      | 31.7 | % | 35.3 | % |

 

The Company markets its solutions in several foreign countries.  Revenues, exclusive ofout-of-pocket expense reimbursements, attributedto countries based on the location of the customer were as follows (inthousands):

 
|           |   | **Three Months EndedOctober 31,  2003** |   | **Three Months EndedOctober 31,  2002** |   |
|----------------|--------|----------------------------------------------|--------|----------------------------------------------|--------|
|           |   | **Amount**                                   |   | **Percent  of total  revenues**              |   | **Amount** |   | **Percent  of total  revenues** |   |
| United States  |   | $                                            | 24,293 |                                         | 81     | % | $ | 27,479 |   | 84 | % |
| Europe         |   | 2,143                                        |   | 7                                            |   | 1,118 |   | 4 |   |
| Australia      |   | 1,244                                        |   | 4                                            |   | 951 |   | 3 |   |
| Canada         |   | 1,565                                        |   | 5                                            |   | 2,336 |   | 7 |   |
| South Africa   |   | 679                                          |   | 2                                            |   | 750 |   | 2 |   |
| Other          |   | 251                                          |   | 1                                            |   | 45 |   | — |   |
| Total revenues |   | $                                            | 30,175 |                                         | 100    | % | $ | 32,679 |   | 100 | % |

 
|           |   | **Nine Months Ended  October 31,  2003** |   | **Nine Months Ended  October 31,  2002** |   |
|----------------|--------|-----------------------------------------------|--------|-----------------------------------------------|--------|
|           |   | **Amount**                                    |   | **Percent  of total  revenues**               |   | **Amount** |   | **Percent  of total  revenues** |   |
| United States  |   | $                                             | 74,828 |                                          | 81     | % | $ | 95,946 |   | 83 | % |
| Europe         |   | 6,400                                         |   | 7                                             |   | 5,907 |   | 5 |   |
| Australia      |   | 3,498                                         |   | 4                                             |   | 3,866 |   | 3 |   |
| Canada         |   | 5,004                                         |   | 5                                             |   | 6,676 |   | 6 |   |
| South Africa   |   | 2,218                                         |   | 2                                             |   | 3,409 |   | 3 |   |
| Other          |   | 505                                           |   | 1                                             |   | 165 |   | — |   |
| Total revenues |   | $                                             | 92,453 |                                          | 100    | % | $ | 115,969 |   | 100 | % |

 

21

----

 

**12.****       Restructuringand Other Charges**

 

The Company recorded $545,000 in restructuringand other charges during the three month period ended April 30, 2003,principally associated with the separation of 17 employees, within both theCorporate and Global Payments Consulting (“GPC”) business segments.  During the quarterly period ended April 30,2003, the Company recorded a charge of $139,000 relating to legal andprofessional fees relating to the Company’s restatement efforts and the legalactions described in Note 10.

 

The Company recorded $648,000 inrestructuring and other charges during the three month period endedJuly 31, 2003, principally associated with the separation of 9 employees,within both the Corporate and GPC business segments.  During the quarterly period ended July 31, 2003, the Companyrecorded a charge of $130,000 relating to legal fees relating to the legalactions described in Note 10.

 

As part of the Company’s settlement with oneof the CheckFlow Suite customers, the customer agreed to pay the Company forthe replacement product and installation. These payments are recorded directly to this reserve and all futureexpenditures to install the replacement product will be charged against thisreserve.  During the quarterly periodending July 31, 2003, $366,000 was received from this customer.

 

The Company recorded $170,000 inrestructuring and other charges during the three month period endedOctober 31, 2003, principally associated with the separation of 3employees, within the Corporate business segment.  During the quarterly period ended October 31, 2003, theCompany recorded a charge of $141,000 relating to legal fees relating to thelegal actions described in Note 10.

 

Additionally, during the three months endedOctober 31, 2003, the Company reversed $421,000 primarily related to thetrue-up of termination benefits as actual costs were lower than estimatedamounts.  Additionally, $119,000 wasreversed when estimated costs to close certain facilities were lower than ouroriginal estimates.  The effect of theserevisions in estimates, net of tax, was $0.02 per share on a fully dilutedbasis.

 

22

----

 

The activity related to the accrued mergerand restructuring costs reserve during the nine months ended October 31,2003 is as follows (in thousands):

 
|                                   |   | **Workforce  Reductions** |   | **Charges  Relating to  CheckFlow  Suite** |   | **Facility  Closures** |   | **Total** |   |
|----------------------------------------|--------|---------------------------|--------|--------------------------------------------|--------|------------------------|--------|-----------|--------|
|                                   |   |                      |   |                                       |   |                   |   |      |   |
| January 31,  2003 reserve balance |   | $                         | 953    |                                       | $      | 1,273                  |   | $         | 124    |   | $ | 2,350 |   |
|                                   |   |                      |   |                                       |   |                   |   |      |   |
| Additions to  reserve balance:         |   |                      |   |                                       |   |                   |   |      |   |
| Severance  charges                     |   | 545                       |   | —                                     |   | —                 |   | 545       |   |
| Reduction to  reserve balance:         |   |                      |   |                                       |   |                   |   |      |   |
| Cash paid                              |   | (550                      | )      | (68                                        | )      | —                 |   | (618      | )      |
| April 30,  2003 reserve balance   |   | 948                       |   | 1,205                                      |   | 124                    |   | 2,277     |   |
|                                   |   |                      |   |                                       |   |                   |   |      |   |
| Additions to  reserve balance:         |   |                      |   |                                       |   |                   |   |      |   |
| Severance  charges                     |   | 648                       |   | —                                     |   | —                 |   | 648       |   |
| Cash received from customer            |   | —                    |   | 366                                        |   | —                 |   | 366       |   |
| Reduction to  reserve balance:         |   |                      |   |                                       |   |                   |   |      |   |
| Cash paid                              |   | (563                      | )      | (60                                        | )      | —                 |   | (623      | )      |
| July 31,  2003 reserve balance    |   | 1,033                     |   | 1,511                                      |   | 124                    |   | 2,668     |   |
|                                   |   |                      |   |                                       |   |                   |   |      |   |
| Additions to  reserve balance:         |   |                      |   |                                       |   |                   |   |      |   |
| Severance  charges                     |   | 170                       |   | —                                     |   | —                 |   | 170       |   |
| Reduction to  reserve balance:         |   |                      |   |                                       |   |                   |   |      |   |
| Change in  estimate                    |   | (421                      | )      | —                                     |   | (119                   | )      | (540      | )      |
| Cash paid                              |   | (395                      | )      | (57                                        | )      | —                 |   | (452      | )      |
| October 31,  2003 reserve balance |   | $                         | 387    |                                       | $      | 1,454                  |   | $         | 5      |   | $ | 1,846 |   |

 

**13.****       RelatedParty Transactions**

 

In March 2001, the Company loaned$500,000 to a former officer of the Company pursuant to a Limited RecoursePromissory Note (“Note”) collateralized solely by shares of ExchangeApplications, Inc. common stock.  Theprincipal was due in full on March 30, 2004.  In January 2002, the Note was adjusted to its estimated fairvalue of $125,000, resulting in a charge to earnings of $375,000.  During the quarterly period endedApril 30, 2002, the Note was adjusted to its estimated fair value of$25,000 resulting in an additional charge to earnings of $100,000.  During the quarterly period endedJuly 31, 2002, the Note was deemed worthless resulting in a charge toearnings of $25,000.

 

In connection with the completion of theCheck Solutions acquisition, the Company assumed a $10.0 million obligation tocertain current and former employees of Check Solutions.  During the quarterly period endedJanuary 31, 2002, $3.3 million of this obligation was paid and during thequarterly period ended April 30, 2002 the remaining $6.7 million was paid.

 

23

----

 

**Item2****. Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

All statements other than statements ofhistorical fact contained in this report, including statements in this“Management’s Discussion and Analysis of Financial Condition and Results ofOperations” concerning our financial position and liquidity, results ofoperations, prospects for future growth, and other matters, are forward-lookingstatements.  Although we believe thatthe expectations reflected in such forward-looking statements are reasonable,no assurance can be given that such expectations will prove correct.  Factors that could cause our results todiffer materially from the results discussed in, or contemplated by, suchforward-looking statements include the risks described under “Business –Forward Looking Statements and Risk Factors” contained in our Form 10-K for theyear ended January 31, 2003, as filed with the Securities and ExchangeCommission (SEC).  Such risks include,without limitation, dependence on the banking industry, decline in checkvolumes, fluctuations in operating results, use of fixed-price or value-pricedarrangements, lack of long-term agreements, ability to manage growth, dependenceon key personnel, product liability, rapid technological change and dependenceon new products, dependence on third-party providers and the Internet, newfocus on providing business process outsourcing with significant offshorecomponent, ability to attract and retain qualified personnel, customerconcentration, indebtedness, competition, potential strategic alliances andacquisitions, proprietary rights, infringement claims and legal proceedings,dependence on third parties for technology licenses, liability claims, classaction lawsuits, stock price fluctuations, continued NASDAQ listing,international operations, use of independent contractors, changing governmentand tax regulations, anti-takeover provisions in our charter and impairment ofgoodwill, capitalized software costs, acquired developed technology orintangible assets.  Finally, negativetrends in our operating results could result in noncompliance of financialcovenants related to our revolving credit agreement which could impair ourliquidity.  All forward-lookingstatements in this report are expressly qualified in their entirety by thecautionary statements in this paragraph, in the “risk factors” included in ourSEC filings and elsewhere in this report.

 

**Overview**

 

We provide payments-related software andconsulting solutions to financial institutions and financial serviceproviders.  These solutions help ourcustomers improve operational efficiency in how payments are processed; enhancerevenue and profitability from payments-oriented products and services; reducelosses associated with fraudulent payment transactions; and evolve towardnext-generation payment practices and technologies.

 

We are organized into three primary operatingdivisions:  Global Payments Technologies(GPT), Revenue Enhancement (RevE) and Global Payments Consulting (GPC).  These divisions represent our three currentreportable business segments.  See Note11 of our Notes to Condensed Consolidated Unaudited Financial Statements.  During the three months ended July 31, 2003,we formed Carretek LLC (Carretek), a 51% jointly owned Company to offerfinancial institutions offshore-centric outsourcing of their business processesand IT services needs.  As thisoutsourcing business is in the development phase, its operations and financialresults are immaterial.

 

We derive our revenues from consulting fees,software license fees, software maintenance fees, and software implementationfees. While many customer contracts provide for both the performance ofconsulting services and the license of related software, some customercontracts require only the performance of consulting services or only asoftware license (and, at the election of the customer, related implementationservices and/or annual software maintenance services). We enter into thesecontracts with our customers on a project-by-project basis.

 

We seek to establish long-term relationshipswith our customers that will lead to on-going projects utilizing our solutions.We are typically retained to perform one or more discrete projects for acustomer, and we use these opportunities to extend our solutions intoadditional areas of the customer’s operations. To this end, a significantportion of our current revenues is derived from customers who were customers inprior years, and we are therefore dependent to a significant degree on ourability to maintain our existing relationships with these customers.

 

**Restatement**

 

We restated our audited financial statementsfor the years ended January 31, 2002, 2001, 2000 and 1999, and ourunaudited financial statements for each of the quarters in the year endedJanuary 31, 2002 and for the quarters ended April 30, 2002 andJuly 31, 2002.  Refer to our Form10-K for the year ended January 31, 2003 for details of the restatement,as well as the impact of the restatement on the years and quarters previouslyreported.

 

24

----

 

**Productsand Services**

 

*Global Payments Technologies Solutions.*  Carreker’s technology solutions helpfinancial institutions address the needs of some critical payment services anddelivery functions that impact overall operating costs and riskmanagement.  These functions includepresentment of checks in paper and electronic form, determination of theavailability of funds, identification and mitigation of fraudulent payments,handling irregular items such as checks returned unpaid (exceptions),maintaining a record of past transactions (archiving), responding to relatedcustomer inquiries (research), and correcting any errors that are discovered(adjustments).  The Global PaymentsTechnologies solutions suite addresses these key functions in the context ofimproving operational efficiency and a gradual transition from paper toelectronic-based payment systems.  Inaddition, we offer technology solutions that optimize the inventory managementof a bank’s cash stock levels, including managing how much is needed, when itis needed and where it is needed.  Oursolutions reduce the amount of cash banks need to hold in reserve accounts andas cash-on-hand, while ensuring a high level of customer service through timelyreplenishment of ATM cash supplies.

 

Specific solutions in the Global PaymentsTechnologies group include:

 
| **Solution**                   |   | **Description**                                                                                                                                                                                                                                                                              |   | **Products Offered**                                                                                                                                                                                      |
|--------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                           |   |                                                                                                                                                                                                                                                                                         |   |                                                                                                                                                                                                      |
| Fraud Mitigation               |   | Automated fraud detection and prevention  solutions that reduce incidents of check fraud, deposit fraud, check kiting,  and electronic fraud. Scalable solutions are offered for community banks.                                                                                            |   | FraudLink On-Us, FraudLink Deposit,  FraudLink Kite, FraudLink Positive Pay, FraudLink eTracker, FraudLink PC,  CORE, FraudLink ACHeCK, eFraudLink.com, Fraud Solutions Consulting                        |
|                           |   |                                                                                                                                                                                                                                                                                         |   |                                                                                                                                                                                                      |
| Back Office Processing         |   | Products that bring new efficiencies to  back-office operations through leading-edge image, workflow, and RECO  (character recognition) technologies.                                                                                                                                        |   | Adjustments/Express, Exceptions/Express,  Input/Express, Inbound Returns/Express, Image Bulk-File, All Transactions  File and Fine Sort                                                                   |
|                           |   |                                                                                                                                                                                                                                                                                         |   |                                                                                                                                                                                                      |
| Remittance Processing          |   | Both host- and client/server-based  platforms for improved productivity in processing retail and wholesale  remittance transactions.                                                                                                                                                         |   | 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, LTA (Large Table Access)                                     |
|                           |   |                                                                                                                                                                                                                                                                                         |   |                                                                                                                                                                                                      |
| Check Image Capture            |   | Products and services related to the  capture, storage and delivery of check images.                                                                                                                                                                                                         |   | ALS & CIMS Products (MVS, AIX,  Windows), NeXGen Image Processor, Image Enhancement Products, Reject Repair,  RECO Technology, Image POD, Image Delivery Products, Delivery Express, Image  Inspector |
|                           |   |                                                                                                                                                                                                                                                                                         |   |                                                                                                                                                                                                      |
| 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, NeXGen Remittance, +  CDRom Delivery, Input/Express, Express Capture, Payee Name Verification,  Amount Encoding Verification,                                                           |
|                           |   |                                                                                                                                                                                                                                                                                         |   |                                                                                                                                                                                                      |
| Global Tracking                |   | A complete bar code tracking system  eliminates manual log sheets, automates data gathering and maximizes workflow  by tracking accountable mail, branch bags, item volumes, currency bags,  incoming domestic and international deposits, outgoing cash letters,  exceptions and much more. |   | Receive Sentry                                                                                                                                                                                            |

 

25

----

 
| 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                      |
|------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------|
|                         |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |                                                                         |
| Electronic Check Presentment |   | Enables banks to transition from  paper-based to electronic payment systems by automating key elements of the  processing stream, as well as improving a bank’s yield from float management.  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.                                                |   | CheckLink, CheckLink PC, Deposit Manager,  Branch Truncation Manager, Cnotes |
|                         |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |                                                                         |
| Float Management             |   | Solutions that manage a bank’s float  through float analysis, pricing and a comprehensive consulting practice to  improve profitability, reporting, workflow and check clearing  operations.  These products also  provide critical activity summaries, aid in creating multiple availability  and pricing schedules, and pinpoint the cost/profitability of any transaction  or relationship.                                                             |   | Float Analysis System, Float Pricing System                                  |
|                         |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |                                                                         |
| 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; an Internet-based cash forecasting and  inventory management desktop system for reducing cash needs by 20-40% across  the enterprise; and a real-time Internet-based system for efficient handling  of ATM service requests and responses. |   | eiManager, eiGateway, iCom                                                   |
|                         |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |                                                                         |
| 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 automate and  standardize the cash ordering process.   Consulting solutions can drive further efficiency and automation in  vault, branch and ATM operations.                                     |   | iCom, ReserveLink, ReserveLink Plus, Cash  Supply Chain Consulting           |

 

26

----

 

*Revenue Enhancement Solutions.*  The Revenue Enhancement division includestwo business units:  RevE and EnAct.RevE is a highly specialized division that provides consulting services focusedon tactical methods of increasing banks’ fee income. The scope and depth ofthis practice has expanded throughout its 13 year history and now includesretail, small business, and commercial deposits, treasury management, consumerand commercial lending, credit card lending and trust and investment services.Our solutions involve developing strategies that enable our clients to takeadvantage of electronification trends, often gaining first mover advantages forour clients. In addition to developing strategies, our business model ensuresthat we continue to translate those strategies into tactical implementationswith measurable revenue streams. Our client base has continued to expand withvery high penetration rates in the markets in which we operate. Thus, we have experienceda trend of becoming longer term strategic partners with our clients.

 

Another component of our Revenue EnhancementDivision is our business providing EnAct software and proprietary salesmanagement methodology. Our Customer Value Management and EnAct solutionsassist financial institutions in leveraging central intelligence with localinsight. This enables our clients to recognize those customers and prospectsrepresenting the greatest value or potential. Our approach is unique andcomplimentary to many CRM investments that banks have made in recent years andis designed to focus their activities such that they can actually attain thereturns that have been promised.

 

*Global Payments Consulting.*  Carreker helps financial institutionspro-actively plan, prepare and optimize for the regulatory, competitive andtechnological impacts affecting the financial payments environment.

 

Our Global Payments Consulting (GPC) divisionprovides strategic planning and implementation advisory services for financial institutions.  We provide payment research services,predictive financial and operational modeling, organizational design, andbusiness planning services focused on assisting financial institutions inpreparing and positioning their organization for the rapidly changing paymentlandscape of financial services.

 

GPC has specialized advisory services focusedon operational and infrastructure planning, implementation and measurementsassociated with the changing payment technology and delivery landscape.  Specific areas of focus and expertise arebusiness infrastructure planning in image processing, float/available fundoptimization, operational migration planning and fraud and risk managementacross all types of payments.  Inaddition, Carreker provides comprehensive advisory services around Check 21readiness, business case assessments, and operational and business integrationrequirements for financial institutions.

 

*Outsourcing.*  Carretek is a jointly owned company withMajesco Software Inc., the US subsidiary of Mastek Limited, a leading Indianoutsourcing company with global operations. Carretek enables financial institutions and their processors to realizethe benefits of offshore-centric outsourcing (offshoring) of their businessprocesses and IT services needs.  Thesebenefits could include reduction in operating costs, improvements inproductivity, and enhancement of quality.

 

Initially, Carretek is focused on offshoringpayments-related business processes and IT services such as custom softwaredevelopment and application maintenance services.  Within this area of expertise, the Carretek offering includes aflexible array of offshore outsourcing services to financial institutions,which include: global sourcing strategy development (consulting, methodology,and tools) to help banks understand their offshoring opportunities and optimizetheir decisions in this regard; outsourcing of selected payment processes toIndia through a range of business models suited to each bank’s needs; andapplication development, maintenance and support.

 

Carretek draws on Carreker’s expertise inpayments systems and associated business processes to help banks rationalizethe business case for transitioning some of these processes to cost-efficientoffshore locations and improving banks’ return on investments in paymentstechnologies.  Carreker’s image-relatedtechnologies, already in place at many large U.S. banks, enable suchtransitioning and leverage the banks’ previous investment in these systems.

 

27

----

 

**Results of Operations**

 

For the periods indicated, the followingtable sets forth the percentage that selected items in the unaudited condensedconsolidated statements of operations bear to total revenues.  The period-to-period comparisons offinancial results are not necessarily indicative of future results.

 
|                                                |   | **Three  Months Ended  October 31,** |   | **Nine  Months Ended  October 31,** |   |
|-----------------------------------------------------|--------|-------------------------------------------|--------|------------------------------------------|--------|
|                                                |   | **2003**                                  |   | **2002**                                 |   | **2003** |   | **2002** |   |
|                                                |   |                                      |   |                                     |   |   |   |   |   |
| Revenues:                                           |   |                                      |   |                                     |   |   |   |   |   |
| Consulting  fees                                    |   | 20.4                                      | %      | 23.8                                     | %      | 22.3 | % | 25.3 | % |
| Software  license fees                              |   | 22.4                                      |   | 18.5                                     |   | 22.9 |   | 26.7 |   |
| Software  maintenance fees                          |   | 37.5                                      |   | 34.0                                     |   | 36.3 |   | 27.5 |   |
| Software  implementation fees                       |   | 15.8                                      |   | 19.3                                     |   | 15.0 |   | 16.1 |   |
| Out-of-pocket  expense reimbursements               |   | 3.9                                       |   | 4.4                                      |   | 3.5 |   | 4.4 |   |
| Total  revenues                                     |   | 100.0                                     |   | 100.0                                    |   | 100.0 |   | 100.0 |   |
|                                                |   |                                      |   |                                     |   |   |   |   |   |
| Cost of  revenues:                                  |   |                                      |   |                                     |   |   |   |   |   |
| Consulting  fees                                    |   | 15.7                                      |   | 16.5                                     |   | 15.8 |   | 16.2 |   |
| Software  license fees                              |   | 6.5                                       |   | 5.5                                      |   | 5.9 |   | 4.6 |   |
| Software  maintenance fees                          |   | 11.0                                      |   | 7.3                                      |   | 10.1 |   | 6.4 |   |
| Software  implementation fees                       |   | 14.0                                      |   | 13.6                                     |   | 14.9 |   | 11.9 |   |
| Out-of-pocket  expenses                             |   | 3.6                                       |   | 4.6                                      |   | 3.6 |   | 4.8 |   |
| Total cost  of revenues                             |   | 50.8                                      |   | 47.5                                     |   | 50.3 |   | 43.9 |   |
|                                                |   |                                      |   |                                     |   |   |   |   |   |
| Gross profit                                        |   | 49.2                                      |   | 52.5                                     |   | 49.7 |   | 56.1 |   |
|                                                |   |                                      |   |                                     |   |   |   |   |   |
| Operating  costs and expenses:                      |   |                                      |   |                                     |   |   |   |   |   |
| Selling,  general and administrative                |   | 38.7                                      |   | 36.8                                     |   | 38.5 |   | 31.3 |   |
| Research and  development                           |   | 5.5                                       |   | 9.4                                      |   | 5.5 |   | 7.7 |   |
| Amortization  of intangible assets                  |   | 1.1                                       |   | 1.0                                      |   | 1.1 |   | 0.9 |   |
| Restructuring  and other charges                    |   | (0.7                                      | )      | —                                   |   | 1.3 |   | — |   |
| Total  operating costs and expenses                 |   | 44.6                                      |   | 47.2                                     |   | 46.4 |   | 39.9 |   |
|                                                |   |                                      |   |                                     |   |   |   |   |   |
| Income from  operations                             |   | 4.6                                       |   | 5.3                                      |   | 3.3 |   | 16.2 |   |
| Other income  (expense), net                        |   | 0.1                                       |   | (1.2                                     | )      | (0.5 | ) | (1.4 | ) |
|                                                |   |                                      |   |                                     |   |   |   |   |   |
| Income  before provision (benefit) for income taxes |   | 4.7                                       |   | 4.1                                      |   | 2.8 |   | 14.8 |   |
| Provision  (benefit) for income taxes               |   | 0.4                                       |   | 1.2                                      |   | 0.4 |   | (0.5 | ) |
|                                                |   |                                      |   |                                     |   |   |   |   |   |
| Net income                                          |   | 4.3                                       | %      | 2.9                                      | %      | 2.4 | % | 15.3 | % |

 

For the periods indicated, the followingtable sets forth the selected items comprising cost of revenues as a percentageof the revenues generated by that category of our operations.  The period-to-period comparisons offinancial results are not necessarily indicative of future results.

 
|                          |   | **Three  Months Ended  October 31,** |   | **Nine  Months Ended  October 31,** |   |
|-------------------------------|--------|-------------------------------------------|--------|------------------------------------------|--------|
|                          |   | **2003**                                  |   | **2002**                                 |   | **2003** |   | **2002** |   |
|                          |   |                                      |   |                                     |   |   |   |   |   |
| Cost of  revenues:            |   |                                      |   |                                     |   |   |   |   |   |
| Consulting  fees              |   | 77.2                                      | %      | 69.4                                     | %      | 71.2 | % | 64.0 | % |
| Software  license fees        |   | 29.0                                      |   | 29.5                                     |   | 25.8 |   | 17.3 |   |
| Software  maintenance fees    |   | 29.4                                      |   | 21.4                                     |   | 27.7 |   | 23.2 |   |
| Software  implementation fees |   | 88.6                                      |   | 70.6                                     |   | 99.2 |   | 74.3 |   |
| Out-of-pocket  expenses       |   | 91.4                                      |   | 105.6                                    |   | 101.4 |   | 109.4 |   |

 

28

----

 

*Revenues:* Our total revenues decreased by $2.8 million, or 8.1%, to $31.4 millionfor the three months ended October 31, 2003, from $34.2 million for thethree months ended October 31, 2002, and by $25.5 million, or 21.0%, to$95.8 million for the nine months ended October 31, 2003, from $121.3million for the nine months ended October 31, 2002.  The decrease in total revenue for the threemonths ended October 31, 2003, as compared to the three months endedOctober 31, 2002, was a result of declines in consulting fees and softwareimplementation fees, which were partially offset by an increase in softwaremaintenance fees and software license fees. The decrease in total revenue for the nine months ended October 31,2003, compared to the nine months ended October 31, 2002, was a result ofdeclines in consulting fees, software license fees and software implementationfees, which were partially offset by an increase in software maintenance.  Each of these components of revenue isdescribed in more detail below.

 

*Consulting Fees:*  Revenues from consulting fees decreased by$1.7 million, or 21.4%, to $6.4 million for the three months endedOctober 31, 2003, from $8.1 million for the three months endedOctober 31, 2002.  Consulting feesdecreased by $9.4 million, or 30.4%, to $21.3 million for the nine months endedOctober 31, 2003, from $30.7 million for the nine months ended October 31,2002.  Consulting fees are primarilyderived from Revenue Enhancement’s value-priced engagements and from GlobalPayments Consulting business segments consulting solutions.  Consulting revenue from Revenue Enhancementdecreased $600,000, or 9.6%, to $6.2 million for the three months endedOctober 31, 2003, from $6.8 million for the three months endedOctober 31, 2002.  Consultingrevenue from Revenue Enhancement decreased $5.0 million, or 19.7%, to $20.0million for the nine months ended October 31, 2003, from $25.0 million forthe nine months ended October 31, 2002. We are facing strong competition and downward pricing pressure and ourrevenue realization timelines have continued to be extended within RevenueEnhancement.  Additionally, we have seenour Revenue Enhancement consulting fees derived from our international customerbase decline $1.0 million for the three months ended October 31, 2003, ascompared to the three months ended October 31, 2002, and $3.8 million forthe nine months ended October 31, 2003, as compared to the nine monthsended October 31, 2002.  GlobalPayments Consulting revenue decreased $1.1 million, or 84.2% to $200,000 forthe three months ended October 31, 2003, from $1.3 million for the threemonths ended October 31, 2002. Global Payments Consulting revenue decreased $4.3 million, or 79.0%, to$1.2 million for the nine months ended October 31, 2003, from $5.5 millionfor the nine months ended October 31, 2002.  Traditionally, the Global Payments Consulting business segmentgenerated IT consulting revenues particularly when a financial institutioncustomer was merging or consolidating. With the reduction in the number and size of these mergers, we aretransitioning this business segment to address enterprise-wide paymentstrategies and image enabling planning and integration.  Although we believe the recently enactedCheck 21 legislation will increase the speed of this transition, we continue tobe cautious about the prospects for this business segment as the transitiontakes place.

 

*Software LicenseFees:*  Revenuesfrom software license fees increased $700,000, or 11.0%, to $7.0 million forthe three months ended October 31, 2003 from $6.3 million for the threemonths ended October 31, 2002. Revenues from software license fees decreased $10.4 million, or 32.3%,to $22.0 million for the nine months ended October 31, 2003 from $32.4million for the nine months ended October 31, 2002.  The majority of our software licensearrangements are sold with implementation services that are essential to thefunctionality of the software.  In thesecases, software license fees are recognized as the essential services areperformed.  The increase in softwarelicense fees for the three months ended October 31, 2003, as compared tothe three months ended October 31, 2002, was primarily attributable toincreased licensing of the EnAct software and proprietary sales managementmethodology especially to our international customers.  However, we have continued to experiencedelayed customer purchasing decisions as customer technology budgets remainedtight.  In addition, our customers arein a period of transition as the form of payments transfer from traditionalpaper checks to electronic forms of payments. The difficulty in predicting the timing, form and sequence of thistransition may be causing our customers to delay buying decisions.  This general market weakness becameparticularly visible beginning in the latter half of fiscal 2002.  These conditions, along with intensecompetition contributed to the lower software revenue in the nine month periodended October 31, 2003.  In thenine months ended October 31, 2002, software license fees were higher dueto sales of our Check Image Archive software to a provider of image archiveservices to financial institutions. This software required no implementation services and the associatedrevenue was recognized immediately, resulting in revenues of $7.5 million forthe nine months ended October 31, 2002.

 

29

----

 

*Software MaintenanceFees:*  Revenuesfrom software maintenance fees increased $200,000, or 1.3%, to $11.8 millionfor the three months ended October 31, 2003, from $11.6 million for thethree months ended October 31, 2002. Software maintenance fees have increased by $1.4 million, or 4.1%, to$34.8 million for the nine months ended October 31, 2003 from $33.4million for the nine months ended October 31, 2002.  Software maintenance fees represent annuallyrenewable product and telephone support for our software customers.  The annual maintenance fee generally is paidto us at the beginning of the maintenance period, and we recognize theserevenues ratably over the term of the related contract.  We defer revenue recognition on maintenancefees until cash is collected.  However,because we normally continue to provide maintenance services while awaitingpayment from customers, when the payment is received, revenue is recognized forthe period that revenue was previously deferred.  This can cause quarter-to-quarter fluctuations.  The increase in both the three and ninemonths ended October 31, 2003, as compared to the previous year was theresult of new maintenance contracts along with normal maintenance priceincreases.

 

*SoftwareImplementation Fees:* Revenues from software implementation fees decreased $1.6 million, or24.4%, to $5.0 million for the three months ended October 31, 2003, from$6.6 million for the three months ended October 31, 2002.  Revenues from software implementation feesdecreased by $5.1 million, or 26.2%, to $14.4 million for the nine months endedOctober 31, 2003, from $19.5 million for the nine months endedOctober 31, 2002.  The decline insoftware implementation fee revenue for the three and nine months endedOctober 31, 2003, as compared to the three and nine months ended October 31,2002, can be primarily attributed to declines in software license fees withinour Global Payments Technologies business segment of approximately 38.6% forthe nine months ended October 31, 2003.

 

*Out-of-PocketExpense Reimbursements:*  Revenues from out-of-pocket expense reimbursements decreased$300,000, or 18.0%, to $1.2 million for the three months ended October 31,2003, from $1.5 million for the three months ended October 31, 2002.  Revenue from out-of-pocket expensereimbursements decreased $2.0 million, or 37.1%, to $3.4 million for the ninemonths ended October 31, 2003 from $5.4 million for the nine months endedOctober 31, 2002.  Decreases inthese reimbursements are primarily the result of a general decline within allof our business segments, especially in our Global Payments Consulting businesssegment.  Engagements in this segmentusually require our employees to be at the customer location for extendedperiods of time.

 

*Cost of Revenues:*  Our total cost of revenues was $16.0million, or 50.8%, of total revenue for the three months ended October 31,2003, and was $16.2 million, or 47.5% of total revenue for the three monthsended October 31, 2002.  Our totalcost of revenues was $48.2 million, or 50.3%, of total revenue for the ninemonths ended October 31, 2003, and was $53.3 million, or 43.9%, of totalrevenue for the nine months ended October 31, 2002.  In absolute dollars the decrease in the costof revenues for both the three and nine months ended October 31, 2003,compared to the three and nine months ended October 31, 2002, is thedirect result of lower costs of consulting, especially within our GlobalPayments Consulting business segment. These cost reductions were the result of headcount reductions withinthis business segment.  In addition,with the decline in consulting engagements and software implementations,out-of-pocket expenses from air travel and lodging have also declined.  The decreases in cost of revenues was offsetby increased costs of software maintenance. This increase is the result of a concentration of projects classified ascost of software maintenance as opposed to research and development.  The increase in these costs as a percentageof total revenue is a result of the 8.1% decline in total revenues and a 1.6%decline in these costs during the three months ended October 31, 2003, ascompared to the three months ended October 31, 2002, and a 21.0% declinein total revenues and a 9.6% decline in these costs for the nine months endedOctober 31, 2003, as compared to the nine months ended October 31,2002.

 

30

----

 

*Cost of Consulting:*  Our cost of consulting was $4.9 million, or77.2% of consulting fees for the three months ended October 31, 2003, andwas $5.7 million, or 69.4%, of consulting fees for the three months endedOctober 31, 2002.  Our cost ofconsulting was $15.2 million, or 71.2%, of consulting fees for the nine monthsended October 31, 2003 and was $19.6 million, or 64.0%, of consulting feesfor the nine months ended October 31, 2002.  Cost of consulting decreased in absolute dollars due primarily toreduced personnel-related and contract labor costs through cost reduction andrestructuring efforts completed during fiscal 2002, particularly within theGlobal Payments Consulting business segment. The costs of consulting within Global Payments Consulting declined $1.2million, or 50.3%, to $1.2 million for the three months ended October 31,2003, from $2.4 million for the three months ended October 31, 2002.  The costs of consulting within GlobalPayments Consulting declined $3.9 million, or 48.6%, to $4.0 million for thenine months ended October 31, 2003, from $7.9 million for the nine monthsended October 31, 2002.  Themajority of our consulting fee revenue is driven by value-priced engagementswithin our Revenue Enhancement business segment that fluctuate significantlyfrom period-to-period; as a result, our consulting costs as a percentage ofrevenue will also fluctuate based on the amount of value-priced revenuerecognized.

 

*Cost of SoftwareLicenses:*  Ourcost of software licenses was $2.0 million, or 29.0%, of software license feesfor the three months ended October 31, 2003, and $1.9 million, or 29.5%,of software license fees for the three months ended October 31, 2002.  Our cost of software licenses was $5.7million, or 25.8%, of software license fees for the nine months endedOctober 31, 2003 and $5.6 million, or 17.3%, of software license fees forthe nine months ended October 31, 2002. Cost of software licenses consist principally of amortization ofcapitalized software costs, amortization of acquired developed technology androyalties payable to third parties. Despite the fixed nature of approximately $1.3 million per quarter ofamortization of capitalized software costs, costs of acquired developedtechnology and costs of software licenses as a percentage of software licensefees will fluctuate based on the level of software license fee revenuerecognized.  Additionally, in connectionwith software license agreements entered into with certain banks and purchaseagreements with vendors under which our acquired software technology is used inproducts sold to our customers, we are required to pay royalties on sales ofcertain software products.  Under these arrangements,we record royalty expense when the associated revenue is recognized.  The royalty percentages generally range from20% to 30% of the associated revenue. Approximately $718,000 and $384,000 of royalty expense was recordedunder these agreements for the three months ended October 31, 2003 and2002, respectively, and $1.7 million and $1.8 million for the nine months endedOctober 31, 2003 and 2002, respectively.

 

*Cost of SoftwareMaintenance:* Our cost of software maintenance was $3.5 million, or 29.4%, of softwaremaintenance fees for the three months ended October 31, 2003, and $2.5million, or 21.4%, of software maintenance fees for the three months endedOctober 31, 2002.  Our cost ofsoftware maintenance was $9.6 million, or 27.7%, of software maintenance feesfor the nine months ended October 31, 2003, and $7.7 million, or 23.2%, ofsoftware maintenance fees for the nine months ended October 31, 2002.  In absolute dollars, the costs of softwaremaintenance have increased in both the three and nine months endedOctober 31, 2003, as compared to the three and nine months endedOctober 31, 2002, as a result of traditional Research and Developmentemployees working on projects classified as maintenance.  These maintenance costs generally consist oftelephone support, product defect support and other enhancements to ourexisting products which are not significant enough to extend the product’s lifecycle, or substantially increase its marketability.  Because our maintenance revenue is not recognized until the cashis collected, maintenance revenue can fluctuate from period-to-period and as aresult our cost of software maintenance as a percentage of related maintenancerevenue will also fluctuate.

 

*Cost of SoftwareImplementation:* Our cost of software implementation was $4.4 million, or 88.6%, ofsoftware implementation fees for the three months ended October 31, 2003and $4.7 million, or 70.6%, of software implementation fees for the threemonths ended October 31, 2002.  Ourcost of software implementation was $14.3 million, or 99.2%, of softwareimplementation fees for the nine months ended October 31, 2003 and $14.5million, or 74.3%, of software implementation fees for the nine months endedOctober 31, 2002.  In absolutedollars, the costs of software implementation have remained relatively flat inthe three and nine months ended October 31, 2003, as compared to the threeand nine months ended October 31, 2002. The increase of our costs of software implementation, as a percentage ofthe related software implementation revenue, was the result of declines in newsoftware licensed within our Global Payments Technologies business segment,compounded by a deferral of $768,000 of software implementation revenue duringthe nine months ended October 31, 2003, on a project when it was concludedthat collection was not considered probable. Any future recoveries related to this contract will be recognized onlywhen the cash is received.

 

31

----

 

*Cost of Out-of-PocketExpense Reimbursements:*  Our cost of out-of-pocket expense reimbursements was $1.1million, or 91.4% of related revenues for the three months endedOctober 31, 2003, and was $1.6 million, or 105.6% of related revenues forthe three months ended October 31, 2002. Our cost of out-of-pocket expense reimbursements was $3.4 million, or101.4% of related revenues for the nine months ended October 31, 2003, andwas $5.9 million, or 109.4% of related revenues for the nine months endedOctober 31, 2002.  Costs ofout-of-pocket expense reimbursements have generally declined, along withreduced engagements, within our Global Payments Consulting businesssegment.  This segment has historicallyhad engagements which required extended stays at customer locations.  Subject to timing differences, thesubstantial majority of these expenses are billed to customers and recorded asOut-of-Pocket Expense Reimbursements revenue. Gross margins will fluctuate due to contractual terms, such as thetiming of billing for the out-of-pocket expenses and limitations or caps in theamount of expense that can be billed to the customer.

 

*Selling, General and Administrative:*  Our selling, general and administrative expenses were $12.2million, or 38.7%, of total revenue for the three months ended October 31,2003, and $12.6 million, or 36.8%, of total revenue for the three months endedOctober 31, 2002.  Our selling,general and administrative expenses were $36.9 million, or 38.5%, of totalrevenue for the nine months ended October 31, 2003, and $38.0 million, or31.3%, of total revenue for the nine months ended October 31, 2002.  Selling, general and administrative expensesgenerally consist of personnel costs such as salaries, commissions and otherincentive compensation along with travel associated with selling, marketing,general management and software management. Additionally, the provision for doubtful accounts, as well as fees forprofessional services, directors and officers’ insurance and other relatedcosts are classified within selling, general and administrative expense.  In absolute dollars, selling, general andadministrative costs have decreased for the three months ended October 31,2003, as compared to the three months ended October 31, 2002, primarilydue to decreased health insurance claims. These costs have decreased for the nine months ended October 31,2003, as compared to the nine months ended October 31, 2002, as a resultof decreases in certain personnel costs, along with decreased health insurancecosts.  The increase in these costs as apercent of total revenue is the result of a 8.1% decline in total revenue forthe three months ended October 31, 2003, as compared to the three monthsended October 31, 2002 and a 21.0% decline in total revenue for the ninemonths ended October 31, 2003, as compared to the nine months endedOctober 31, 2002.  We have reducedcertain selling, general and administrative expenses during fiscal 2003,however, we have largely redeployed a portion of these funds in targeted areasto provide a foundation for future growth. In addition, certain expenses such as directors and officers insurancehave increased.  The absolute amount ofselling, general and administrative expenses is not expected to declinesignificantly for the balance of fiscal 2003.

 

*Research and Development:* Research and development costs were $1.7 million, or 5.5%, of totalrevenue for the three months ended October 31, 2003, and $3.2 million, or9.4%, of total revenue for the three months ended October 31, 2002.  Our research and development costs were $5.3million, or 5.5%, of total revenue for the nine months ended October 31,2003, and $9.4 million, or 7.7%, of total revenue for the nine months endedOctober 31, 2002.  Research anddevelopment costs have decreased for the three months ended October 31,2003, as compared to October 31, 2002, as a result of a concentration ofprojects classified as cost of software maintenance.  Research and development costs are typically limited todevelopment of new software products, or enhancements to existing softwareproducts, which extend the products life cycle and/or substantially increaseits marketability.  We have continued toinvest in our solutions, in support of revenue growth and quality enhancements,and we expect Research and Development spending activities to increase for thebalance of fiscal 2003 and into fiscal 2004 as we invest in technologies tomeet our customers’ needs for shifting from paper-based payments to electronicpayments.  In the three months endedOctober 31, 2003, we capitalized software costs of $204,000 related to thedevelopment of software for sending and receiving check images.  We expect the capitalization of softwarecosts to increase in the future.

 

*Amortization ofIntangible Assets:* Our amortization of intangibles was $350,000, or 1.1%, of total revenuefor the three months ended October 31, 2003, and $350,000, or 1.0%, oftotal revenue for the three months ended October 31, 2002.  Our amortization of intangibles was $1.1million, or 1.1%, of total revenue for the nine months ended October 31,2003, and $1.1 million, or 0.9%, of total revenue for the nine months endedOctober 31, 2002.  The expense forthe three months ended October 31, 2003 and 2002 is a result of therecognition of amortization expense for a customer relationship intangibleasset acquired in the Check Solutions acquisition.

 

*Restructuring andother charges:* We recorded $311,000 of restructuring and other charges during thethree month period ended October 31, 2003, and $1.4 million during thenine months ended October 31, 2003. These charges consist principally of severance for terminatedemployees.  In the three months endedOctober 31, 2003, we reversed $421,000 primarily related to the true-up oftermination benefits as actual costs were lower than estimated amounts.  Additionally, $119,000 was reversed whenestimated costs to close certain facilities were lower than our originalestimates.  The effect of theserevisions in estimates, net of tax, was $0.02 per share on a fully dilutedbasis for the three months ended October 31, 2003.

 

32

----

 

The activity related to the accrued mergerand restructuring costs reserve during our three and nine month period endedOctober 31, 2003 is as follows (in thousands):

 
|                                   |   | **Workforce  Reductions** |   | **Charges  Relating to  CheckFlow  Suite** |   | **Facility  Closures** |   | **Total** |   |
|----------------------------------------|--------|---------------------------|--------|--------------------------------------------|--------|------------------------|--------|-----------|--------|
|                                   |   |                      |   |                                       |   |                   |   |      |   |
| January 31,  2003 reserve balance |   | $                         | 953    |                                       | $      | 1,273                  |   | $         | 124    |   | $ | 2,350 |   |
|                                   |   |                      |   |                                       |   |                   |   |      |   |
| Additions to  reserve balance:         |   |                      |   |                                       |   |                   |   |      |   |
| Severance  charges                     |   | 545                       |   | —                                     |   | —                 |   | 545       |   |
| Reduction to  reserve balance:         |   |                      |   |                                       |   |                   |   |      |   |
| Cash paid                              |   | (550                      | )      | (68                                        | )      | —                 |   | (618      | )      |
| April 30,  2003 reserve balance   |   | 948                       |   | 1,205                                      |   | 124                    |   | 2,277     |   |
|                                   |   |                      |   |                                       |   |                   |   |      |   |
| Additions to  reserve balance:         |   |                      |   |                                       |   |                   |   |      |   |
| Severance  charges                     |   | 648                       |   | —                                     |   | —                 |   | 648       |   |
| Cash received from customer            |   | —                    |   | 366                                        |   | —                 |   | 366       |   |
| Reduction to  reserve balance:         |   |                      |   |                                       |   |                   |   |      |   |
| Cash paid                              |   | (563                      | )      | (60                                        | )      | —                 |   | (623      | )      |
| July 31,  2003 reserve balance    |   | 1,033                     |   | 1,511                                      |   | 124                    |   | 2,668     |   |
|                                   |   |                      |   |                                       |   |                   |   |      |   |
| Additions to  reserve balance:         |   |                      |   |                                       |   |                   |   |      |   |
| Severance  charges                     |   | 170                       |   | —                                     |   | —                 |   | 170       |   |
| Reduction to  reserve balance:         |   |                      |   |                                       |   |                   |   |      |   |
| Change in  estimate                    |   | (421                      | )      | —                                     |   | (119                   | )      | (540      | )      |
| Cash paid                              |   | (395                      | )      | (57                                        | )      | —                 |   | (452      | )      |
| October 31,  2003 reserve balance |   | $                         | 387    |                                       | $      | 1,454                  |   | $         | 5      |   | $ | 1,846 |   |

 

We also recorded $141,000 and $410,000 oflegal and professional fees relating to our restatement effort and associatedlegal actions during the three and nine months ended October 31, 2003.

 

*Interest Income:*  Interest income was $69,000 for the threemonths ended October 31, 2003, compared to $138,000 for the three monthsended October 31, 2002.  Interestincome decreased $108,000 to $223,000 for the nine months endedOctober 31, 2003, from $331,000 for the nine months ended October 31,2002.  The level of interest income isdetermined by the available funds for investment and by the effective interestrates earned.  If lower interest ratespersist, we expect interest income to continue to be minimal during fiscal 2003.

 

*Interest Expense:*  Interest expense decreased $371,000 to$234,000 for the three months ended October 31, 2003, from $605,000 forthe three months ended October 31, 2002. Interest expense decreased $1.1 million to $1.0 million for the ninemonths ended October 31, 2003, from $2.1 million for the nine months endedOctober 31, 2002.  Interest expensedecreased on both a three and nine month basis due to a decreased amount ofborrowings outstanding under the revolving credit agreement and decreasedinterest rates.

 

33

----

 

*Provision (Benefit)for Income Taxes:* The Company has established a valuation allowance to reserve its netdeferred tax assets at October 31, 2003 because the more likely than notcriteria for future realization of the Company’s net deferred tax assetsspecified in Statements of Financial Accounting Standards No. 109, “*Accounting for Income Taxes,”* (“SFAS No.109”) were not met.** **The net tax provision of $146,000 and $372,000 for thethree and nine months ended October 31, 2003, respectively, consists of aprovision for state and foreign taxes. The effective tax rate varied from the federal statutory rate in 2003primarily due to the expected utilization of net operating loss carryforwards.  The net tax provision of $392,000 for thethree months ended October 31, 2002 consists of****a provision for state and foreign taxes based on theestimated annual effective rate for the year ended January 31, 2003.  The net tax benefit of $666,000 for the ninemonths ended October 31, 2002 consists of a $1.9 million tax benefitgenerated by additional tax loss carrybacks available to the Company as aresult of the Job Creation and Workers Assistance Act of 2002, offset by a $1.2million provision for state and foreign taxes based on the estimated annualeffective tax rate for the year ending January 31, 2003.  The estimated annual effective tax rate infiscal 2002 was lower than the statutory federal and state rates as a result ofthe benefits from carryforward of net operating losses expected to be utilized.

 

**Liquidityand Capital Resources**

 

At October 31, 2003, we had workingcapital of $11.7 million compared with $17.4 million at January 31,2003.  We had $21.2 million in cash andcash equivalents at October 31, 2003, a decrease of $5.8 million from$27.0 million in cash and cash equivalents at January 31, 2003.  At October 31, 2003, we had $12.5million of long-term debt compared to $25.0 million at January 31, 2003.  The decrease in working capital is primarilya result of the payments made on the long-term debt during the nine monthsended October 31, 2003.

 

During the three months endedOctober 31, 2003, we used $4.8 million of cash from operating activities,as compared to generating $163,000 during the three months endedOctober 31, 2002.  During the ninemonths ended October 31, 2003, we generated $9.2 million of cash fromoperating activities, as compared to generating $7.8 million during the ninemonths ended October 31, 2002.  Thedecrease in cash generated from operating activities during the three monthperiod ended October 31, 2003, as compared to the three months endedOctober 31, 2002, is primarily the result of the receipt of approximately$7.0 million Federal income tax refund during the three months endedOctober 31, 2002.  The increase inthe cash generated from operating activities during the nine months endedOctober 31, 2003, as compared to the nine months ended October 31,2002, is primarily the result of payments for accrued merger and restructuringcharges and accrued compensation benefits paid to certain former and currentemployees of Check Solutions during the nine months ended October 31, 2002which were accrued at the purchase date.

 

The timing of cash collections can causefluctuations from quarter-to-quarter in our cash generated from operatingactivities.  Average days’ salesoutstanding fluctuate for a variety of reasons, including the timing ofbillings specified by contractual agreement and receivables for expensereimbursements.  The following tablecontains the quarterly days sales outstanding (DSO):

 
| **Quarter ended**      |   | **DSO** |   |
|------------------------|--------|---------|--------|
| October 31,  2003 |   | 56      |   |
| July 31,  2003    |   | 43      |   |
| April 30,  2003   |   | 51      |   |
| January 31,  2003 |   | 72      |   |
| October 31,  2002 |   | 97      |   |

 

From an investing perspective, we used $2.0million and $1.6 million during the three months ended October 31, 2003and 2002, respectively.  Cash used ininvesting activities was $2.6 million and $3.5 million during the nine monthsended October 31, 2003 and 2002, respectively.  These uses of cash are comprised of purchases of property andequipment, acquired developed technology and capitalized softwaredevelopment.  We expect increases in theamount of capitalized software development during the balance of fiscal 2003and for at least the first half of fiscal 2004.

 

34

----

 

From a financing perspective, we generated$482,000 during the three months ended October 31, 2003, as compared tousing $7.0 million during the period ended October 31, 2002.  Cash used in financing activities for thenine months ended October 31, 2003 was $12.5 million, and the cashprovided by financing activities was $4.4 million during the nine months endedOctober 31, 2002.  The cashgenerated during the three months ended October 31, 2003 was primarilyfrom the proceeds from the exercise of stock options.  The cash used during the three months ended October 31, 2002is primarily due to $7.0 million of payments on our revolving credit agreement.  The cash used during the nine months endedOctober 31, 2003 was primarily due to $12.5 million of payments on ourrevolving credit agreement.  The cashused during the nine months ended October 31, 2002 consisted primarily of$16.0 million of payments on our revolving credit agreement offset by the $9.3million of net proceeds received from the sale of 1,282,214 shares of commonstock to a group of institutional investors in a private transaction, and the$2.3 million of proceeds from the exercises of stock options.

 

On June 6, 2001, we entered into athree-year revolving credit agreement with a group of banks in an amount not toexceed $60.0 million to fund the acquisition of Check Solutions.  On July 31, 2003, the revolving creditwas amended to reduce the commitment amount to $30.0 million, and to extend thematurity date of outstanding borrowings to July 31, 2006.  As of the date of the extension, theoutstanding balance was $12.5 million. Borrowings under the credit agreement, as amended, currently bearinterest equal to either the greater of prime or federal funds rate plus amargin ranging from 1.25% to 2.25% depending on our ratio of funded debt toEarnings before Interest, Taxes, Depreciation and Amortization (“EBITDA”), orLIBOR plus a margin equal to 2.75% to 3.75% depending on the Company’s ratio offunded debt to EBITDA.  Interestpayments are due quarterly.  We arerequired to pay a commitment fee equal to 0.50% on the unused amount of therevolving credit agreement.  Therevolving credit agreement contains customary affirmative and negativecovenants, including financial covenants requiring the maintenance of specifiedinterest coverage, ratio of EBITDA to funded debt, and ratio of 80% of accountsreceivable, cash and short-term investments to funded debt.  The interest coverage covenant was amendedon July 31, 2003 to be more favorable to the Company.  Additionally, the payment of dividends isprecluded except upon the approval of the banks.  Substantially all of our assets collateralize the revolvingcredit agreement.  As ofOctober 31, 2003, we are in compliance with the covenants of the revolvingcredit agreement, as amended.

 

At October 31, 2003, we had $12.5million outstanding under the credit agreement.  At October 31, 2003, the interest rate on the debt was4.375% on 50% of the outstanding borrowings and 4.500% on the remaining50%.  Because the interest on the debtis variable, the carrying value approximates the fair value.  Interest expense, exclusive of theamortization of deferred loan costs, on the credit agreement was $166,000 and$496,000 for the three months ended October 31, 2003 and 2002,respectively, and $707,000 and $1.7 million for the nine months endedOctober 31, 2003 and October 31, 2002, respectively.

 

We expect that existing cash and cashgenerated from operating activities will be sufficient to meet our anticipatedcash needs for working capital, capital expenditures and other activities forat least the next 12 months.  However,if current sources are not sufficient to meet our needs, we may seek to borrowunder the existing credit agreement or seek additional equity or debtfinancing.  There can be no assurancethat additional financing would be available on acceptable terms, if atall.  We are presently involved in anumber of lawsuits, the outcome of which could affect our liquidity.  Further, in the future we may pursueacquisitions of businesses, products or technologies that could complement orexpand our business and product offerings, which could change our financingneeds.  Our forecast of the period oftime through which our financial resources will be adequate to support ouroperations is a forward-looking statement that involves risks anduncertainties, and actual results could vary. The failure to secure additional financing when needed could have amaterial adverse effect on our business, financial condition and results ofoperations.

 

The following summarizes our contractualobligations at October 31, 2003 and the effect these contractualobligations are expected to have on our liquidity and cash flows in futureperiods (in thousands):

 
|                        |   |      |   | **Payments  Due by Period** |   |
|-----------------------------|--------|-----------|--------|-----------------------------|--------|
|                        |   | **Total** |   | **1 Year or  Less**         |   | **Years  2-3** |   | **After  3 Years** |   |
| Revolving  credit agreement |   | $         | 12,500 |                        | $      | — |   | $ | 12,500 |   | $ | — |   |
| Operating  leases           |   | 18,298    |   | 3,829                       |   | 6,627 |   | 7,842 |   |
|                        |   | $         | 30,798 |                        | $      | 3,829 |   | $ | 19,127 |   | $ | 7,842 |   |

 

35

----

 

**Critical Accounting Policies**

 

In preparing our consolidated financialstatements in conformity with accounting principles generally accepted in theUnited States, we use certain estimates and assumptions that affect thereported amounts and related disclosures and our estimates may vary from actualresults.  We consider the followingseven accounting policies the most important to the portrayal of our financialcondition and those 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

 

Our revenue recognition policies are inaccordance with Statement of Position (“SOP”) 97-2, *“Software Revenue Recognition,”*as amended by SOP 98-9, “*Modification of SOP 97-2, Software RevenueRecognition with Respect to Certain Transactions,”* and StaffAccounting Bulletin (“SAB”) No. 101, *“Revenue Recognition in Financial Statements.”*  In the case of software arrangements thatrequire significant production, modification, or customization of software, orthe license agreement requires the Company to provide implementation servicesthat are determined to be essential to other elements of the arrangement, theCompany follows the guidance in SOP 81-1, *“Accounting for Performance of Construction – Typeand Certain Production – Type Contracts.”*

 

*Consulting Fees.*  We employ three primary pricing methods in connection with ourdelivery of consulting services. First, we may price our 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, we are generally paid fees and related amounts on amonthly basis, and we recognize revenues as the services are performed. Second,we may deliver consulting services on a fixed-price basis. In this case, we aregenerally paid on a monthly basis or pursuant to an agreed upon paymentschedule, and we recognize revenues on a percentage-of-completion basis. Webelieve that this method is appropriate because of our ability to determineperformance milestones and determine dependable estimates of our costs applicableto each phase of a contract.  Becausefinancial reporting 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-priced contracts are recognized when estimable.  Third, we may deliver consulting servicespursuant to a value-priced contract with the customer. In this case, we arepaid, on an agreed upon basis with the customer, either a specified percentageof (1) the projected increased revenues and/or decreased costs that areexpected to be derived by the customer generally over a period of up to twelvemonths following implementation of our solution or (2) the actual increasedrevenues and/or decreased costs experienced by the customer generally over aperiod of up to twelve months following implementation of our solution, subjectin either case to a maximum, if any is agreed to, on the total amount ofpayments to be made to us.  We mustfirst commit time and resources to develop projections associated withvalue-pricing contracts before a bank will commit to purchase our solutions,and we therefore assume the risk of making these commitments with no assurancethat the bank will purchase the solution. Costs associated with these value-pricing contracts are expensed asincurred**.**  These contracts typically include paymentsto be made to us pursuant to an agreed upon schedule ranging from one totwelve months in length. We recognize revenues generated from consulting servicesin connection with value-priced contracts based upon projected results onlyupon completion of all services and agreement upon the actual fee to be paid(even though billings for these services may be delayed by mutual agreement forperiods not to exceed twelve months). In an effort to allow customers to moreclosely match expected benefits from our services with payments to us, we mayon occasion, offer payment terms which extend beyond 12 months.  When we enter into an agreement that has asignificant component of the total amount payable under the agreement duebeyond 12 months or if it is determined payments are not fixed and determinableat the date the agreement is entered into, revenue under the arrangement willbe recognized as payments become due and payable.  When fees are to be paid based on a percentage of actual revenuesand/or savings to our customers, we recognize revenues only upon completion ofall services and as the amounts of actual revenues or savings are confirmed bythe customer with a fixed payment date.

 

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

 

We expect that value-priced contracts willcontinue to account for a significant portion of our revenues in the future. Asa consequence of the use of value-priced contracts and due to the revenuerecognition policy associated with those contracts, our results of operationswill likely fluctuate significantly from period to period.

 

Regardless of the pricing method employed byus in a given contract, we are typically reimbursed on a monthly basis forout-of-pocket expenses incurred on behalf of our customers.

 

36

----

 

*Software License Fees.*  A software license is sold either togetherwith implementation services or on a stand-alone basis.  We are usually paid software license fees inone or more installments, as provided in the customer’s contract but not toexceed 12 months.  Under SOP 97-2, werecognize software license revenue upon execution of a contract and delivery ofthe 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 us to provide implementation services that are essential to thefunctionality 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.

 

Software licenses are often sold as part of amultiple element arrangement that may include maintenance, implementation orconsulting.  We determine whether thereis vendor specific objective evidence of fair value (“VSOEFV”) for each elementidentified in the arrangement to determine whether the total arrangement feescan be allocated to each element.  If VSOEFVexists for each element, the total arrangement fee is allocated based on therelative fair value of each element.  Incases where there is not VSOEFV for each element, or if it is determinedservices are essential to the functionality of the software being delivered, orif significant production, modification or customization of the software isrequired, we defer revenue recognition of the software license fees.  However, if VSOEFV is determinable for allof the undelivered elements, and assuming the undelivered elements are notessential to the delivered elements, we 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 as setforth in SOP 98-9.  Where VSOEFV has notbeen established for certain undelivered elements, revenue for all elements isdeferred until those elements have been delivered or their fair values havebeen determined.  Evidence of VSOEFV isdetermined for software products based on actual sales prices for the productsold to a similar class of customer and based on pricing strategies set forthin our price book.  Evidence of VSOEFVfor services (installation, implementation and consulting) is based upon standardbilling rates and the estimated level of effort for individuals expected toperform the related services.  Weestablish VSOEFV for maintenance agreements using the percentage method suchthat VSOEFV for maintenance is a percentage of the license fee charged annuallyfor specific software product, which in most instances is 20% of the portion ofarrangement fees allocated to the software license element.

 

Although substantially all of our currentsoftware licenses provide for a fixed-price license fee, some licenses providefor the customer to pay a monthly license fee based on the actual use of thesoftware product.  The level of licensefees earned by us under this arrangement will vary based on the actual amountof use by the customer.  Revenue underthese arrangements is recognized on a monthly basis as the usage becomesdeterminable.

 

*Software Maintenance Fees.*  In connection with our sale of a softwarelicense, a customer may elect to purchase software maintenance services. Mostof the customers that purchase software licenses from us also purchase softwaremaintenance services, which typically are renewed annually. We charge an annualmaintenance fee, which is typically a percentage of the initial softwarelicense fee. The annual maintenance fee generally is paid to us at thebeginning of the maintenance period, and we recognize these revenues ratablyover the term of the related contract. If the annual maintenance fee is not paid at the beginning of the maintenanceperiod, we defer revenue recognition until the time that the maintenance fee ispaid by the customer.  We normallycontinue to provide maintenance service while awaiting payment fromcustomers.  When the payment isreceived, revenue is recognized for the period that revenue was previouslydeferred.  This may result in volatilityin software maintenance revenue from period-to-period.

 

*SoftwareImplementation Fees.* In connection with the sale of a software license, a customer may electto purchase software implementation services, including software enhancements,patches and other software support services. Most of the customers that purchase software licenses from us alsopurchase software implementation services. We price our implementation services on a time-and-material or on a fixed-pricebasis, and we recognize the related revenues as services are performed.  Costs associated with these engagements areexpensed as incurred.

 

Our contracts typically do not include rightof return clauses, and as a result, we do not record a provision for returns.

 

Royalties

 

In connection with software license andmaintenance agreements entered into with certain banks and purchase agreementswith vendors under which we acquired software technology used in products soldto its customers, we are required to pay royalties on sales of certain softwareproducts.  Under these arrangements, weaccrue royalty expense when the associated revenue is recognized.  For current product offerings, the royaltypercentages generally range from 20%-30% of the associated revenues.  Royalty expense is included as a componentof the cost of software license fees and cost of software maintenance fees inthe accompanying consolidated statement of operations.

 

37

----

 

Allowance for Doubtful Accounts

 

A large proportion of our revenues andreceivables are attributable 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 of recoverabilityof amounts due us could be reduced by a material amount.

 

Software Costs Capitalized, Goodwill, OtherIntangible 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 also include amounts paidfor purchased software on products that have reached technological feasibility.Technological feasibility of the product is determined after completion of adetailed program design and a determination has been made that anyuncertainties related to high-risk development issues have been resolved. Ifthe process of developing the product does not include a detailed programdesign, technological feasibility is determined only after completion of aworking model that has been beta tested. All capitalized software developmentcosts are amortized using an amount determined as the greater of: (1) the ratiothat current gross revenues for a capitalized software project bears to thetotal of current and future projected gross revenues for that project or (2)the straight-line method over the remaining economic life of the product(generally three to six years).

 

Goodwill and intangibles with indefinitelives are assessed on an annual basis for impairment at the reporting unit levelby applying a fair value based test.  Weperformed the initial impairment test of goodwill and intangibles withindefinite lives assets at February 1, 2002 and a follow up test atNovember 1, 2002 to determine if an impairment charge should be recognizedunder SFAS 142.  The initial impairmentanalysis did not result in any write-down of capitalized costs.  We perform an annual impairment assessmenton November 1st of each year or when factors indicate thatother long-lived assets should be evaluated for possible impairment.  We use an estimate of undiscounted futurenet cash flows over the remaining life of the asset to determine if impairmenthas occurred.  Assets are grouped at thelowest level for which there are identifiable cash flows that are largelyindependent from other asset groups.  Animpairment in the carrying value of an asset is assessed when the undiscounted,expected future operating cash flows derived from the asset are less than itscarrying value.  Management believesthat assumptions used to determine cash flows are reasonable, but actual futurecash flows may differ from those estimated. If we determine an asset has been impaired, the impairment is recordedbased on the estimated fair value of the impaired asset.  During the period ended January 31,2003, events and circumstances caused us to revaluate goodwill resulting in animpairment charge of $46.0 million. Goodwill at October 31, 2003 totaled $21.2 million.  Any deterioration in market conditions,increases in interest rates and changes in our projections with respect to theGlobal Payments Technologies reporting unit to which goodwill is allocatedwould result in additional impairment charges in the future.

 

Restructuring and Other Charges

 

During fiscal year 2001, we recorded significantreserves in connection with our acquisition of Check Solutions and subsequentoperational restructurings.  Additionalreserves were recorded during the three and nine months ended October 31,2003 and 2002.  These reserves containsignificant estimates pertaining to work force reductions, and the settlementof contractual obligations resulting from our actions.  In the three months ended October 31,2003, we recorded $311,000 in restructuring and other charges relatedprincipally to severance and legal fees. In the three months ended October 31, 2003, we revised ourestimates related to severance benefits and facility closures and reduced ourreserve by $540,000.  Although we do notanticipate any additional significant changes, the actual costs may differ fromthese estimates.

 

38

----

 

Contingencies

 

We are subject to proceedings, lawsuits andother claims.  We are required to assessthe likelihood of any adverse judgments of 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 change in settlement strategy.

 

Income Taxes

 

We recognize deferred tax assets orliabilities for the expected future tax consequences of temporary differencesbetween the book and tax bases of assets and liabilities.  We review our deferred tax assets forrecoverability and establish a valuation allowance based on historical taxableincome, projected future taxable income and the expected timing of thereversals of existing temporary differences. As a result of our cumulative net losses we have provided a fullvaluation allowance against our net deferred tax assets.  In addition, we expect to provide a fullvaluation allowance of any future tax benefits until we can sustain a level ofprofitability that demonstrates our ability to utilize these assets.

 

**RecentlyIssued Accounting Standards**

 

In November 2002, the EITF reached aconsensus on Issue 00-21, *“MultipleDeliverable Revenue Arrangements.”* EITF 00-21 addresses certain aspects of the accounting by a vendor forarrangements under which it will perform multiple revenue-generatingactivities.  It also addresses when andhow an arrangement involving multiple deliverables should be divided intoseparate units of accounting.  The guidancein EITF 00-21 is effective for revenue arrangements entered into in fiscalperiods beginning after June 15, 2003, with early applicationpermitted.  Companies may elect toreport the change in accounting as a cumulative effect of a change in accountingprinciple in accordance with APB Opinion 20, *“AccountingChanges” and SFAS 3, “Reporting Accounting Changes in Interim FinancialStatements (an amendment of APB Opinion No. 28).”*  The adoption of EITF 00-21 did not have asignificant impact on our accounting for multiple element arrangements.

 

In June 2003, the FASB issuedInterpretation No. 46, “Consolidation of Variable Interest Entities.”  Interpretation No. 46 clarifies theapplication of Accounting Research Bulletin No. 51 and applies immediately to anyvariable interest entities created after January 31, 2003 and to variableinterest entities in which an interest is obtained after that date.  This Interpretation is applicable to theCompany in the quarter ending October 31, 2003, for interests acquired invariable interest entities prior to February 1, 2003.  This Interpretation requires variableinterest entities to be consolidated if the equity investment at risk is notsufficient to permit an entity to finance its activities without support fromother parties or the equity investors lack specified characteristics.  The adoption of the Interpretation did nothave a material impact on the Company’s financial statements.

 

39

----

 

**Item3.  Quantitative and QualitativeDisclosures About Market Risk**

 

**Interest Rate Risk**

 

We invest our cash in a variety of financialinstruments.  These investments aredenominated in U.S. dollars and maintained with nationally recognized financialinstitutions and mutual fund companies.

 

We account for our investment instruments inaccordance with Statement of Financial Accounting Standards No. 115, “*Accounting for Certain Investments in Debt and EquitySecurities”* (“SFAS 115”).  Wetreat all of our cash equivalents and short-term investments asavailable-for-sale under SFAS 115.

 

Investments in both fixed-rate andfloating-rate interest-earning instruments carry a degree of interest raterisk.  Fixed-rate securities may havetheir fair market value adversely impacted due to a rise in interest rates,while floating rate securities may produce less income than expected ifinterest rates fall.  Due in part tothese factors, our future investment income may fall short of expectations dueto changes in interest rates, or we may suffer losses in principal if forced tosell securities that have seen a decline in market value due to changes ininterest rates.  Our investmentsecurities are held for purposes other than trading.  At October 31, 2003, we did not hold any fixed-rateinvestments.

 

We currently have $12.5 million outstandingunder our revolving credit agreement at October 31, 2003.  As described in Note 5 of our Notes toCondensed Consolidated Unaudited Financial Statements, the interest rate isvariable.  At October 31, 2003, theinterest rate on the debt was 4.375% on 50% of the outstanding borrowings and4.500% on the remaining 50%.

 

**Foreign Currency Risk**

 

We currently have operations in severalinternational locations including Canada, United Kingdom, South Africa andAustralia.  As a result, we have assetsand liabilities outside the United States that are subject to fluctuations inforeign currency exchange rates.  Due tothe nature of these operations, we currently utilize the U.S. Dollar as thefunctional currency for all international operations.

 

An insignificant portion of our accountsreceivable balance at October 31, 2003 was denominated in a foreigncurrency.  Our exposure to adversemovements to foreign exchange rates is not significant.  Therefore, we do not currently hedge ourforeign currency exposure; however, we do try to limit our foreign currencyexposure by negotiating foreign currency exchange rates within our customercontracts.  Historically, foreigncurrency gains and losses have not had a significant impact on our results ofoperations or financial position.  Wewill continue to evaluate the need to adopt a hedge strategy in the future andmay implement a formal strategy if our business transacted in foreigncurrencies increases.

 

40

----

 

**Item4.  Controls and Procedures**

 

*Disclosure Controls*

 

We maintain disclosure controls andprocedures designed to ensure that we are able to collect the information weare required to disclose in the reports we file with the SEC, and to process,summarize and disclose this information within the time periods specified inthe rules of the SEC.

 

Our management, under the supervision andwith the participation of our Chief Executive and Chief Financial Officers, isresponsible for evaluating the effectiveness of our disclosure controls andprocedures.  As of October 31,2003, they carried out an evaluation of our disclosure controls and procedures,and the Chief Executive and Chief Financial Officers believe that theseprocedures 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 disclosurecontrols and procedures, management recognized that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives, andmanagement necessarily was required to apply its judgment in evaluating the cost-benefitrelationship of possible controls and procedures.

 

*Internal Controls*

 

There have been no changes in our internalcontrol over financial reporting during our most recently completed fiscalquarter that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

 

41

----

 

**PART II:  OTHER INFORMATION**

 

**ITEM 1.****                             LEGALPROCEEDINGS**

 

Except as noted below, the informationcontained under Part II, Item 1 (Legal Proceedings) in our Form 10-Q for theperiod ended April 30, 2003 is herby incorporated by reference.

 

*Barbara I. Smith,Derivatively on behalf of Nominal Defendant Carreker Corporation v. John D.Carreker, Jr., James D. Carreker, Richard R. Lee, Jr., James L. Fischer, DonaldL. House, David K. Sias, Terry L. Gage and Carreker Corporation, NominalDefendant  In the United States DistrictCourt for the Northern District of Texas, Dallas Division, Civil Action No.303CV1211-D*

 

On November 20, 2003 the parties to thisaction filed a joint motion with the Court requesting that the Court dismissthe action without prejudice.  This is avoluntary dismissal by the plaintiff and there is no compensation being givenby or on behalf of the Company or the individual defendants.  The Court has ordered the plaintiffs topublish, no later than December 22, 2003, a notice of the parties' intentto voluntarily dismiss this action.

 

**ITEM 2.****                             CHANGESIN SECURITIES AND USE OF PROCEEDS**

 

None.

 

**ITEM 3.****                             DEFAULTSUPON SENIOR SECURITIES**

 

None.

 

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

 

None.

 

**ITEM 5.****                             OTHERINFORMATION**

 

None.

 

42

----

 

 

**ITEM 6.****                             EXHIBITSAND REPORTS ON FORM 8-K**

 

(a)                                  Exhibits

 
| **Number** |   | **Exhibit  Description**                                                                                                           |
|------------|--------|------------------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                               |
| 10.1       |   | Employment Agreement dated October 6,  2003 between the Company and Lisa Peterson                                             |
|       |   |                                                                                                                               |
| 31.1       |   | Certification Pursuant to Section 302  of the Sarbanes-Oxley Act of 2002                                                      |
|       |   |                                                                                                                               |
| 31.2       |   | Certification Pursuant to Section 302  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 |

 

(b)                                 Reportson Form 8-K

 

We filed the following Current Reports onForm 8-K with the Securities and Exchange Commission during the quarterlyperiod ended October 31, 2003:

 

(i)                                     Acurrent report on Form 8-K dated September 10, 2003 was filed withSecurities and Exchange Commission furnishing certain disclosure under Item 9.

 

43

----

 

**SIGNATURES**

 

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

 

CARREKER CORPORATION

 

 
| By:    | /s/ John D. Carreker, Jr.  |   | Date: | December 11,  2003 |   |
|--------|----------------------------|--------|-------|-------------------------|--------|
|   | John D. Carreker, Jr.      |   |
|   | Chairman of the  Board and |   |
|   | Chief Executive  Officer   |   |
|   |                       |   |
|   |                       |   |
| By:    | /s/ Lisa K. Peterson       |   | Date: | December 11,  2003 |   |
|   | Lisa K. Peterson           |   |
|   | Chief Financial Officer    |   |

 

44

----