**United StatesSecurities and Exchange Commission**

**Washington,D.C.  20549**

# **FORM 10-Q**

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

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

**Commissionfile number  0-24201**

**Carreker Corporation**

(Exact name ofregistrant as specified in its charter)

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

**(972)458-1981**

(Registrant’stelephone number, including area code)

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

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

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

Large Accelerated Filer o                  Accelerated Filer x            Non-AcceleratedFiler o

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

Yes o    No x

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

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

 

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**CARREKERCORPORATION**

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

 

2

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**PARTI:  FINANCIAL INFORMATION**

**Item1.  Financial Statements**

**CARREKER CORPORATION**

**Condensed Consolidated Balance Sheets**

**(Unaudited)**

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

**ASSETS**

 
| ** **                                                                                                                                     | ** ** | **   July 31,   ** | ** ** | **   January 31,   ** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                                                                                     | ** ** | **2006**                                              | ** ** | **2006**                                                 | ** ** |
|                                                                                                                                           |       |                                                  |       |                                                     |       |
| Current assets                                                                                                                                 |       |                                                  |       |                                                     |       |
| Cash and cash  equivalents                                                                                                                     |       | $                                                     | 27,614     |                                                     | $          | 29,684 |   |
| Marketable  securities                                                                                                                         |       | 5,900                                                 |       | 4,700                                                    |       |
| Accounts  receivable, net of allowance of $610 and $601 at July 31, 2006 and January  31, 2006, respectively                                   |       | 17,266                                                |       | 12,225                                                   |       |
| Prepaid expenses  and other current assets                                                                                                     |       | 2,343                                                 |       | 2,940                                                    |       |
| Total current assets                                                                                                                           |       | 53,123                                                |       | 49,549                                                   |       |
|                                                                                                                                           |       |                                                  |       |                                                     |       |
| Property and equipment,  net of accumulated depreciation of $24,265 and $23,050 at July 31, 2006 and  January 31, 2006, respectively           |       | 6,593                                                 |       | 5,947                                                    |       |
| Capitalized software  costs, net of accumulated amortization of $14,333 and $13,686 at July 31,  2006 and January 31, 2006, respectively       |       | 3,359                                                 |       | 2,761                                                    |       |
| Acquired developed  technology, net of accumulated amortization of $22,617 and $20,393 at July  31, 2006 and January 31, 2006, respectively    |       | 3,083                                                 |       | 5,307                                                    |       |
| Goodwill, net of  accumulated amortization of $3,405 at July 31, 2006 and January 31, 2006                                                     |       | 20,765                                                |       | 20,765                                                   |       |
| Customer relationships,  net of accumulated amortization of $7,233 and $6,533 at July 31, 2006 and  January 31, 2006, respectively             |       | 1,167                                                 |       | 1,867                                                    |       |
| Deferred loan costs,  net of accumulated amortization of $1,571 at January 31, 2006                                                            |       | —                                                |       | 136                                                      |       |
| Other assets                                                                                                                                   |       | 797                                                   |       | 793                                                      |       |
| Total assets                                                                                                                                   |       | $                                                     | 88,887     |                                                     | $          | 87,125 |   |
|                                                                                                                                           |       |                                                  |       |                                                     |       |
| Current liabilities                                                                                                                            |       |                                                  |       |                                                     |       |
| Accounts payable                                                                                                                               |       | $                                                     | 1,086      |                                                     | $          | 1,168 |   |
| Accrued  compensation and benefits                                                                                                             |       | 6,190                                                 |       | 6,153                                                    |       |
| Other accrued  expenses                                                                                                                        |       | 4,114                                                 |       | 4,608                                                    |       |
| Income tax  payable                                                                                                                            |       | 77                                                    |       | 220                                                      |       |
| Deferred revenue                                                                                                                               |       | 19,366                                                |       | 19,151                                                   |       |
| Accrued merger  and restructuring costs                                                                                                        |       | 247                                                   |       | 334                                                      |       |
| Total current  liabilities                                                                                                                     |       | 31,080                                                |       | 31,634                                                   |       |
|                                                                                                                                           |       |                                                  |       |                                                     |       |
| Commitments and  Contingencies                                                                                                                 |       |                                                  |       |                                                     |       |
|                                                                                                                                           |       |                                                  |       |                                                     |       |
| Stockholders’ equity                                                                                                                      |       |                                                  |       |                                                     |       |
| Preferred stock,  $.01 par value: 2,000 shares authorized; no shares issued or outstanding                                                     |       | —                                                |       | —                                                   |       |
| Common stock,  $.01 par value: 100,000 shares authorized; 25,589 and 25,329 shares issued at  July 31, 2006 and January 31, 2006, respectively |       | 256                                                   |       | 254                                                      |       |
| Additional  paid-in capital                                                                                                                    |       | 113,847                                               |       | 112,316                                                  |       |
| Accumulated  deficit                                                                                                                           |       | (52,921                                               | )          | (53,848                                                  | )          |
| Less treasury  stock, at cost: 663 and 641 common shares at July 31, 2006 and January 31,  2006, respectively                                  |       | (3,375                                                | )          | (3,231                                                   | )          |
| Total stockholders’  equity                                                                                                               |       | 57,807                                                |       | 55,491                                                   |       |
| Total liabilities and stockholders’ equity                                                                                                |       | $                                                     | 88,887     |                                                     | $          | 87,125 |   |

See accompanyingnotes.

3

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**CARREKERCORPORATION**

**CondensedConsolidated Statements of Operations**

**(Unaudited)**

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

 

|                                                      | ** ** | **Three Months Ended  July 31,** | ** ** | **Six Months Ended  July 31,** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                 |       |                                            |       |                                          |       |   |   |   |   |
| **Revenues:**                                        | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Consulting                                           |       | $                                               | 6,839      |                                          | $          | 9,502 |   | $ | 15,397 |   | $ | 17,820 |   |
| Software license                                     |       | 5,493                                           |       | 3,782                                         |       | 8,050 |   | 7,141 |   |
| Software maintenance                                 |       | 10,899                                          |       | 10,576                                        |       | 21,651 |   | 21,888 |   |
| Software implementation and other services           |       | 4,249                                           |       | 4,892                                         |       | 8,384 |   | 9,026 |   |
| Outsourcing services                                 |       | 530                                             |       | 241                                           |       | 1,040 |   | 498 |   |
| Out-of-pocket expense reimbursements                 |       | 793                                             |       | 927                                           |       | 1,526 |   | 1,745 |   |
| Total revenues                                       |       | 28,803                                          |       | 29,920                                        |       | 56,048 |   | 58,118 |   |
|                                                 |       |                                            |       |                                          |       |   |   |   |   |
| **Cost of  revenues:**                               | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Consulting                                           |       | 4,798                                           |       | 4,277                                         |       | 9,670 |   | 8,518 |   |
| Software license                                     |       | 1,885                                           |       | 1,828                                         |       | 3,725 |   | 3,364 |   |
| Software maintenance                                 |       | 3,189                                           |       | 3,436                                         |       | 6,361 |   | 7,411 |   |
| Software implementation and other services           |       | 2,938                                           |       | 3,682                                         |       | 6,014 |   | 6,655 |   |
| Outsourcing services                                 |       | 514                                             |       | 434                                           |       | 990 |   | 1,013 |   |
| Out-of-pocket expenses                               |       | 774                                             |       | 808                                           |       | 1,548 |   | 1,598 |   |
| Total cost of revenues                               |       | 14,098                                          |       | 14,465                                        |       | 28,308 |   | 28,559 |   |
| Gross profit                                         |       | 14,705                                          |       | 15,455                                        |       | 27,740 |   | 29,559 |   |
|                                                 |       |                                            |       |                                          |       |   |   |   |   |
| **Operating  costs and expenses:**                   | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Selling, general and administrative                  |       | 11,423                                          |       | 11,593                                        |       | 22,203 |   | 22,497 |   |
| Research and development                             |       | 2,453                                           |       | 2,516                                         |       | 4,658 |   | 5,037 |   |
| Amortization of customer relationships               |       | 350                                             |       | 350                                           |       | 700 |   | 700 |   |
| Restructuring and other charges                      |       | —                                          |       | 28                                            |       | — |   | 123 |   |
| Total operating costs and expenses                   |       | 14,226                                          |       | 14,487                                        |       | 27,561 |   | 28,357 |   |
| Income from  operations                              |       | 479                                             |       | 968                                           |       | 179 |   | 1,202 |   |
|                                                 |       |                                            |       |                                          |       |   |   |   |   |
| **Other  income (expense):**                         | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest income                                      |       | 407                                             |       | 166                                           |       | 678 |   | 310 |   |
| Interest expense                                     |       | (106                                            | )          | (107                                          | )          | (211 | ) | (212 | ) |
| Other income                                         |       | 315                                             |       | 129                                           |       | 515 |   | 435 |   |
| Total other income, net                              |       | 616                                             |       | 188                                           |       | 982 |   | 533 |   |
| Income before  provision for income taxes            |       | 1,095                                           |       | 1,156                                         |       | 1,161 |   | 1,735 |   |
| Provision for  income taxes                          |       | 134                                             |       | 102                                           |       | 234 |   | 183 |   |
| Net income                                           |       | $                                               | 961        |                                          | $          | 1,054 |   | $ | 927 |   | $ | 1,552 |   |
| Basic earnings  per share                            |       | $                                               | 0.04       |                                          | $          | 0.04 |   | $ | 0.04 |   | $ | 0.06 |   |
| Diluted earnings  per share                          |       | $                                               | 0.04       |                                          | $          | 0.04 |   | $ | 0.04 |   | $ | 0.06 |   |
| Shares used in  computing basic earnings per share   |       | 24,041                                          |       | 24,127                                        |       | 23,986 |   | 24,326 |   |
| Shares used in  computing diluted earnings per share |       | 24,461                                          |       | 24,421                                        |       | 24,407 |   | 24,703 |   |

See accompanyingnotes.

4

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**CARREKER CORPORATION**

**CondensedConsolidated Statements Of Stockholders’ Equity**

**(Unaudited)**

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

See accompanyingnotes.

5

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**CARREKERCORPORATION**

**CondensedConsolidated Statements of Cash Flows**

**(Unaudited)(In thousands)**
| ** **                                                                                   | ** ** | **Three Months Ended  July 31,** | ** ** | **Six Months Ended  July 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Operating  Activities:**                                                                   | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                                   |       | $                                               | 961        |                                          | $          | 1,054 |   | $ | 927 |   | $ | 1,552 |   |
| Adjustments to reconcile net income to net cash  provided by (used in) operating activities: |       |                                            |       |                                          |       |   |   |   |   |
| Depreciation and amortization of property and  equipment                                     |       | 707                                             |       | 805                                           |       | 1,486 |   | 1,598 |   |
| Amortization of capitalized software costs                                                   |       | 324                                             |       | 201                                           |       | 646 |   | 467 |   |
| Amortization of acquired developed technology                                                |       | 1,069                                           |       | 1,155                                         |       | 2,224 |   | 2,310 |   |
| Amortization of customer relationships                                                       |       | 350                                             |       | 350                                           |       | 700 |   | 700 |   |
| Amortization of deferred loan costs                                                          |       | 68                                              |       | 68                                            |       | 136 |   | 135 |   |
| Stock based compensation                                                                     |       | 627                                             |       | 130                                           |       | 1,249 |   | 258 |   |
| Minority share of loss in Carretek LLC                                                       |       | (194                                            | )          | (213                                          | )          | (327 | ) | (531 | ) |
| Non-cash charge for merger costs                                                             |       | —                                          |       | —                                        |       | — |   | (32 | ) |
| Allowance for doubtful accounts                                                              |       | 76                                              |       | (48                                           | )          | 28 |   | (41 | ) |
| Changes in operating assets and liabilities:                                                 |       |                                            |       |                                          |       |   |   |   |   |
| Accounts receivable                                                                          |       | (7,385                                          | )          | (5,606                                        | )          | (5,069 | ) | (5,205 | ) |
| Prepaid expenses and other assets                                                            |       | 200                                             |       | 363                                           |       | 647 |   | (289 | ) |
| Accounts payable and accrued expenses                                                        |       | 1,244                                           |       | (242                                          | )          | (644 | ) | (2,606 | ) |
| Income taxes payable                                                                         |       | (33                                             | )          | (275                                          | )          | (143 | ) | (264 | ) |
| Deferred revenue                                                                             |       | (3,852                                          | )          | (3,620                                        | )          | 215 |   | (1,820 | ) |
| Net cash  provided by (used in) operating activities                                         |       | (5,838                                          | )          | (5,878                                        | )          | 2,075 |   | (3,768 | ) |
|                                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| **Investing  Activities:**                                                                   | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Purchases of property and equipment                                                          |       | (1,136                                          | )          | (588                                          | )          | (2,185 | ) | (1,286 | ) |
| Purchases of marketable securities                                                           |       | —                                          |       | (4,600                                        | )          | (3,500 | ) | (4,600 | ) |
| Sales of marketable securities                                                               |       | —                                          |       | —                                        |       | 2,300 |   | — |   |
| Software development costs capitalized                                                       |       | (718                                            | )          | (271                                          | )          | (1,244 | ) | (708 | ) |
| Net cash used in  investing activities                                                       |       | (1,854                                          | )          | (5,459                                        | )          | (4,629 | ) | (6,594 | ) |
|                                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| **Financing  Activities:**                                                                   | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Proceeds from exercises of stock options                                                     |       | 284                                             |       | 214                                           |       | 284 |   | 266 |   |
| Purchase of treasury stock                                                                   |       | —                                          |       | (2,873                                        | )          | — |   | (3,222 | ) |
| Proceeds from minority shareholder equity  contributions to Carretek LLC                     |       | 200                                             |       | —                                        |       | 200 |   | 551 |   |
| Net cash  provided by (used in) financing activities                                         |       | 484                                             |       | (2,659                                        | )          | 484 |   | (2,405 | ) |
| Net decrease in  cash and cash equivalents                                                   |       | (7,208                                          | )          | (13,996                                       | )          | (2,070 | ) | (12,767 | ) |
| Cash and cash  equivalents at beginning of period                                            |       | 34,822                                          |       | 35,745                                        |       | 29,684 |   | 34,516 |   |
| Cash and cash  equivalents at end of period                                                  |       | $                                               | 27,614     |                                          | $          | 21,749 |   | $ | 27,614 |   | $ | 21,749 |   |
|                                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Supplemental  disclosures of cash flow information:                                          |       |                                            |       |                                          |       |   |   |   |   |
| Cash paid for interest                                                                       |       | $                                               | 38         |                                          | $          | 38 |   | $ | 76 |   | $ | 76 |   |
| Cash paid for  income taxes, net                                                             |       | $                                               | 166        |                                          | $          | 351 |   | $ | 364 |   | $ | 427 |   |

See accompanyingnotes.

6

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**Carreker Corporation**

**Notesto Condensed Consolidated Unaudited Financial Statements**

**Forthe Three and Six Months Ended July 31, 2006**

**1.****           Description of Business**

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

**2.****           Summary of SignificantAccounting Procedures**

**Principles of Consolidation**

The condensed consolidated unaudited financialstatements include the accounts of the Company and its wholly ownedsubsidiaries. All significant intercompany balances and transactions have beeneliminated in consolidation.

The condensed consolidated unaudited financialstatements also reflect the operations of Carretek LLC, which is a 51% ownedsubsidiary.  The minority interest andminority share of net loss of Carretek LLC represent the 49% minoritystockholder’s investment and share of the loss of this consolidatedsubsidiary.  The minority interest iscurrently classified in other accrued expenses in the accompanying condensedconsolidated unaudited balance sheet and the minority share of net loss ofCarretek LLC is recorded in other income in the accompanying condensedconsolidated unaudited statements of operations.

The accompanying condensed consolidated unauditedfinancial statements and notes have been prepared in accordance with the rulesand regulations of the Securities and Exchange Commission for Form 10-Q andinclude all of the information and disclosures required by generally acceptedaccounting principles for interim financial reporting.  The accompanying financial statements reflectall adjustments (consisting of normal recurring entries) which in the opinionof management are necessary for a fair presentation of the results for theinterim periods presented.  The resultsof operations for the three and six months ended July 31, 2006 are notnecessarily indicative of full-year results.

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States requires theuse of estimates and assumptions that affect the amounts reported in thefinancial statements and accompanying notes. As discussed below, the Company makes significant estimates andassumptions in the areas of accounts receivable, impairment of intangibles andrevenue recognition.  Although theCompany believes that the estimates and assumptions are reasonable, actualresults may differ, and such differences could be significant to the Company’sfinancial 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 consist primarily of demand deposit accountsand demand money market accounts with nationally recognized financialinstitutions, along with domestic commercial paper.  The Company utilizes a sweep service from afinancial institution to invest daily in overnight repurchase agreements,typically in U.S. Treasury or agency issues.

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**Marketable Securities**

We classify our investments in marketable securitiesas “available-for-sale” in accordance with the provisions of Statement ofFinancial Accounting Standards No. 115, *“Accounting for CertainInvestments in Debt and Equity Securities”* (“SFAS 115”).  We currently have no investments that weintend to hold for more than one year and therefore all investments areclassified as short term investments.

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

Marketable securities at July 31, 2006 consist ofinsured municipal bonds and guaranteed student loan backed debt securities witha cost of $5.9 million, which approximates fair value.

All original maturities of debt securities classifiedas available for sale at July 31, 2006 were due after 10 years.  All the debt securities are auction ratesecurities and the interest rates for these investments will adjust to currentmarket rates at each interest reset date, which is typically on at least a monthlybasis.

**Comprehensive Income**

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

**Foreign Currency Translation**

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

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

Financial instruments which potentially subject theCompany to concentration of credit risk consist principally of temporary cashinvestments such as short term commercial paper and marketable debt securitiesalong with accounts receivable.  TheCompany places temporary cash investments with major banks and limits itsexposure with any one financial institution, commercial issuer, municipalissuer or government agency issuer.  TheCompany has not experienced any material credit losses on these investments.

A significant portion of the Company’s businessconsists of providing consulting services and licensing software to majordomestic and international banks, which gives rise to a concentration of creditrisk in receivables.  Because the Company’saccounts receivable are typically unsecured, the Company periodically evaluatesthe collectibility of its accounts based on a combination of factors, includinga particular customer’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 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.  Duringthe three months ended July 31, 2006 and 2005, write-offs of receivables were$37,000 and $9,000, respectively.  Duringthe six months ended July 31, 2006 and 2005, write-offs of receivables, net ofrecoveries, were $19,000 and $42,000, respectively.

The fair value of accounts receivable approximates thecarrying amount of accounts receivable.

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**Property and Equipment**

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

The Company accounts for the costs of computersoftware developed or obtained for internal use in accordance with Statement ofPosition 98-1, *“Accounting for the Costs ofComputer Software Developed or Obtained for Internal Use”.*  The Company capitalizes software costsincurred after the preliminary project stage is complete, the Company hascommitted to the project and it is probable that the software will be used toperform the function intended. Capitalized software costs are amortized on an individual basis usingthe estimated economic life of the product on a straight-line basis, generallythree to five years.  These capitalizedsoftware costs are included in “Equipment and Software”.  Costs incurred during preliminary project andpost-implementation stages are charged to expense.

The components of property and equipment are as follows(in thousands):
|                                                 | ** ** | **July 31,** | ** ** | **January 31,** | ** ** |
|-------------------------------------------------|------------|-------------------|------------|----------------------|------------|
| ** **                                      | ** ** | **2006**          | ** ** | **2006**             | ** ** |
|                                            |       |              |       |                 |       |
| Furniture                                       |       | $                 | 5,049      |                 | $          | 5,070 |   |
| Equipment and  software                         |       | 24,412            |       | 22,643               |       |
| Leasehold  improvements                         |       | 1,397             |       | 1,284                |       |
| Total cost                                      |       | 30,858            |       | 28,997               |       |
|                                            |       |              |       |                 |       |
| Less accumulated  depreciation and amortization |       | (24,265           | )          | (23,050              | )          |
| Net property and  equipment                     |       | $                 | 6,593      |                 | $          | 5,947 |   |

**LongLived Assets**

The Company accounts for goodwill and other intangibleassets in accordance with Statement of Financial Accounting Standards No. 142, *“Goodwill and Other Intangible Assets”* (“SFAS142”).  Under the provisions of SFAS 142,an annual assessment of goodwill impairment is performed.  This assessment involves the use of estimatesrelated to fair market values of the Company’s reporting units with which thegoodwill is associated.  The assessmentof goodwill impairment in the future will be impacted if future operating cashflows of the Company’s reporting units decline significantly, which couldresult in decreases in the related estimate of fair market value.  The Company performs its annual impairmentanalysis as of November 1st of each year andwhenever facts and circumstances indicate impairment may exist.

The Company accounts 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 are testedfor recoverability whenever events or changes in circumstances indicate thatthe 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 asset exceeds the estimated fairvalue of the asset.

**Deferred Loan Costs**

Deferred loancosts consist of loan closing costs associated with the Company’s revolvingcredit agreement.  The Company chose notto renew the revolving credit agreement which expired by its terms on July 31,2006.  These costs were amortized tointerest expense over the 36 month life of the revolving credit agreement andwere fully amortized at July 31, 2006.

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**Capitalized Software Costs andAcquired Developed Technology**

The Company capitalizes the development costs ofsoftware, 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 to capitalizesoftware development costs incurred in developing a product once technologicalfeasibility of the product has been established. Technological feasibility ofthe product is determined after completion of a detailed program design and adetermination has been made that any uncertainties related to high-riskdevelopment issues have been resolved. If the process of developing the productdoes not include a detail program design, technological feasibility isdetermined only after completion of a working model. All capitalized softwaredevelopment costs are amortized using an amount determined as the greater of:(1) the ratio that current gross revenues for a capitalized software projectbears to the total of current and estimated future gross revenues for thatproject or (2) the straight-line method over the estimated remaining economiclife of the product (generally three to five years). The Company capitalized$718,000 and $271,000 in the three months ended July 31, 2006 and 2005,respectively.  The Company capitalized$1.2 million and $708,000 in the six months ended July 31, 2006 and 2005,respectively.  The software developmentefforts in both periods were related to several new Cash and Risk solutionswithin the Global Payments Technologies business segment.

The Company recorded amortization relating to softwaredevelopment costs capitalized of $324,000 and $201,000 in the three monthsended July 31, 2006 and 2005, respectively. The Company recorded amortization relating to software development costscapitalized of $646,000 and $467,000 in the six months ended July 31, 2006 and2005, respectively.  Amortization expenseis recorded as a component of cost of software license fees in the accompanyingconsolidated statements of operations.

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

Acquired developed technology with a useful life of3-6 years is amortized on a straight-line basis, resulting in amortizationexpense of $1.1 million and $1.2 million for the three months ended July 31,2006 and 2005, respectively, and $2.2 million and $2.3 million for the sixmonths ended July 31, 2006 and 2005. Amortization expense is recorded as a component of cost of softwarelicense fees in the accompanying consolidated statements 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 (in thousands):
| Year               | ** ** | **Capitalized  Software  Costs** | ** ** | **Acquired  Developed  Technology** | ** ** |
|--------------------|------------|----------------------------------|------------|-------------------------------------|------------|
|               |       |                             |       |                                |       |
| Remainder of  2007 |       | $                                | 577        |                                | $          | 1,883 |   |
| 2008               |       | 830                              |       | 1,200                               |       |
| 2009               |       | 331                              |       | —                              |       |
|                    |            |                                  |            |                                     |            |  |  |

The table does notinclude the estimated amortization expense for $1.6 million of capitalizedsoftware products that are currently being developed, and for whichamortization has not commenced.

The Company continually monitors the net realizablevalue of software capitalized and acquired developed technology for factorsthat would indicate impairment such as a decline in demand or a loss of asignificant customer.  During thequarterly period ended January 31, 2006, the Company performed its annualformal evaluation for impairment and determined that the carrying amount ofthese assets was not impaired and has subsequently noted no factors in the sixmonths ended July 31, 2006 that would indicate impairment.

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**Revenue Recognition**

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

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

*Consulting.*  TheCompany employs three primary pricingmethods in connection with its delivery of consulting services. First, theCompany may price its delivery of consultingservices on the basis of time and materials, in which case the customer ischarged agreed-upon daily rates for services performed and out-of-pocketexpenses. In this case, the Company isgenerally paid fees and related amounts usually on a monthly basis, and theCompany recognizes revenues as the servicesare performed. Second, the Company maydeliver consulting services on a fixed-price basis. In this case, theCompany is paid on a monthly basis or pursuantto an agreed upon payment schedule, and the Company recognizes revenues on a proportionate performancebasis.  The Company believes that this method is appropriate becauseof its ability to determine performance milestones and determine dependableestimates of its costs applicable to each phase of a contract.  Because financial reporting of thesecontracts depends on estimates, which are assessed continually during the termof the contract, costs are subject to revisions as the contractprogresses.  Anticipated losses onfixed-price contracts are recognized when estimable.  Third, the Company may deliver consulting services pursuant to avalue-priced contract with the customer. In this case, the Company ispaid, 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 its 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 its solution, subjectin either case to a maximum, if any is agreed to, on the total amount ofpayments to be made to the Company.  TheCompany must first commit time and resources to develop projections associatedwith value-pricing contracts before a customer will commit to purchase itssolutions, and the Company therefore assumes the risk of making thesecommitments with no assurance that the customer will purchase thesolution.  Costs associated with thesevalue-pricing contracts are expensed as incurred.  These contracts typically include payments tobe made to the Company pursuant to an agreed upon schedule ranging from one totwelve months in length.  TheCompany recognizes revenues generated fromconsulting services in connection with value-priced contracts oncecustomer acknowledgement is obtained that confirms fees have become fixed anddeterminable.  In some cases, theseacknowledgements contain future deliverables or services, in which case therevenue from these engagements is recognized on a proportionate performancebasis based on efforts to be incurred following the customer acknowledgement.  In an effort to allow customers to moreclosely match expected benefits from services with payments to theCompany, the Company on occasion, may offer payment terms which extend beyond 12months.  When the Company enters into anagreement which has a significant component of the total amount payable underthe agreement due beyond 12 months or if it is determined payments are notfixed and determinable at the date the agreement was entered into, revenueunder the arrangement will be recognized as payments become due and payable.  When fees are to be paid based on apercentage of actual revenues and/or savings to customers, the Company recognizes revenues only upon completion of allservices and as the amounts of actual revenues or savings are confirmed by thecustomer with a fixed payment date.

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

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

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

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*SoftwareLicense.*  A perpetual software license is sold eithertogether with implementation services or on a stand-alone basis.  The Company is usually paid software license fees in one or more installments, asprovided in the customer’s contract but not to exceed twelve months.  The Company recognizes software licenserevenue upon execution of a contract and delivery of the software, providedthat the license fee is fixed and determinable, no significant production,modification or customization of the software is required and collection isconsidered probable by management.  Whenthe software license arrangement requires the Company to provide implementationservices that are essential to the functionality of the software or significantproduction, customization or modification of the software is required, both theproduct license revenue and implementation fees are recognized as services areperformed.  A term software license issold either together with implementation services and/or with maintenanceservices.  These term licenses areusually paid in annual installments over the term of the license.  If the term software license is sold withoutessential implementation services, the revenue is recognized ratably over thenon-cancelable license term.  If the termlicense is sold with essential implementation services, the license revenue isrecognized as the lesser of the amount of license revenue recognized asservices are performed or on a ratable basis.

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

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

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

*SoftwareMaintenance.*  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 purchase software maintenance services, whichtypically are renewed annually.  TheCompany charges an annual maintenance fee,which is typically a percentage of the initial software license fee. The annualmaintenance fee generally is paid to the Company at the beginning of the maintenance period, and the Company recognizes these revenues ratably over the term ofthe related contract.  If the annualmaintenance fee is not paid at the beginning of the maintenance period, theCompany defers revenue recognition until the time that the maintenance fee ispaid by the customer.  The Companynormally continues to provide maintenance service while awaiting payment fromcustomers.  When the payment is received,revenue is recognized for the period that revenue was previously deferred.  This may result in volatility in softwaremaintenance revenue from period to period.

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

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

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

**Royalties**

The Company is required to pay royalties in connectionwith software license, maintenance, and consulting agreements entered into withcertain customers under which the Company acquired third party softwaretechnology or other intellectual property used in products and services sold toits customers.  Under these arrangements,the Company recognizes royalty expense when the associated revenue isrecognized.  For current productofferings, the royalty percentages generally range from 20% to 50% of theassociated revenues.  Approximately$543,000 and $535,000 of royalty expense was recorded under these agreements inthe three months ended July 31, 2006 and 2005, respectively, and $982,000 and$749,000 of royalty expense was recorded under these agreements in the sixmonths ended July 31, 2006 and 2005. Royalty expense is primarily included as a component of the cost ofsoftware license revenues; however, certain amounts are also included in costof consulting revenues and cost of software maintenance revenues in theaccompanying consolidated statements of operations.

**Deferred Revenue**

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.

Deferred revenue consists of the following (inthousands):
|                                                    | ** ** | **July 31,** | ** ** | **January 31,** | ** ** |
|----------------------------------------------------|------------|-------------------|------------|----------------------|------------|
| ** **                                         | ** ** | **2006**          | ** ** | **2006**             | ** ** |
|                                               |       |              |       |                 |       |
| Deferred  software maintenance fees                |       | $                 | 24,596     |                 | $          | 39,343 |   |
| Deferred  software implementation and license fees |       | 15,533            |       | 15,769               |       |
|                                               |       | 40,129            |       | 55,112               |       |
| Less amounts not  yet collected                    |       | (20,763           | )          | (35,961              | )          |
| Net deferred revenue                               |       | $                 | 19,366     |                 | $          | 19,151 |   |

**Research and Development Costs**

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

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**Other income (expense)**

Otherincome (expense) is comprised of the following (in thousands):
|                                            | ** ** | **Three Months Ended  July 31,** | ** ** | **Six Months Ended  July 31,** | ** ** |
|--------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                 | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                       |       |                                            |       |                                          |       |   |   |   |   |
| Minority share of net loss of Carretek LLC |       | $                                               | 194        |                                          | $          | 213 |   | $ | 327 |   | $ | 531 |   |
| Foreign exchange gains (losses)            |       | 123                                             |       | (84                                           | )          | 193 |   | (101 | ) |
| Other                                      |       | (2                                              | )          | —                                        |       | (5 | ) | 5 |   |
| Total                                      |       | $                                               | 315        |                                          | $          | 129 |   | $ | 515 |   | $ | 435 |   |

**IncomeTaxes**

The Company accounts for income taxes using theliability method, whereby deferred tax assets and liabilities are determinedbased on differences between financial reporting and the tax basis of assetsand liabilities measured using enacted tax rates and laws that will be ineffect 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.

**Earnings Per Share**

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

**Stock-Based Compensation**

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

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

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

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

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

Asa result of adopting SFAS 123(R) on February 1, 2006, the Company’s net incomefor the three and six months ended July 31, 2006 is $340,000 and $722,000lower, respectively, than if it had continued to account for share-based compensationunder APB 25.  Basic earnings per sharefor the three and six months ended July 31, 2006 are $0.01 and $0.03 lower,respectively, and diluted earnings per share for the three and six months endedJuly 31, 2006 are $0.01 and $0.03 lower, respectively, than if the Company hadcontinued to account for share-based compensation under APB 25.

Determining Fair Value

*Valuation and AmortizationMethod.*  The Companyestimates the fair value of share-based awards granted using the Black-Scholesoption valuation model.  The Companyamortizes the fair value of all awards on a straight-line basis over therequisite service periods, which are generally the vesting periods.

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

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

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

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

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

The fair value of each option grant isestimated on the date of grant using the Black-Scholes option pricingmodel.  A summary of the weighted averageassumptions and results for options granted during the three and six monthsended July 31, 2006 are as follows:
|                                                 | ** ** | **Three Months Ended  July 31,** | ** ** | **Six Months Ended  July 31,** | ** ** |
|-------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                      | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                            |       |                                            |       |                                          |       |   |   |   |   |
| Volatility                                      |       | 0.745                                           |       | 0.835                                         |       | 0.744 |   | 0.837 |   |
| Weighted-average  expected lives (years)        |       | 4.500                                           |       | 4.000                                         |       | 4.400 |   | 4.000 |   |
| Expected  dividend yields                       |       | —                                          |       | —                                        |       | — |   | — |   |
| Weighted-average  risk-free interest rates      |       | 5.06                                            | %          | 3.91                                          | %          | 5.02 | % | 3.91 | % |
| Weighted-average fair  value of options granted |       | $                                               | 4.02       |                                          | $          | 3.61 |   | $ | 3.93 |   | $ | 3.63 |   |
|                                                 |            |                                                 |            |                                               |            |  |  |  |  |  |  |  |  |

15

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Share-Based Compensation

The following table summarizesshare-based compensation expense related to share-based awards under SFAS No.123(R) for the three and six months ended July 31, 2006 and 2005 which isrecorded in the statement of operations as follows (in thousands):
| ** **                                   | ** ** | **Three Months Ended  July 31, 2006** | ** ** | **Six Months Ended  July 31, 2006** | ** ** |
|----------------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                   | ** ** | **Unvested  Stock  Options**                              | ** ** | **Unvested  Restricted  Common  Stock**                 | ** ** | **Total** | ** ** | **Unvested  Stock  Options** | ** ** | **Unvested  Restricted  Common  Stock** | ** ** | **Total** | ** ** |
|                                         |       |                                                      |       |                                                    |       |   |   |   |   |   |   |   |   |
| Cost of revenues                             |       | $                                                         | 63         |                                                    | $          | 98 |   | $ | 161 |   | $ | 133 |   | $ | 184 |   | $ | 317 |   |
| Selling, general  and administrative expense |       | 274                                                       |       | 175                                                     |       | 449 |   | 578 |   | 316 |   | 894 |   |
| Research and  development expense            |       | 3                                                         |       | 14                                                      |       | 17 |   | 11 |   | 27 |   | 38 |   |
| Total share-based  compensation              |       | $                                                         | 340        |                                                    | $          | 287 |   | $ | 627 |   | $ | 722 |   | $ | 527 |   | $ | 1,249 |   |

 
| ** **                                   | ** ** | **Three Months Ended  July 31, 2005** | ** ** | **Six Months Ended  July 31, 2005** | ** ** |
|----------------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                   | ** ** | **Unvested  Stock  Options**                              | ** ** | **Unvested  Restricted  Common  Stock**                 | ** ** | **Total** | ** ** | **Unvested  Stock  Options** | ** ** | **Unvested  Restricted  Common  Stock** | ** ** | **Total** | ** ** |
|                                         |       |                                                      |       |                                                    |       |   |   |   |   |   |   |   |   |
| Cost of revenues                             |       | $                                                         | —     |                                                    | $          | 71 |   | $ | 71 |   | $ | — |   | $ | 126 |   | $ | 126 |   |
| Selling, general  and administrative expense |       | —                                                    |       | 50                                                      |       | 50 |   | — |   | 118 |   | 118 |   |
| Research and  development expense            |       | —                                                    |       | 9                                                       |       | 9 |   | — |   | 14 |   | 14 |   |
| Total share-based  compensation              |       | $                                                         | —     |                                                    | $          | 130 |   | $ | 130 |   | $ | — |   | $ | 258 |   | $ | 258 |   |

AtJuly 31, 2006, the Company had unvested options to purchase 645,721 shares witha weighted average grant date fair value of $3.88.  Additionally, the Company had 783,949 sharesof unvested restricted common stock with a weighted average fair value on thedates the awards were granted of $6.22.

The unrecognized compensation costs areexpected to be amortized over the following indicated fiscal years endingJanuary 31 (in thousands):
|                    | ** ** | **Unvested Stock  Options** | ** ** | **Unvested  Restricted  Common Stock** | ** ** | **Total** | ** ** |
|--------------------|------------|----------------------------------|------------|---------------------------------------------|------------|-----------|------------|
|               |       |                             |       |                                        |       |      |       |
| Remainder of  2007 |       | $                                | 417        |                                        | $          | 610       |       | $ | 1,027 |   |
| 2008               |       | 756                              |       | 1,219                                       |       | 1,975     |       |
| 2009               |       | 509                              |       | 1,129                                       |       | 1,638     |       |
| 2010               |       | 123                              |       | 853                                         |       | 976       |       |
| 2011               |       | —                           |       | 454                                         |       | 454       |       |
| 2012               |       | —                           |       | 75                                          |       | 75        |       |
| Total              |       | $                                | 1,805      |                                        | $          | 4,340     |       | $ | 6,145 |   |

16

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Stock Option Activity

In the quarter ended January 31, 2006, the Companyaccelerated the vesting of all unvested stock options, except those optionsgranted to the CEO, with a grant price in excess of $7.50.  This acceleration was accomplished to reducethe stock option expense in future years. This acceleration results in approximately $1.9 million of expensesavings over the four year period from February 1, 2006 through January 31,2010.

On March 10, 2006, the Compensation Committee of theBoard of Directors of the Company (the “Committee”) voted to provide for theautomatic accelerated vesting of all outstanding stock options and restrictedstock of the Company upon the occurrence of certain specified triggering eventsdeemed to constitute a change in control of the Company.  This provision will require the Company toaccelerate unrecognized stock-based compensation expense if a change in controlevent occurs prior to the original vesting schedule of the stock options orrestricted stock.

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

Stock option transactions during the six months endedJuly 31, 2006 were as follows (dollars and share data in thousands):
|                                                                | ** ** | **Six Months Ended July 31, 2006** | ** ** |
|----------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                                     | ** ** | **Number of  Shares**                                  | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Remaining  Contractual  Life (Years)** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|                                                           |       |                                                        |       |   |   |   |   |   |   |
| Stock  options outstanding at the beginning of the period      |       | 3,781                                                       |       | $ | 8.44 |   | — |   | — |   |
| Granted                                                        |       | 279                                                         |       | 6.42 |   | — |   | — |   |
| Exercised                                                      |       | (63                                                         | )          | 4.52 |   | — |   | — |   |
| Forfeited                                                      |       | (72                                                         | )          | 8.74 |   | — |   | — |   |
| Stock options  outstanding at the end of the period            |       | 3,925                                                       |       | $ | 8.36 |   | 4.33 |   | $ | 2,436 |   |
|                                                           |       |                                                        |       |   |   |   |   |   |   |
| Stock options vested and exercisable at the end of  the period |       | 3,279                                                       |       | $ | 8.85 |   | 4.24 |   | $ | 1,842 |   |

Other informationpertaining to option activity during the six months ended July 31, 2006 was asfollows (dollars in thousands, except per share data):
| Weighted average grant-date  fair value of options granted |   | $ | 3.93        |   |
|------------------------------------------------------------|--------|---|-------------|--------|
| Total fair value  of stock options vested                  |   | $ |  1,371 |   |
| Total intrinsic value  of stock options exercised          |   | $ | 145         |   |

Information related tooptions outstanding at July 31, 2006 is summarized below (option amounts inthousands):
| Range of Exercise  Price | ** ** | **Options  Outstanding at  July 31, 2006** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Remaining  Contractual Life** | ** ** | **Options Vested  and Exercisable  at  July 31, 2006** | ** ** | **Weighted Average  Exercise Price of  Vested and  Exercisable  Options** | ** ** |
|------------------------------------|------------|-----------------------------------------------------------|------------|--------------------------------------------|------------|---------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|
| $3.00 to $4.97                     |       | 1,020                                                     |       | $                                          | 4.63       |                                                    | 4.28       |                                                                       | 838        |                                                                                          | $          | 4.68 |   |
| $5.00 to $7.79                     |       | 830                                                       |       | 6.32                                       |       | 5.45                                                    |       | 384                                                                        |       | 6.35                                                                                          |       |
| $8.00 to $9.88                     |       | 795                                                       |       | 8.62                                       |       | 4.07                                                    |       | 795                                                                        |       | 8.62                                                                                          |       |
| $10.00 to $25.44                   |       | 1,280                                                     |       | 12.48                                      |       | 3.79                                                    |       | 1,262                                                                      |       | 12.51                                                                                         |       |
|                               |       | 3,925                                                     |       | $                                          | 8.36       |                                                    | 4.33       |                                                                       | 3,279      |                                                                                          | $          | 8.85 |   |

17

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As of July 31, 2006, the Company has reserved forissuance under the Plans 5,190,995 shares of common stock, of which 3,925,062shares are subject to currently outstanding options to employees and directors,and 1,265,933 shares are reserved for future awards.

Restricted Common StockActivity

For the stock compensation expense related to therestricted common stock issued to employees and officers, the Company isamortizing the compensation expense on a straight line basis over the periodthat the restrictions on the common stock lapse.  The Company recorded $287,000 and $130,000 ofcompensation expense related to the restricted common stock during the threemonths ended July 31, 2006 and 2005, respectively, and $528,000 and $258,000for the six months ended July 31, 2006 and 2005, respectively.  Restricted common stock transactions duringthe six months ended July 31, 2006 were as follows (number of shares in thousands):
|                                                                  | ** ** | **Six Months Ended  July 31, 2006** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                       | ** ** | **Number of  Shares**                              | ** ** | **Weighted  Average Grant  Date Fair Value** | ** ** |
|                                                             |       |                                                    |       |   |   |
| Restricted  common stock unvested at the beginning of the period |       | 732                                                     |       | $ | 6.14 |   |
| Granted                                                          |       | 210                                                     |       | 6.34 |   |
| Vested  and released                                             |       | (146                                                    | )          | 5.98 |   |
| Forfeited                                                        |       | (12                                                     | )          | 6.41 |   |
| Restricted common stock unvested at the end of the  period       |       | 784                                                     |       | $ | 6.22 |   |

PriorPeriod Proforma Presentations

Had compensation cost for stock-basedcompensation plans been determined based on the fair value at the grant datesfor awards under those plans in accordance with the provisions of SFAS 123(R),net income and net income per share would have been as follows (in thousands,except per share data):
|                                                                            | ** ** | **Three Months  Ended** | ** ** | **Six Months  Ended**  | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                 | ** ** | **July 31, 2005**  | ** ** | **July 31, 2005** | ** ** |
|                                                                       |       |                         |       |                        |       |
| Net income, as  reported                                                   |       | $                            | 1,054      |                        | $          | 1,552 |   |
| Stock  compensation expense recorded under the intrinsic value method      |       | 130                          |       | 258                         |       |
| Pro forma stock  compensation expense computed under the fair value method |       | (989                         | )          | (1,743                      | )          |
| Pro forma net  income                                                      |       | $                            | 195        |                        | $          | 67 |   |
|                                                                       |       |                         |       |                        |       |
| Basic earnings  per common share, as reported                              |       | $                            | 0.04       |                        | $          | 0.06 |   |
| Diluted earnings  per common share, as reported                            |       | $                            | 0.04       |                        | $          | 0.06 |   |
| Pro forma basic  loss per common share                                     |       | $                            | 0.01       |                        | $          | 0.00 |   |
| Pro forma diluted loss  per common share                                   |       | $                            | 0.01       |                        | $          | 0.00 |   |

18

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**FinancialGuarantees**

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

Under the terms of the majority of the Company’ssoftware license agreements with its customers, the Company agrees that in theevent the software sold infringes upon any patent, copyright, trademark, or anyother proprietary right of a third party, it will indemnify its customerlicensee against any loss, expense, or liability from any damages that may beawarded against its customer.  TheCompany includes this infringement indemnification in most of its softwarelicense agreements.  In the event thecustomer cannot use the software or service due to infringement and the Companycannot obtain the right to use, replace or modify the license or service in acommercially feasible manner so that it no longer infringes, then the Companymay generally terminate the license and provide the customer a pro-rata refundof the fees paid by the customer for the infringing license or service.  The Company has recorded no liabilityassociated with this indemnification, as it is not aware of any pending orthreatened infringement actions that are probable losses.

The Company has agreed to indemnify members of theboard of directors, officers and certain key employees of the Company if theyare made a party or are threatened to be made a party to any proceeding byreason of the fact that they are acting in their capacities on behalf of theCompany, or by reason of anything done or not done by them in any suchcapacities.  The indemnity is for any andall expenses and liabilities of any type whatsoever (including but not limitedto, judgments, fines and amounts paid in settlement) actually and reasonablyincurred by the directors, officers and key employees in connection with theinvestigation, defense, settlement or appeal of such proceeding, provided theyacted in good faith.  The Companymaintains insurance coverage for directors and officers liability (“D&Oinsurance”).  No maximum liability isstipulated in these agreements that include indemnifications of members of theboard of directors, officers and certain key employees of the Company.  The Company has recorded no liabilityassociated with these indemnifications as it is not aware of any pending orthreatened actions or claims against the members of its board of directors orofficers that are probable losses in excess of amounts covered by its D&Oinsurance.

**RecentlyIssued Accounting Standards**

In June 2006, the Financial Accounting Standards Board (“FASB”) issuedInterpretation No. 48, “*Accounting for Uncertaintyin Income Taxes”* – an interpretation of FAS 109, *“Accounting for Income Taxes”* (“FIN 48”) to create a singlemodel to address accounting for uncertainty in tax positions.  FIN 48 clarifies the accounting for incometaxes, by prescribing a minimum recognition threshold a tax position isrequired to meet before being recognized in the financial statements.  FIN 48 also provides guidance on derecognition,measurement, classification, interest and penalties, accounting in interimperiods, disclosure and transition.  FIN48 is effective for fiscal years beginning after December 15, 2006.  The Company will adopt FIN 48 as of February1, 2007, as required.  The cumulativeeffect of adopting FIN 48 will be recorded in retained earnings and otheraccounts as applicable.  The Company hasnot determined the effect, if any, that the adoption of FIN 48 will have on theCompany’s financial position and results of operations.

19

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**3.****           Goodwill and IntangibleAssets**

Goodwill and intangible assets deemed to haveindefinite lives are not amortized but are subject to annual impairmenttests.  Other intangible assets, whichinclude acquired developed technology and customer relationships, are amortizedover their estimated useful lives.

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

The following table sets forth the estimatedamortization expense of customer relationships for the indicated fiscal yearsending January 31 (in thousands):
| Year               | ** ** | **Amount** | ** ** |
|--------------------|------------|------------|------------|
|               |       |       |       |
| Remainder of  2007 |       | $          | 700        |   |
| 2008               |       | 467        |       |
|                    |            |            |            |  |

During the fourthquarter of the year ended January 31, 2006, the Company performed its annualevaluation for goodwill impairment and determined that the carrying amount ofgoodwill was not impaired and subsequently has noted no factors that wouldindicate impairment.

**4.****           Revolving CreditAgreement**

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

Interest expense, including thecommitment fee and exclusive of the amortization of deferred loan costs on thecredit agreement, was $38,000 for the three months ended July 31, 2006 and2005, and $76,000 for the six months ended July 31, 2006 and 2005.

**5.****           Provision for IncomeTaxes**

The Company has established a valuationallowance to reserve its net deferred tax assets at July 31, 2006 because ofthe Company’s inconsistent history of generating profitable operations andtaxable income.  The tax provision wascomputed based on actual results by jurisdiction which resulted in a foreigntax provision of $134,000 and $102,000 for the three months ended July 31, 2006and 2005, respectively, and $234,000 and $183,000 for the six months ended July31, 2006 and 2005, respectively.  Inaddition to the provision for foreign taxes, the Company recorded $20,000 and$15,000 of U.S. Federal and State tax expense in the three and six months endedJuly 31, 2006 and 2005, respectively, for alternative minimum tax purposes.

20

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**6.****    BenefitPlans**

**401(k) Plan**

The Company has adopteda plan pursuant to Section 401(k) of the Internal Revenue Code (“the Code”)whereby participants may contribute a percentage of compensation not in excessof the maximum allowed under the Code. Employer matching contributions amountedto $256,000 and $267,000 for the three months ended July 31, 2006 and 2005,respectively, and $542,000 and $605,000 for the six months ended July 31, 2006and 2005, respectively. The Company may make additional contributions at thediscretion of the Board of Directors.  Nodiscretionary contributions were made during the three and six months endedJuly 31, 2006 and 2005.

**Incentive Compensation Plans**

The Carreker Incentive Bonus Plan (“CIBP”) awardsemployees bonuses based on the Company’s or the applicable business unit’soperating results.  Substantially allemployees are eligible to receive cash awards under the CIBP.  Awards from this plan are paid to employeessubsequent to the end of the fiscal year. The Company’s Compensation Committee of the Board of Directors has theauthority to determine the final amount of the bonus that is ultimately paid tothe officers of the Company.  In thethree months ended July 31, 2006 and 2005, the Company recorded expense underthis plan of approximately $504,000 and $19,000, respectively.  In the six months ended July 31, 2006 and2005, the Company recorded expense under this plan of approximately $504,000and $263,000, respectively.

The Company paysdiscretionary bonuses to key employees based primarily on the extent to whichindividuals meet agreed-upon objectives for the year. The Company recordeddiscretionary bonus expense of approximately $0 and $459,000 for the threemonths ended July 31, 2006 and 2005, respectively, and $0 and $724,000 for thesix months ended July 31, 2006 and 2005, respectively.

**7.****    EarningsPer Share**

The following table sets forth the computation ofbasic and diluted earnings per share (in thousands, except per share amounts):
| ** **                                                                  | ** ** | **Three Months Ended  July 31,** | ** ** | **Six Months Ended  July 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                  | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                                        |       |                                            |       |                                          |       |   |   |   |   |
| Basic earnings  per share:                                                  |       |                                            |       |                                          |       |   |   |   |   |
| Net income                                                                  |       | $                                               | 961        |                                          | $          | 1,054 |   | $ | 927 |   | $ | 1,552 |   |
|                                                                        |       |                                            |       |                                          |       |   |   |   |   |
| Weighted average shares outstanding                                         |       | 24,041                                          |       | 24,127                                        |       | 23,986 |   | 24,326 |   |
|                                                                        |       |                                            |       |                                          |       |   |   |   |   |
| Basic earnings per share                                                    |       | $                                               | 0.04       |                                          | $          | 0.04 |   | $ | 0.04 |   | $ | 0.06 |   |
|                                                                        |       |                                            |       |                                          |       |   |   |   |   |
| Diluted earnings  per share:                                                |       |                                            |       |                                          |       |   |   |   |   |
| Net income                                                                  |       | $                                               | 961        |                                          | $          | 1,054 |   | $ | 927 |   | $ | 1,552 |   |
|                                                                        |       |                                            |       |                                          |       |   |   |   |   |
| Weighted average shares outstanding                                         |       | 24,041                                          |       | 24,127                                        |       | 23,986 |   | 24,326 |   |
| Assumed conversion of employee stock options and  unvested restricted stock |       | 420                                             |       | 294                                           |       | 421 |   | 377 |   |
| Shares used in diluted earnings per share  calculation                      |       | 24,461                                          |       | 24,421                                        |       | 24,407 |   | 24,703 |   |
|                                                                        |       |                                            |       |                                          |       |   |   |   |   |
| Diluted earnings  per share                                                 |       | $                                               | 0.04       |                                          | $          | 0.04 |   | $ | 0.04 |   | $ | 0.06 |   |

Options for 2,439,901 shares and 2,609,894 shares forthe three months ended July 31, 2006 and 2005, respectively, and 2,439,901shares and 2,666,520 shares for the six months ended July 31, 2006 and 2005,respectively, have been excluded from the diluted earnings per sharecomputation as the options were anti-dilutive.

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**8.****           Commitments andContingencies**

*Shareholder Class Action.*

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

## OnMay 31, 2005, the plaintiffs filed an Amended Consolidated Class ActionComplaint on behalf of purchasers of the Company’s common stock between July30, 1999 and December 10, 2002, inclusive, which reiterates the allegations inthe first complaint, and alleges violations of Section 10(b) of the SecuritiesExchange Act of 1934 and Rule 10b-5 against all defendants (the Company, JohnD. Carreker Jr., Ronald Antinori and Terry L. Gage) except Ernst & YoungLLP, violations of Section 20(a) of the Exchange Act against the individualdefendants, and violations of Section 20A of the Securities Exchange Actagainst defendants John D. Carreker, Jr. and Ronald Antinori.  The plaintiffs soughtunspecified amounts of compensatory damages, interest and costs, includinglegal fees.

On April 21, 2006, counsel for the plaintiffs anddefendants agreed to settle the class action litigation for a payment of$5,250,000.  The District Court entered aFinal Judgment and Order of Dismissal with Prejudice on August 17, 2006 concludingthe litigation.  The settlement paymentin the class action was fully covered by the Company’s directors and officer’sinsurance policies.

TheCompany is periodically involved in various other legal actions and claimswhich arise in the normal course of business. In the opinion of management, the final disposition of these matters isnot expected to have a material adverse effect on the Company’s financialposition or results of operations.

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**9.****              Business Segmentsand Revenue Concentration**

The tables below showrevenues and income (loss) from operations for the periods indicated for ourfour reportable business segments: Revenue Enhancement, Global PaymentsTechnologies, Global Payments Consulting and Business Process Outsourcing.  Certain prior year amounts have beenreclassified to conform with the current year business segmentpresentation.  Our customer projects aresold on a solution basis, so it is necessary to break them down by segment andallocate accordingly.  Included in “CorporateUnallocated” are costs related to selling and marketing, and certainunallocated corporate overhead expense such as executive management, finance,accounting, human resources, legal and certain IT and facility functions.  Business segment results, which include costsfor research and development as well as product royalty expense, theamortization and impairment of goodwill and intangible assets, the write-off ofcapitalized software costs and restructuring and other charges, were as follows(in thousands):
| ** **                                  | ** ** | **Three months ended July 31, 2006** | ** ** |
|---------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                  | ** ** | **Revenue  Enhancement**                                      | ** ** | **Global  Payments  Technologies** | ** ** | **Global  Payments  Consulting** | ** ** | **Business  Process  Outsourcing** | ** ** | **Corporate  Unallocated** | ** ** | **Total** | ** ** |
| Revenues                                    |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Consulting                                  |       | $                                                             | 6,251      |   | $ | 121 |   | $ | 467 |   | $ | — |   | $ | — |   | $ | 6,839 |   |
| Software license                            |       | 69                                                            |       | 5,396 |   | 28 |   | — |   | — |   | 5,493 |   |
| Software  maintenance                       |       | 69                                                            |       | 10,599 |   | 231 |   | — |   | — |   | 10,899 |   |
| Software  implementation and other services |       | 641                                                           |       | 3,399 |   | 209 |   | — |   | — |   | 4,249 |   |
| Outsourcing  services                       |       | —                                                        |       | — |   | — |   | 530 |   | — |   | 530 |   |
| Out-of-pocket  expense reimbursements       |       | 323                                                           |       | 387 |   | 83 |   | — |   | — |   | 793 |   |
| Total revenues                              |       | $                                                             | 7,353      |   | $ | 19,902 |   | $ | 1,018 |   | $ | 530 |   | $ | — |   | $ | 28,803 |   |
|                                        |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Income (loss) from operations               |       | $                                                             | 1,740      |   | $ | 4,528 |   | $ | (176 | ) | $ | (360 | ) | $ | (5,253 | ) | $ | 479 |   |

 
| ** **                                  | ** ** | **Three months ended July 31, 2005** | ** ** |
|---------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                  | ** ** | **Revenue  Enhancement**                                      | ** ** | **Global  Payments  Technologies** | ** ** | **Global  Payments  Consulting** | ** ** | **Business  Process  Outsourcing** | ** ** | **Corporate  Unallocated** | ** ** | **Total** | ** ** |
| Revenues                                    |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Consulting                                  |       | $                                                             | 8,832      |   | $ | 2 |   | $ | 668 |   | $ | — |   | $ | — |   | $ | 9,502 |   |
| Software license                            |       | 252                                                           |       | 3,415 |   | 115 |   | — |   | — |   | 3,782 |   |
| Software  maintenance                       |       | 152                                                           |       | 10,210 |   | 214 |   | — |   | — |   | 10,576 |   |
| Software  implementation and other services |       | 1,176                                                         |       | 3,523 |   | 193 |   | — |   | — |   | 4,892 |   |
| Outsourcing  services                       |       | —                                                        |       | — |   | — |   | 241 |   | — |   | 241 |   |
| Out-of-pocket  expense reimbursements       |       | 485                                                           |       | 331 |   | 111 |   | — |   | — |   | 927 |   |
| Total revenues                              |       | $                                                             | 10,897     |   | $ | 17,481 |   | $ | 1,301 |   | $ | 241 |   | $ | — |   | $ | 29,920 |   |
|                                        |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Income (loss) from operations               |       | $                                                             | 5,470      |   | $ | 1,690 |   | $ | 8 |   | $ | (430 | ) | $ | (5,770 | ) | $ | 968 |   |

 

23

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| ** **                                 | ** ** | **Six months ended July 31, 2006** | ** ** |
|--------------------------------------------|------------|------------------------------------|------------|
| ** **                                 | ** ** | **Revenue  Enhancement**           | ** ** | **Global  Payments  Technologies** | ** ** | **Global  Payments  Consulting** | ** ** | **Business  Process  Outsourcing** | ** ** | **Corporate  Unallocated** | ** ** | **Total** | ** ** |
| Revenues                                   |       |                               |       |   |   |   |   |   |   |   |   |   |   |
| Consulting                                 |       | $                                  | 13,769     |   | $ | 262 |   | $ | 1,366 |   | $ | — |   | $ | — |   | $ | 15,397 |   |
| Software license                           |       | 248                                |       | 7,531 |   | 271 |   | — |   | — |   | 8,050 |   |
| Software maintenance                       |       | 164                                |       | 21,025 |   | 462 |   | — |   | — |   | 21,651 |   |
| Software implementation and other services |       | 1,176                              |       | 6,604 |   | 604 |   | — |   | — |   | 8,384 |   |
| Outsourcing services                       |       | —                             |       | — |   | — |   | 1,040 |   | — |   | 1,040 |   |
| Out-of-pocket expense reimbursements       |       | 594                                |       | 698 |   | 234 |   | — |   | — |   | 1,526 |   |
| Total revenues                             |       | $                                  | 15,951     |   | $ | 36,120 |   | $ | 2,937 |   | $ | 1,040 |   | $ | — |   | $ | 56,048 |   |
|                                       |       |                               |       |   |   |   |   |   |   |   |   |   |   |
| Income (loss)  from operations             |       | $                                  | 5,133      |   | $ | 6,183 |   | $ | 277 |   | $ | (651 | ) | $ | (10,763 | ) | $ | 179 |   |

 
| ** **                                 | ** ** | **Six months ended July 31, 2005** | ** ** |
|--------------------------------------------|------------|------------------------------------|------------|
| ** **                                 | ** ** | **Revenue  Enhancement**           | ** ** | **Global  Payments  Technologies** | ** ** | **Global  Payments  Consulting** | ** ** | **Business  Process  Outsourcing** | ** ** | **Corporate  Unallocated** | ** ** | **Total** | ** ** |
| Revenues                                   |       |                               |       |   |   |   |   |   |   |   |   |   |   |
| Consulting                                 |       | $                                  | 16,554     |   | $ | 52 |   | $ | 1,214 |   | $ | — |   | $ | — |   | $ | 17,820 |   |
| Software license                           |       | 553                                |       | 6,473 |   | 115 |   | — |   | — |   | 7,141 |   |
| Software maintenance                       |       | 265                                |       | 21,180 |   | 443 |   | — |   | — |   | 21,888 |   |
| Software implementation and other services |       | 1,652                              |       | 7,072 |   | 302 |   | — |   | — |   | 9,026 |   |
| Outsourcing services                       |       | —                             |       | — |   | — |   | 498 |   | — |   | 498 |   |
| Out-of-pocket expense reimbursements       |       | 872                                |       | 672 |   | 201 |   | — |   | — |   | 1,745 |   |
| Total revenues                             |       | $                                  | 19,896     |   | $ | 35,449 |   | $ | 2,275 |   | $ | 498 |   | $ | — |   | $ | 58,118 |   |
|                                       |       |                               |       |   |   |   |   |   |   |   |   |   |   |
| Income (loss)  from operations             |       | $                                  | 9,408      |   | $ | 3,763 |   | $ | (292 | ) | $ | (1,056 | ) | $ | (10,621 | ) | $ | 1,202 |   |

 

During the year ended January 31, 2004, the Companyformed Carretek LLC (Carretek), in which it owns a 51% interest, to offerfinancial institutions offshore-centric outsourcing of their business processesand IT services needs.  During July 2004,Carretek signed its first contract to perform outsourced services with acustomer.

The 49% share relating to the minority interest in theCarretek losses, which was $194,000 and $213,000 for the three months endedJuly 31, 2006 and 2005, respectively, and $327,000 and $531,000 for the sixmonths ended July 31, 2006, respectively, was recorded in other income in theaccompanying consolidated statements of operations.  The Company and its partner have fundedCarretek to date in the aggregate amount of $4.9 million of equity.  Carretek’s operations are included in ourbusiness process outsourcing segment.

24

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The following table summarizes revenues, exclusive of out-of-pocketexpense reimbursements, derived from the Company’s largest customer and topfive customers during the periods indicated.
|                    | ** ** | Three Months Ended | ** ** | **Six Months Ended** | ** ** |
|--------------------|------------|------------------------------|------------|--------------------------------|------------|
| ** **         | ** ** | **July 31,**            | ** ** | **July 31, **        | ** ** |
| ** **         | ** ** | **2006**                     | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
|               |       |                         |       |                           |       |   |   |   |   |
| Single customer    |       | 12.1                         | %          | 15.0                           | %          | 16.6 | % | 12.2 | % |
| Top five customers |       | 42.4                         | %          | 39.0                           | %          | 42.6 | % | 38.3 | % |

 

U.S. Bank accounted for approximately 12.1% of totalrevenues during the three months ended July 31, 2006 and National City Corporationaccounted for approximately 15.0% of total revenues during the three monthsended July 31, 2005. U.S. Bank accounted for approximately 16.6% of totalrevenues during the six months ended July 31, 2006 and Wells Fargo accountedfor approximately 12.2% of total revenues during the six months ended July 31,2005.

The Company markets itssolutions in several foreign countries. Revenues, exclusive of out-of-pocket expense reimbursements, attributedto countries based on the location of the customers were as follows (inthousands):
| ** **     | ** ** | **Three Months Ended** | ** ** |
|----------------|------------|----------------------------------|------------|
| ** **     | ** ** | **July 31,**                | ** ** | **July 31,** | ** ** |
| ** **     | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| ** **     | ** ** | **Amount**                       | ** ** | **Percent of  total  revenues** | ** ** | **Amount** | ** ** | **Percent of  total  revenues** | ** ** |
| ** **     | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States  |       | $                                | 23,148     |   | 83 | % | $ | 20,890 |   | 72 | % |
| Europe         |       | 1,269                            |       | 4 |   | 1,548 |   | 5 |   |
| Canada         |       | 1,871                            |       | 7 |   | 1,562 |   | 6 |   |
| Asia Pacific   |       | 1,282                            |       | 4 |   | 1,769 |   | 6 |   |
| South Africa   |       | 188                              |       | 1 |   | 2,410 |   | 8 |   |
| Other          |       | 252                              |       | 1 |   | 814 |   | 3 |   |
| Total revenues |       | $                                | 28,010     |   | 100 | % | $ | 28,993 |   | 100 | % |

 
| ** **     | ** ** | **Six Months Ended** | ** ** |
|----------------|------------|----------------------|------------|
| ** **     | ** ** | **July 31,**    | ** ** | **July 31,** | ** ** |
| ** **     | ** ** | **2006**             | ** ** | **2005** | ** ** |
| ** **     | ** ** | **Amount**           | ** ** | **Percent of  total  revenues** | ** ** | **Amount** | ** ** | **Percent of  total  revenues** | ** ** |
| ** **     | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States  |       | $                    | 44,686     |   | 82 | % | $ | 40,962 |   | 73 | % |
| Europe         |       | 2,367                |       | 4 |   | 3,319 |   | 6 |   |
| Canada         |       | 3,831                |       | 7 |   | 3,422 |   | 6 |   |
| Asia Pacific   |       | 2,376                |       | 4 |   | 2,831 |   | 5 |   |
| South Africa   |       | 402                  |       | 1 |   | 4,420 |   | 8 |   |
| Other          |       | 860                  |       | 2 |   | 1,419 |   | 2 |   |
| Total revenues |       | $                    | 54,522     |   | 100 | % | $ | 56,373 |   | 100 | % |

 

25

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**10.****    Restructuring and OtherCharges**

**There were no restructuring and other chargesrecorded during Q1 2006.  However,**the Company recorded $127,000 in restructuring and other charges duringQ1 2005, principally associated with the separation of 6 employees.  The Company also lowered its estimate by$32,000 for the costs associated with the discontinuance of one of its softwareofferings originally recorded in January 2004.

**There were no restructuring and other chargesrecorded during Q2 2006.  However,**the Company recorded $28,000 in restructuring and other charges duringQ2 2005, principally associated with the separation of 2 employees

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

 

|                                                      | ** ** | **Workforce  Reductions** | ** ** | **CheckFlow  Suite** | ** ** | **Other** | ** ** | **Total** | ** ** |
|------------------------------------------------------|------------|---------------------------|------------|----------------------|------------|-----------|------------|-----------|------------|
|                                                 |       |                      |       |                 |       |      |       |      |       |
| Reserve balance  at January 31, 2006                 |       | $                         | 87         |                 | $          | 200       |       | $         | 47         |   | $ | 334 |   |
| Cash paid                                            |       | (87                       | )          | —               |       | —    |       | (87       | )          |
| Reserve balance at  April 30, 2006 and July 31, 2006 |       | $                         | —     |                 | $          | 200       |       | $         | 47         |   | $ | 247 |   |

 

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

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

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

**Overview**

Since 1978, Carreker Corporation has designed,developed, sold and delivered payments-related software and consultingsolutions to financial institutions and financial service providers.  More recently, we have introduced a businessprocess outsourcing solution to our customers. Our products and services address a broad spectrum of payment activitiesand are designed to help our clients enhance the performance of their paymentsbusinesses; improve operational efficiency in payments processing; enhancerevenue and profitability from payments-oriented products and services; reducelosses associated with fraudulent payment transactions; facilitate compliancewith risk-related laws and regulations; and/or maximize clients’ customerincome streams by aligning their customer interactions and products withcustomer needs.  Carreker employed atotal of 492 employees at July 31, 2006.

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

*Global Payments Technologies*.  Thisdivision is responsible for design, development, sales, and support of ourtechnology solutions.  The division hasthree lines of business with distinct solution offerings:  Risk solutions, Payments solutions and Cash& Logistics solutions.  Revenue isprimarily derived from license fees, implementation fees and maintenancefees.  As of July 31, 2006, GPT had 282 employees.

*Revenue Enhancement*.  This highly specializeddivision provides consulting and software solutions focused on increasingclients’ revenue streams.  Areasof expertise include fee income, market segmentation, management of customerprice structures, account retention, account acquisitions andprofitability.  A majority of the revenuegenerated by this division is through benefit-sharing agreements with ourcustomers, recorded as consulting revenue along with license fees, maintenancefees and implementation fees from our CVE software offering.  As of July31, 2006, RevE had 85 employees.

*GlobalPayments Consulting*. The objective of this professional services division is to provide ourclients with “applied thought leadership” related to the business ofpayments.  Revenue in the GPC division isprimarily derived through the delivery of consulting services offered primarilyon a time and materials basis to our clients, along with the license fees,maintenance fees and services fees associated with our Float Pricing Systemsoftware offering and Payments Clearing Model product offering.  As of July31, 2006, GPC had 23 employees.

*BusinessProcess Outsourcing.* In fiscal 2003 we formed Carretek. Carretek is a transformational business outsourcer for informationtechnology and payment and transaction processing jointly owned by CarrekerCorporation and Majesco Software, Inc., the U.S. subsidiary of Mastek Limited,a leading Indian outsourcing company with global operations.  As of July 31, 2006, 2 of the Company’s U.S.based employees and 119 offshore personnel of Mastek Limited were seconded toCarretek on a contract basis.

27

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*Costof Revenues and Gross Margins.*  We strive to control our cost of revenues andthereby maintain or improve our gross margins. The major items impacting cost of consulting, cost of softwaremaintenance and cost of software implementation are personnel, overhead andrelated expenses.  The major itemsimpacting cost of software licenses are amortization of both capitalized andacquired software and also software royalties for software from thirdparties.  While the amortization expenseis relatively fixed, the third party royalty expense can vary significantlybased on the relative product mix.

*Operating Expenses.*  Operating expenses, includingselling, general and administrative and research and development, aresubstantially driven by personnel and overhead expenses.  Other significant operating expenses that wemonitor include professional fees, use of contractors, travel, insurance andoffice services expenses.  As of July31, 2006, the Corporate Account RelationshipManagement and Marketing staff had 20 employees,and the Corporate staff which includes Executive Management, Legal, Finance andAccounting, Human Resources, Facilities and IT had 80 employees.

*Liquidity and Cash Flows.*  Cash andcash equivalents at July 31, 2006 and January 31, 2006 totaled $27.6 million and $29.7 million, respectively.  In addition, we had $5.9 million of marketable debt securities at July 31,2006, as compared to $4.7 million at January 31, 2006.  At July 31, 2006 and January 31, 2006, therewere no borrowings outstanding under our revolving credit agreement.  Additionally, we did not renew our revolvingcredit agreement which expired by its terms on July 31, 2006 as current cash onhand, marketable securities and our cash projected to be generated fromoperations are believed to be sufficient to meet our cash requirements for theforeseeable future.

**Products and Services**

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

*Global Payments Technologies.*  Carreker’stechnology solutions help financial institutions address the needs of somecritical payment services and delivery functions that impact overall operatingrevenues and costs and risk management. These functions include presentment of checks in paper and electronicform, identification and mitigation of fraudulent payments, handling irregularitems such as checks returned unpaid (exceptions), maintaining a record of pasttransactions (archiving), responding to related customer inquiries (research),and correcting any errors that are discovered (adjustments).  Global Payments Technologies (“GPT”)solutions address these and other key functions in the context of improvingoperational efficiency and a gradual transition from paper to electronic-basedpayment systems.  GPT offers riskmanagement solutions that mitigate depository account risk through profilingand advanced analytics technology.  GPTrisk management solutions leverage transaction monitoring and filteringcapabilities for AML and OFAC compliance. Finally, we offer technology solutions that optimize the inventorymanagement of a bank’s cash stock levels and logistical service requirements,including managing how much is needed, when it is needed and where it isneeded.  Our solutions reduce the amountof cash banks need to hold in reserve accounts and as cash-on-hand whileensuring a high level of customer service through timely replenishment of ATMcash supplies at minimal logistical services cost.

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Specific solutions in the GPT group include:
| **Solution**                                           | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   | ** ** | **Products Offered**                                                                                                                                                                                                                                                                                 |
|--------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                             | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | ** ** | ** **                                                                                                                                                                                                                                                                                           |
| **Risk  Solutions:**                                   | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | ** ** | ** **                                                                                                                                                                                                                                                                                           |
| ** **                                             | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | ** ** | ** **                                                                                                                                                                                                                                                                                           |
| Fraud Mitigation  and Anti-Money Laundering Compliance |       | Automated fraud detection and prevention solutions  that reduce incidents of check fraud, deposit fraud, check kiting, and  electronic fraud. Anti-money laundering solutions screen names and related  data against industry blacklists, local high-risk lists and other customized  databases. Information management solution aggregates fraud source  information and serves as a risk management dashboard. Multi-payment  transaction monitoring solution uses advanced analytics and rules to detect  suspicious activity. |       | FraudLink On-Us, FraudLink Deposit, FraudLink Deposit  – Branch Access Option, Kite, FraudLink Positive Pay, FraudLink eTracker,  FraudLink ACHeCK, FraudLink PC, Workflow Manager, AML Filter, Information  Manager, Fraud Manager On-Us, Deposit, Wires, AML, and Fraud Solutions  Consulting |
|                                                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                                                                 |
| **Payment  Solutions:**                                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                                                                 |
| ** **                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                                                                 |
| Exception  Management                                  |       | Products that bring new efficiencies to back-office  operations through leading-edge image, workflow, and RECO (character  recognition) technologies.                                                                                                                                                                                                                                                                                                                                                                             |       | Adjustments/Express, Exceptions/Express, Express  Capture, Express Decision, Input/Express, Inbound Returns/Express, and All  Transactions File                                                                                                                                                      |
|                                                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                                                                 |
| Remittance and  Payments Processing                    |       | Both host and client/server-based platforms for  improved productivity in processing retail and wholesale remittance  transactions for financial institutions and payments processing for a wide  variety of cross-industry applications.                                                                                                                                                                                                                                                                                         |       | NeXGen Remittance                                                                                                                                                                                                                                                                                    |
|                                                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                                                                 |
| Conventional  Check Capture                            |       | An extensive array of enhancement products that add  flexibility and usability to IBM’s Check Processing Control System (CPCS) and  the IBM 3890/XP series of Document Processors.                                                                                                                                                                                                                                                                                                                                           |       | Conventional Capture Products, CPCS Enhancements  Products, XP/Productivity Tools, Platform Emulation, NeXGen Settlement,  NeXGen Balancing, and LTA (Large Table Access)                                                                                                                            |
|                                                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                                                                 |
| Check Image  Capture                                   |       | Products and services related to the centralized and  distributed capture, quality and inspection assurance, storage and delivery  of check images. Distributed capture solutions come in web-based thin client  and thick client. Distributed capture branch solution serves as a core  component to full bank branch image enablement.                                                                                                                                                                                          |       | ALS & CIMS Products (MVS, AIX, Windows), NeXGen  Image Processor, Image Enhancement Products, Reject Repair, RECO Technology,  Image POD, Image Delivery Products, Delivery Express QAS Image Inspector,  NeXGen Capture, Source Capture Suite                                                   |
|                                                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                                                                 |
| Check Image  Archive Management                        |       | Comprehensive array of check image archive  management products that may be tailored to a bank’s unique requirements  based on their operational environments and volumes. Carreker offers archive  technology for both in-house solutions and shared outsource providers.                                                                                                                                                                                                                                                   |       | Check Image Archive-AIX, Check Image Archive-MVS,  Check Image Archive Load                                                                                                                                                                                                                          |
|                                                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                                                                 |
| Other Check  Image Applications                        |       | An array of solutions that address revenue  enhancement, risk reduction, and expense reduction issues through the  application of image, workflow and RECO technologies.                                                                                                                                                                                                                                                                                                                                                          |       | Image Statements, CDRom Delivery, Input/Express,  Express Capture, Payee Name Verification, and Amount Encoding Verification                                                                                                                                                                         |

 

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| **Solution**                                     | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | ** ** | **Products Offered**                                                                                                                  |
|--------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------|
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                                                                                                                  |
| Electronic Check  Presentment and Image Exchange |       | Enables banks to transition from paper-based to  electronic payment systems by automating key elements of the processing  stream, creation of image replacement documents (“IRD”) and image quality and  usability checking.                                                                                                                                                                                                                                                                                                    |       | ExchgLink , IRD Create, IRD Author, Image Inspector,  CheckLink, CheckLink PC, Deposit Manager, Branch Truncation Manager and  Cnotes |
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                                                                                                                  |
|                                             |       | Aided by Check 21 legislation, these solutions are  designed to reduce and eventually eliminate the movement of paper payments  through the system, improving productivity, reducing errors, increasing  customer satisfaction and reducing fraud.                                                                                                                                                                                                                                                                                        |       |                                                                                                                                  |
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                                                                                                                  |
| **Cash  & Logistics Solutions:**             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                                                                                                                  |
| ** **                                       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                                                                                                                  |
| ATM Solutions                                    |       | Advanced ATM monitoring and management, improving  ATM availability and ensuring service levels are met. These solutions include  an automated ATM monitoring and dispatching system for maximizing network  availability; and a real-time Internet-based system for efficient handling of  ATM service requests and responses.                                                                                                                                                                                                           |       | eiManager, ATM Logix                                                                                                                  |
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                                                                                                                  |
| Cash Solutions                                   |       | A product suite, now optimized through Web-based  software solutions, that dramatically reduces the amount of cash banks,  financial institutions and companies need to hold as cash-on-hand throughout  vault, branch and ATM networks. These solutions also enable automation and  standardization of the cash ordering process, including the matching and  reconciliation of invoices and the optimization of transportation. Consulting  solutions can drive further efficiency and automation in vault, branch and  ATM operations. |       | iCom, ReserveLink, Matchpoint and Currency Supply  Chain Consulting                                                                   |
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                                                                                                                  |
| Enterprise  Tracking                             |       | An enterprise tracking solution designed to track  any object or virtual item from origination to final destination. Ability to  track accountable mail, branch bags, item volumes, ATM work, currency bags,  incoming domestic and international deposits, customer tapes and much more.  Web-based application with distributed deployment capabilities.                                                                                                                                                                                |       | Receive Sentry, Trackpoint                                                                                                            |
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                                                                                                                  |
| eMetrics                                         |       | Performance-measurement software suite that uses  historical data to generate key performance indicators, item processing  volume data, productivity statistics and quality control benchmarks.                                                                                                                                                                                                                                                                                                                                           |       | Lumen, ProModel, eiMICR, eiStats, eiQuality,  eiPerform                                                                               |

 

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

Another component of our RevE offering isour CVE solutions that include software, proprietary sales managementmethodologies and sales training programs. Our CVE solutions assist financialinstitutions in leveraging central intelligence with local insight, translatingstrategy into specific actions to achieve sustained organizational performance.This enables our clients to improve their identification of those customers andprospects representing the greatest value or potential, while aligning internalprocesses and behaviors with management’s focus. Our approach is unique andcomplementary to many CRM investments that banks have made in recent years andis designed to focus their activities such that they can attain increasedreturns on these CRM investments.

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

·               Enterprisepayment rationalization (strategy through performance optimization)

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

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

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

·               Consolidationand merger/integration planning

·               Payment channelrisk mitigation

·               Imageexchange planning

·               StrategicSourcing evaluation

·               IssueRecovery Services

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

·                    FloatManagement software products – Float Pricing System, Payments Clearing Modeland Float and Pricing Profitability application– for managing and reporting abank’s float profitability through analysis and pricing of  workflow, check clearing operations andcustomer allocation methodologies.  Theseproducts also provide critical activity summaries, aid in creating multipleavailability and pricing schedules, and pinpoint the cost/profitability oftransactions or relationships.

·                    PaymentsModeling product – PaymentsLink is an application that allows a bank to createan enterprise virtual profit and loss statement for the payments business aswell as model business scenarios around product and service pricing andtransactional volume trends.

*Business Process Outsourcing*. Carretek LLC is a transformational business outsourcer for informationtechnology, payment and transaction processing for financial institutionsjointly owned by Carreker Corporation (51%) and Majesco Software Inc. (49%),the U.S. subsidiary of Mastek Limited, a leading Indian outsourcing companywith global operations.  Carretek wasformed in fiscal 2003.

Carretek’s mission is to enable financial institutionsand their processors to realize the benefits of transformationaloffshore-centric outsourcing (“offshoring”) of their information technology andbusiness processes.  The benefits toclients could include reduction in operating costs, improvements inproductivity, and enhancement of quality.

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Initially, Carretek is focused on offshoringpayments-related business processes. Through Carretek, financial institutions can leverage the global workforce at this critical period when Check 21 and other payment electronificationtrends are pressuring financial institutions to reduce their payment per itemcosts beyond the power of traditional cost management practices.  Carretek has designed and built specificproduct offerings targeted at payment and transaction processing functions forthis express purpose.  Within this areaof expertise, the Carretek offering includes a flexible array of offshoreoutsourcing services to financial institutions.

**Executive Summary**

***Comparisonof Three Months Ended July 31, 2006 (“Q2 2006”) to Three Months Ended July 31,2005 (“Q2 2005”) and Six Months Ended July 31, 2006 (“YTD 2006”) to Six MonthsEnded July 31, 2005 (“YTD 2005”)***

Our consolidated revenues declined $1.1 million, or3.7%, to $28.8 million in Q2 2006 as compared to $29.9 million in Q2 2005, andour revenues declined $2.1 million, or 3.6%, to $56.0 million in YTD 2006 ascompared to $58.1 million in YTD 2005. Our net income declined $93,000, or 8.8%, to $961,000 in Q2 2006 ascompared to $1.1 million in Q2 2005 and our net income declined $625,000, or40.3%, to $927,000 in YTD 2006 as compared to $1.6 million in YTD 2005.

The decline in our revenue was primarily associatedwith our RevE business segment.  Both theQ2 2006 and YTD 2006 declines in revenue within RevE were centered in itstraditional contingent fee based consulting revenues, particularly within itsinternational markets.  The decline inRevE revenues was partially offset by an increase in GPT business segmentrevenues.  GPT’s increase in revenues inQ2 2006 and YTD 2006 was primarily the result of an increase in softwarelicense revenue within the Payments group.

The Payments group includes such products as ImageArchive and Exception Management applications as well as Source Capture,ExchgLink and Image Replacement Document (“IRD”) solutions.  During Q2 2006, a single GPT customerexpanded its licenses for both the Image Archive and IRD Author solutions.  This expansion resulted in approximately $2.3million of software license revenue in Q2 2006, and accounted for 41.4% and28.2% of software license revenue in Q2 2006 and YTD 2006, respectively.

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

Total operating expenses declined $261,000, or 1.8%,to $14.2 million in Q2 2006 as compared to $14.5 million in Q2 2005, andoperating expenses declined $796,000, or 2.8%, to $27.6 million in YTD 2006 ascompared to $28.4 million in YTD 2005. There were slight declines in both selling, general and administrativeexpenses and research and development expenses and there have been norestructuring and other charges recorded to date in fiscal 2006, which comparesto $28,000 in Q2 2005 and $123,000 in YTD 2005.

Cash and cash equivalents decreased to $27.6 millionat July 31, 2006, reflecting a decrease of $7.2 million from the end of Q1 2006but only a decrease of $2.1 million on a YTD basis.  This decrease was primarily the result ofincreased accounts receivable, particularly within the RevE business segment inwhich several large contracts recorded in the first six months of fiscal 2006contain payment terms which extend into the latter half of fiscal 2006.

We continue to anticipate revenue growth during thesecond half of the 2006 fiscal year relative to the first half of fiscal2006.  We expect that revenue and net incomefor the third quarter of fiscal 2006 will be roughly in line with the secondquarter of 2006 and that we will achieve improved revenue and net income infiscal 2006 as compared to fiscal 2005. We also believe that we are wellpositioned for improved profitability in fiscal 2007 as a result of anticipatedrevenue growth, improved operating leverage, and the decrease in scheduledamortization expense associated with certain acquisition-related intangibleassets.

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### ***Results of Operations***

***Comparisonof Three Months Ended July 31, 2006 (“Q2 2006”) to Three Months Ended July 31,2005 (“Q2 2005”) and Six Months Ended July 31, 2006 (“YTD 2006”) to Six MonthsEnded July 31, 2005 (“YTD 2005”)***

***Revenues***

*Revenues by Segment ($ inthousands):*
| ** **                    | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|-------------------------------|------------|-------------------------------------------------|------------|--------------|------------|-----------------------------------------------|------------|--------------|------------|
| ** **                    | ** ** | **2006**                                        | ** ** | **2005**     | ** ** | **$**                                         | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|                          |       |                                            |       |         |       |                                          |       |         |       |   |   |   |   |   |   |   |   |
| Revenue  Enhancement          |       | $                                               | 7,353      |         | $          | 10,897                                        |       | $            | (3,544     | ) | (32.5 | )% | $ | 15,951 |   | $ | 19,896 |   | $ | (3,945 | ) | (19.8 | )% |
| Global Payments  Technologies |       | 19,902                                          |       | 17,481       |       | 2,421                                         |       | 13.8         |       | 36,120 |   | 35,449 |   | 671 |   | 1.9 |   |
| Global Payments  Consulting   |       | 1,018                                           |       | 1,301        |       | (283                                          | )          | (21.8        | )          | 2,937 |   | 2,275 |   | 662 |   | 29.1 |   |
| Business Process  Outsourcing |       | 530                                             |       | 241          |       | 289                                           |       | 119.9        |       | 1,040 |   | 498 |   | 542 |   | 108.8 |   |
|                          |       |                                            |       |         |       |                                          |       |         |       |   |   |   |   |   |   |   |   |
| Total Revenues                |       | $                                               | 28,803     |         | $          | 29,920                                        |       | $            | (1,117     | ) | (3.7 | )% | $ | 56,048 |   | $ | 58,118 |   | $ | (2,070 | ) | (3.6 | )% |

 

Overall, total revenue declined $1.1 million, or 3.7%,to $28.8 million in Q2 2006 as compared to $29.9 million in Q2 2005 and totalrevenue declined $2.1 million, or 3.6%, to $56.0 million in YTD 2006 ascompared to $58.1 million in YTD 2005. The decline on both a quarterly and YTD basis is centered within theRevE business segment.

Our RevE segment revenues declined $3.5 million, or32.5%, on a quarterly basis and $3.9 million, or 19.8%, on a YTD basis.  RevE’s traditional contingent consultingrevenues declined $2.6 million, or 29.2%, on a quarterly basis and $2.8million, or 16.8%, on a YTD basis.  Therewere 15 revenue producing consulting engagements in both Q2 2006 and Q2 2005and 17 revenue producing consulting engagements in YTD 2006 and YTD 2005.  RevE did not derive any consulting revenuefrom its international customers in the first six months of fiscal 2006, whichcompares to $3.9 million in the first six months of fiscal 2005.  However, RevE is in the early phases ofseveral international engagements in which the consulting revenue has yet to berealized.  In Q2 2006, approximately $2.8million, or 38.7%, and in YTD 2006 approximately $8.0 million, or 50.4%, ofRevE’s total revenue was derived from a single consulting engagement thatshould be completed in early Q3 2006. Additionally, the software license, maintenance, implementation andother services revenue derived from RevE’s CVE proprietary sales managementoffering declined approximately $801,000, or 50.7%, to $779,000 in Q2 2006 ascompared to $1.6 million in Q2 2005 and declined approximately $882,000, or35.7%, to $1.6 million in YTD 2006 as compared to $2.5 million in YTD 2005 asthe number of active engagements declined from 3 to 2.

The increase in GPT segment revenue on both aquarterly and YTD basis is primarily the result of increased software licenserevenue within our Payments solutions offerings.  In Q2 2006, a single GPT customer expandedits license for both the Image Archive and IRD Author solutions.  The expansion resulted in approximately $2.3million of software license revenue in Q2 2006. This transaction accounted for 11.4% and 6.3% of GPT’s total revenue inQ2 2006 and YTD 2006, respectively.

GPC’s revenue decline in Q2 2006 as compared to Q22005 was primarily the result of decreased consulting revenue.  GPC has intensified its sales focus as wecompleted the repositioning of this business to focus on enterprise-wide paymentelectronification strategies, image enablement planning and integration andrisk mitigation.  The quarterlyconsulting revenue decrease can be attributed to fluctuations in the timing ofcertain engagements.  On a YTD basis, allrevenue categories within GPC have increased in YTD 2006 as compared to YTD2005.  The largest increases are withinsoftware license and software implementation and other services revenue, dueprimarily to our introduction of a new Payments Financial Modeling applicationand, with a rise in interest rates, renewed demand for our Float Managementproducts.

Our outsourcing revenue is derived through Carretek,our 51% owned business which offers outsourcing for information technology andpayment and transaction processing. Carretek was formed in fiscal 2003 and signed its first customeragreement in the second quarter of fiscal 2004. In 2005, we increased staffing under our initial contract and expandedour scope with this single customer to include a second and third set of transactionprocessing functions which has significantly increased revenue on both aquarterly and YTD basis in fiscal 2006 as compared to fiscal 2005.

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*Consulting ($ in thousands):*
| ** ** | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|------------|------------|-------------------------------------------------|------------|--------------|------------|-----------------------------------------------|------------|--------------|------------|
| ** ** | ** ** | **2006**                                        | ** ** | **2005**     | ** ** | **$**                                         | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|       |       |                                            |       |         |       |                                          |       |         |       |   |   |   |   |   |   |   |   |
| Consulting |       | $6,839                                          |       | $9,502       |       | $(2,663                                       | )          | (28.0        | )%         | $15,397 |   | $17,820 |   | $(2,423 | ) | (13.6 | )% |

 

Most of our consulting revenues are derived from ourRevE business segment.  Consultingrevenues derived from our RevE segment declined $2.6 million, or 29.2%, to $6.3million in Q2 2006 as compared to $8.8 million in Q2 2005 and declined $2.8million, or 16.8%, to $13.8 million in YTD 2006 as compared to $16.6 million inYTD 2005.  Within RevE, we continue tofocus on maximizing the value to our existing customer base while expanding ourexpertise to new customers, both domestically and internationally.  There were no revenue producing internationalconsulting engagements in Q2 2006 and YTD 2006 as compared to $2.1 million inQ2 2005 and $3.9 million in YTD 2006. However, RevE is in the early phases of several internationalengagements in which the consulting revenue has yet to be realized.  Additionally, 45.5% of RevE’s consultingrevenue in Q2 2006 and 58.3% in YTD 2006 was derived from one customer.  This compares to 45.2% or RevE’s consultingrevenue in Q2 2005 and 24.2% in YTD 2005 derived from one customer.

Consulting revenues derived from our GPC segmentdeclined $201,000, or 30.1%, to $467,000 in Q2 2006 as compared to $668,000 inQ2 2005 and increased $152,000, or 12.5%, to $1.4 million in YTD 2006 ascompared to $1.2 million in YTD 2005. Beginning in Q4 2005 and carrying over into Q1 2006, the number and sizeof GPC consulting engagements increased; however, several of these engagementsconcluded early in Q2 2006.

*Software License ($ in thousands):*
| ** **       | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|------------------|------------|-------------------------------------------------|------------|--------------|------------|-----------------------------------------------|------------|--------------|------------|
| ** **       | ** ** | **2006**                                        | ** ** | **2005**     | ** ** | **$**                                         | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|             |       |                                            |       |         |       |                                          |       |         |       |   |   |   |   |   |   |   |   |
| Software License |       | $                                               | 5,493      |         | $          | 3,782                                         |       | $            | 1,711      |   | 45.2 | % | $ | 8,050 |   | $ | 7,141 |   | $ | 909 |   | 12.7 | % |
|                  |            |                                                 |            |              |            |                                               |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Most of our software license revenues are derived fromour GPT business segment.  Softwarelicense revenues from our GPT business segment increased $2.0 million, or58.0%, to $5.4 million in Q2 2006 as compared to $3.4 million in Q2 2005 andincreased $1.0 million, or 16.3%, to $7.5 million in YTD 2006 as compared to$6.5 million in YTD 2005.

Within GPT, the software license increase is withinthe Payment Solutions suite of products, which includes products designed toaddress the Check 21 legislation.  Check21 permits U.S. banks to accept digital images of checks the same way that theyaccept a paper check.  We have introducedseveral new Payment solution products to compete in this space such asExchgLink, our solution for exchanging images with other banks, IRD Authorwhich generates and processes substitute checks often referred to as imagereplacement documents (“IRD”), Image Inspector which ensures image quality and,finally, Source Capture which allows customers to capture deposits at branches,ATM’s and bank customer sites.  Delayedindustry adoption rates and intensified competition have dampened resultsrelative to our expectations; however, in Q2 2006, a single GPT customerexpanded its license for both the Image Archive and IRD Author solutions.  This expansion resulted in approximately $2.3million of software license revenue in Q2 2006 as no software implementation orother services were required.  Thistransaction accounted for 42.1% of GPT’s software license revenue in Q2 2006and 30.2% for YTD 2006.

The GPC business segment software license revenuesdecreased $87,000, or 75.7%, to $28,000 in Q2 2006 as compared to $115,000 inQ2 2005 and increased $156,000, or 135.6%, to $271,000 in YTD 2006 as comparedto $115,000 in YTD 2005.  The YTDincrease is primarily due to the introduction of a new Payments FinancialModeling application and renewed demand for its Float Management products.

The software license revenue derived from our CVEproduct offering within our RevE business segment declined $183,000, or 72.6%,to $69,000 in Q2 2006 as compared to $252,000 in Q2 2005 and declined $305,000,or 55.2%, to $248,000 in YTD 2006 as compared to $553,000 in YTD 2005.  This decline is the result of less activeengagements; however, RevE’s strategy changed in fiscal 2006 to focus less onmarketing CVE’s traditional software licenses and putting more emphasis on itsconsulting and other services, such as training.  This change in strategy has led to anexpansion of our CVE services for an existing customer and a pilot project fora new customer.

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*Software Maintenance ($ inthousands):*
| ** **            | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|-----------------------|------------|-------------------------------------------------|------------|--------------|------------|-----------------------------------------------|------------|--------------|------------|
| ** **            | ** ** | **2006**                                        | ** ** | **2005**     | ** ** | **$**                                         | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|                  |       |                                            |       |         |       |                                          |       |         |       |   |   |   |   |   |   |   |   |
| Software  Maintenance |       | $10,899                                         |       | $10,576      |       | $323                                          |       | 3.1          | %          | $21,651 |   | $21,888 |   | $(237 | ) | (1.1 | )% |

 

As with software license fees, most of our maintenancefees are derived from our GPT business segment. Software maintenance fees are paid pursuant to annually renewableproduct and telephone support agreements with our software customers.  The annual maintenance fee is generally paidby the customer at the beginning of the maintenance period and we recognizethis maintenance revenue ratably over the term of the related contract.  If the annual maintenance fee is not paid atthe beginning of the maintenance period, we defer revenue recognition until thetime that the maintenance fee is collected. When the payment is received, maintenance revenue is recognized for theperiod that maintenance revenue was previously deferred.  Also, maintenance contracts usually carryannual maintenance fee escalation clauses typically based on an index, such asthe consumer price index.  Because ourrevenue recognition policy requires the collection of cash before revenue canbegin to be recognized, our software maintenance revenue will fluctuatequarter-to-quarter.  For our GPT businesssegment, one large customer did not pay the maintenance renewal by April 30,2006 and this resulted in the deferral of approximately $374,000.  This renewal was paid in Q2 2006 and thepreviously deferred maintenance revenue was recognized.  Typically, our software maintenance revenuefluctuates between $10.0 million and $11.0 million per quarter.

*Software Implementation and OtherServices ($ in thousands):*
| ** **                                  | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|---------------------------------------------|------------|-------------------------------------------------|------------|--------------|------------|-----------------------------------------------|------------|--------------|------------|
| ** **                                  | ** ** | **2006**                                        | ** ** | **2005**     | ** ** | **$**                                         | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|                                        |       |                                            |       |         |       |                                          |       |         |       |   |   |   |   |   |   |   |   |
| Software  Implementation and Other Services |       | $                                               | 4,249      |         | $          | 4,892                                         |       | $            | (643       | ) | (13.1 | )% | $ | 8,384 |   | $ | 9,026 |   | $ | (642 | ) | (7.1 | )% |
|                                             |            |                                                 |            |              |            |                                               |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

In the majority of our software customer arrangements,installation services are provided to the customer.  Most of our software implementation fees arederived from our GPT business segment. The software implementation and other services revenue derived from GPTdeclined $124,000, or 3.5%, to $3.4 million in Q2 2006 as compared to $3.5million in Q2 2005 and declined $468,000, or 6.6%, to $6.6 million in YTD 2006as compared to $7.1 million in YTD 2005. This decline within GPT on a quarterly basis was primarily within theRisk and Cash product offerings offset by a slight increase within the Paymentsproduct offerings.  This decline withinRisk and Cash is primarily the result of lower software license revenue as bothproduct groups are introducing new and/or enhanced product offerings to theirrespective markets.  On a YTD basis, thedecline is within the Payments product offerings.

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

GPC’s software implementation and other servicesrevenue was relatively flat at approximately $200,000 in both Q2 2006 and 2005,respectively.  However, GPC’s softwareimplementation and other services revenue increased $302,000, or 100.0%, to$604,000 in YTD 2006 as compared to $302,000 in YTD 2005.  This increase is the result of increasedsoftware license revenue described above.

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*Outsourcing Services ($ in**thousands):*
| ** **           | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|----------------------|------------|-------------------------------------------------|------------|--------------|------------|-----------------------------------------------|------------|--------------|------------|
| ** **           | ** ** | **2006**                                        | ** ** | **2005**     | ** ** | **$**                                         | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|                 |       |                                            |       |         |       |                                          |       |         |       |   |   |   |   |   |   |   |   |
| Outsourcing Services |       | $                                               | 530        |         | $          | 241                                           |       | $            | 289        |   | 119.9 | % | $ | 1,040 |   | $ | 498 |   | $ | 542 |   | 108.8 | % |
|                      |            |                                                 |            |              |            |                                               |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

*Out-of-Pocket Expense Reimbursements($ in thousands)*:
| ** **                            | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|---------------------------------------|------------|-------------------------------------------------|------------|--------------|------------|-----------------------------------------------|------------|--------------|------------|
| ** **                            | ** ** | **2006**                                        | ** ** | **2005**     | ** ** | **$**                                         | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|                                  |       |                                            |       |         |       |                                          |       |         |       |   |   |   |   |   |   |   |   |
| Out-of-Pocket Expense  Reimbursements |       | $                                               | 793        |         | $          | 927                                           |       | $            | (134       | ) | (14.5 | )% | $ | 1,526 |   | $ | 1,745 |   | $ | (219 | ) | (12.6 | )% |
|                                       |            |                                                 |            |              |            |                                               |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

These reimbursementstend to fluctuate period to period and the decrease for both the quarterly andYTD periods is primarily related to reduced international travel within theRevE business segment.

***Cost of Revenues***

*Cost of Revenues by Segment ($ inthousands):*
| ** **                    | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **        | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------|------------|----------------------------------|------------|--------------|------------|-------------------|------------|--------------------------------|------------|------------|------------|------------|------------|
| ** **                    | ** ** | **July 31,**                | ** ** | **Variance** | ** ** | **July 31,** | ** ** | **Variance**                   | ** ** |
| ** **                    | ** ** | **2006**                         | ** ** | **2005**     | ** ** | **$**             | ** ** | **%**                          | ** ** | **2006**   | ** ** | **2005**   | ** ** | **$** | ** ** | **%** | ** ** |
|                          |       |                             |       |         |       |              |       |                           |       |       |       |       |       |   |   |   |   |
| Revenue  Enhancement          |       | $                                | 4,903      |         | $          | 4,911             |       | $                              | (8         | )          | (0.2       | )%         | $          | 9,826 |   | $ | 9,381 |   | $ | 445 |   | 4.7 | % |
| % of revenue                  |       | 66.7                             | %          | 45.1         | %          |              |       |                           |       | 61.6       | %          | 47.2       | %          |   |   |   |   |
|                          |       |                             |       |         |       |              |       |                           |       |       |       |       |       |   |   |   |   |
| Global Payments  Technologies |       | $                                | 7,913      |         | $          | 8,248             |       | $                              | (335       | )          | (4.1       | )%         | $          | 15,656 |   | $ | 16,391 |   | $ | (735 | ) | (4.5 | )% |
| % of revenue                  |       | 39.8                             | %          | 47.2         | %          |              |       |                           |       | 43.3       | %          | 46.2       | %          |   |   |   |   |
|                          |       |                             |       |         |       |              |       |                           |       |       |       |       |       |   |   |   |   |
| Global Payments  Consulting   |       | $                                | 768        |         | $          | 872               |       | $                              | (104       | )          | (11.9      | )%         | $          | 1,836 |   | $ | 1,774 |   | $ | 62 |   | 3.5 | % |
| % of revenue                  |       | 75.4                             | %          | 67.0         | %          |              |       |                           |       | 62.5       | %          | 78.0       | %          |   |   |   |   |
|                          |       |                             |       |         |       |              |       |                           |       |       |       |       |       |   |   |   |   |
| Business Process  Outsourcing |       | $                                | 514        |         | $          | 434               |       | $                              | 80         |       | 18.4       | %          | $          | 990 |   | $ | 1,013 |   | $ | (23 | ) | (2.3 | )% |
| % of revenue                  |       | 97.0                             | %          | 180.1        | %          |              |       |                           |       | 95.2       | %          | 203.4      | %          |   |   |   |   |
|                          |       |                             |       |         |       |              |       |                           |       |       |       |       |       |   |   |   |   |
| Total Cost of  Revenues       |       | $                                | 14,098     |         | $          | 14,465            |       | $                              | (367       | )          | (2.5       | )%         | $          | 28,308 |   | $ | 28,559 |   | $ | (251 | ) | (0.9 | )% |
| % of revenue                  |       | 48.9                             | %          | 48.3         | %          |              |       |                           |       | 50.5       | %          | 49.1       | %          |   |   |   |   |

 

In total and by business segment, cost of revenues onan absolute dollar basis remained relatively flat for Q2 2006 and YTD 2006 ascompared to Q2 2005 and YTD 2005.  Thelargest decline was within GPT and was primarily the result of GPT reducing itsworkforce by 29 employees in Q3 2005. RevE’s cost of revenues increased on a YTD basis primarily within thecost of consulting, as this group changed its focus and strategy related to itsCVE product offering discussed above.

With the cost of revenues being relatively flat on aquarterly basis, the fluctuation in the cost of revenues as a percentage oftotal business segment revenue was primarily driven by the revenue fluctuationswithin the respective business segments, with the overall decline in totalrevenue exceeding the decline in cost of revenues.

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*Cost of Consulting ($ in thousands):*
| ** **               | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **        | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------|------------|----------------------------------|------------|--------------|------------|-------------------|------------|--------------------------------|------------|------------|------------|------------|------------|
| ** **               | ** ** | **July 31,**                | ** ** | **Variance** | ** ** | **July 31,** | ** ** | **Variance**                   | ** ** |
| ** **               | ** ** | **2006**                         | ** ** | **2005**     | ** ** | **$**             | ** ** | **%**                          | ** ** | **2006**   | ** ** | **2005**   | ** ** | **$** | ** ** | **%** | ** ** |
| Cost of  Consulting      |       | $                                | 4,798      |         | $          | 4,277             |       | $                              | 521        |       | 12.2       | %          | $          | 9,670 |   | $ | 8,518 |   | $ | 1,152 |   | 13.5 | % |
| % of consulting  revenue |       | 70.2                             | %          | 45.0         | %          |              |       |                           |       | 62.8       | %          | 47.8       | %          |   |   |   |   |
|                          |            |                                  |            |              |            |                   |            |                                |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

The cost of consulting consists primarily of personnelcosts related to our consulting engagements within both our RevE and GPCbusiness segments.  The increase in thecost of consulting on a quarterly and YTD basis is the result of RevE’s changein focus and strategy for its CVE offering from traditional software license,software maintenance and software services offering to consulting benchmarkingand training offerings.  The increase incost of consulting within RevE, without an increase in consulting revenue, hasincreased the cost of consulting as a percentage of consulting revenue on botha quarterly and YTD basis.

*Cost of Software Licenses ($ inthousands):*
| ** **                     | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **        | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|----------------------------------|------------|--------------|------------|-------------------|------------|--------------------------------|------------|------------|------------|------------|------------|
| ** **                     | ** ** | **July 31,**                | ** ** | **Variance** | ** ** | **July 31,** | ** ** | **Variance**                   | ** ** |
| ** **                     | ** ** | **2006**                         | ** ** | **2005**     | ** ** | **$**             | ** ** | **%**                          | ** ** | **2006**   | ** ** | **2005**   | ** ** | **$** | ** ** | **%** | ** ** |
|                           |       |                             |       |         |       |              |       |                           |       |       |       |       |       |   |   |   |   |
| Cost of Software  Licenses     |       | $                                | 1,885      |         | $          | 1,828             |       | $                              | 57         |       | 3.1        | %          | $          | 3,725 |   | $ | 3,364 |   | $ | 361 |   | 10.7 | % |
| % of software  license revenue |       | 34.3                             | %          | 48.3         | %          |              |       |                           |       | 46.3       | %          | 47.1       | %          |   |   |   |   |
|                                |            |                                  |            |              |            |                   |            |                                |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

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

In connectionwith software license, maintenance and certain consulting agreements enteredinto with certain banks and purchase agreements with vendors under which weacquire software technology used in products sold to our customers, we arerequired to pay royalties on sales of certain software products.  Under these arrangements, we recognizeroyalty expense when the associated revenue is recognized.  The royalty percentages generally range from20% to 50% of the associated revenue. Approximately $483,000 and $462,000 of royalty expense was recordedunder these agreements and charged to cost of software licenses in Q2 2006 andQ2 2005, respectively, and $829,000 and $554,000 in YTD 2006 and 2005,respectively.  Depending on our futureproduct mix, our margins from software license fees may be negatively impactedby increased software royalty expense.

*Cost of Software Maintenance ($ inthousands):*
| ** **                         | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **        | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------|------------|----------------------------------|------------|--------------|------------|-------------------|------------|--------------------------------|------------|------------|------------|------------|------------|
| ** **                         | ** ** | **July 31,**                | ** ** | **Variance** | ** ** | **July 31,** | ** ** | **Variance**                   | ** ** |
| ** **                         | ** ** | **2006**                         | ** ** | **2005**     | ** ** | **$**             | ** ** | **%**                          | ** ** | **2006**   | ** ** | **2005**   | ** ** | **$** | ** ** | **%** | ** ** |
|                               |       |                             |       |         |       |              |       |                           |       |       |       |       |       |   |   |   |   |
| Cost of Software  Maintenance      |       | $                                | 3,189      |         | $          | 3,436             |       | $                              | (247       | )          | (7.2       | )%         | $          | 6,361 |   | $ | 7,411 |   | $ | (1,050 | ) | (14.2 | )% |
| % of software  maintenance revenue |       | 29.3                             | %          | 32.5         | %          |              |       |                           |       | 29.4       | %          | 33.9       | %          |   |   |   |   |
|                                    |            |                                  |            |              |            |                   |            |                                |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

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

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

*Cost of Software Implementation andOther Services ($ in thousands):*
| ** **                                               | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **        | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------------------------------|------------|----------------------------------|------------|--------------|------------|-------------------|------------|--------------------------------|------------|------------|------------|------------|------------|
| ** **                                               | ** ** | **July 31,**                | ** ** | **Variance** | ** ** | **July 31,** | ** ** | **Variance**                   | ** ** |
| ** **                                               | ** ** | **2006**                         | ** ** | **2005**     | ** ** | **$**             | ** ** | **%**                          | ** ** | **2006**   | ** ** | **2005**   | ** ** | **$** | ** ** | **%** | ** ** |
|                                                     |       |                             |       |         |       |              |       |                           |       |       |       |       |       |   |   |   |   |
| Cost of Software  Implementation and Other Services      |       | $                                | 2,938      |         | $          | 3,682             |       | $                              | (744       | )          | (20.2      | )%         | $          | 6,014 |   | $ | 6,655 |   | $ | (641 | ) | (9.6 | )% |
| % of software  implementation and other services revenue |       | 69.1                             | %          | 75.3         | %          |              |       |                           |       | 71.7       | %          | 73.7       | %          |   |   |   |   |
|                                                          |            |                                  |            |              |            |                   |            |                                |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

Cost of software implementation consists primarily ofpersonnel and facility costs to provide software implementation and projectmanagement support to customer software implementations primarily within ourGPT business segment.  The decline in thecost of software implementation and other services on both a quarterly and YTDbasis was primarily the result of a decline in personnel costs within both ourGPT and RevE business segments due to reduced levels of software implementationand other services revenue in both business segments.

*Cost of Outsourcing Service ($ in thousands):*
| ** **                         | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **        | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------|------------|----------------------------------|------------|--------------|------------|-------------------|------------|--------------------------------|------------|------------|------------|------------|------------|
| ** **                         | ** ** | **July 31,**                | ** ** | **Variance** | ** ** | **July 31,** | ** ** | **Variance**                   | ** ** |
| ** **                         | ** ** | **2006**                         | ** ** | **2005**     | ** ** | **$**             | ** ** | **%**                          | ** ** | **2006**   | ** ** | **2005**   | ** ** | **$** | ** ** | **%** | ** ** |
|                               |       |                             |       |         |       |              |       |                           |       |       |       |       |       |   |   |   |   |
| Cost of Outsourcing  Service       |       | $                                | 514        |         | $          | 434               |       | $                              | 80         |       | 18.4       | %          | $          | 990 |   | $ | 1,013 |   | $ | (23) |   | (2.3 | )% |
| % of outsourcing  services revenue |       | 97.0                             | %          | 180.1        | %          |              |       |                           |       | 95.2       | %          | 203.4      | %          |   |   |   |   |
|                                    |            |                                  |            |              |            |                   |            |                                |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

The cost of outsourcing service relates to theoperation of Carretek, our 51% owned business outsourcer for informationtechnology and payment and transaction processing.  To date, this business only has a singlecustomer and our scope of business with this single customer includesoutsourcing three business functions. The cost of outsourcing service on both a quarterly and YTD basis isrelatively flat.  The decline in thepercentage of cost of outsourcing service as a percentage of outsourcingservice revenue is primarily the result of increased revenue as two of theoutsourced functions ramp up to full capacity on a relatively fixed coststructure.

*Out-of-Pocket Expenses ($ inthousands):*
| ** **                                 | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **        | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|----------------------------------|------------|--------------|------------|-------------------|------------|--------------------------------|------------|------------|------------|------------|------------|
| ** **                                 | ** ** | **July 31,**                | ** ** | **Variance** | ** ** | **July 31,** | ** ** | **Variance**                   | ** ** |
| ** **                                 | ** ** | **2006**                         | ** ** | **2005**     | ** ** | **$**             | ** ** | **%**                          | ** ** | **2006**   | ** ** | **2005**   | ** ** | **$** | ** ** | **%** | ** ** |
|                                       |       |                             |       |         |       |              |       |                           |       |       |       |       |       |   |   |   |   |
| Cost of  Out-of-Pocket Expenses            |       | $                                | 774        |         | $          | 808               |       | $                              | (34        | )          | (4.2       | )%         | $          | 1,548 |   | $ | 1,598 |   | $ | (50 | ) | (3.1 | )% |
| % of  out-of-pocket expense reimbursements |       | 97.6                             | %          | 87.2         | %          |              |       |                           |       | 101.4      | %          | 91.6       | %          |   |   |   |   |
|                                            |            |                                  |            |              |            |                   |            |                                |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

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

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***Operating Costs and Expenses:***

*Selling, General andAdministrative Expenses**($ in thousands):*
| ** **                                    | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------|------------|--------------|------------|-----------------------------------------------|------------|--------------|------------|
| ** **                                    | ** ** | **2006**                                        | ** ** | **2005**     | ** ** | **$**                                         | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|                                          |       |                                            |       |         |       |                                          |       |         |       |   |   |   |   |   |   |   |   |
| Selling, General  and Administrative Expenses |       | $                                               | 11,423     |         | $          | 11,593                                        |       | $            | (170       | ) | (1.5 | )% | $ | 22,203 |   | $ | 22,497 |   | $ | (294 | ) | (1.3 | )% |
| % of total  revenue                           |       | 39.7                                            | %          | 38.7         | %          |                                          |       |         |       | 39.6 | % | 38.7 | % |   |   |   |   |
|                                               |            |                                                 |            |              |            |                                               |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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, insurance, includingdirectors and officers liability insurance, as well as professional services,such as legal and accounting expenses, and other related costs are classifiedwithin selling, general and administrative expense.  Our selling, general and administrativeexpenses were essentially flat in absolute dollars on both a quarterly and YTDbasis.  However, there were significantchanges within the underlying expense categories.  Corporate sales and marketing declined$584,000 on a quarterly basis and $1.1 million on a YTD basis and our businesssegments also reduced their sales cost by $735,000 on a quarterly basis and$1.4 million on a YTD basis.  Thesedeclines were primarily achieved through reduced personnel and personnelrelated costs.  These cost reductionswere offset by increased general and administrative costs of $1.1 million on aquarterly basis and $2.2 million on a YTD basis.  The increases in general and administrativecosts consist of increased professional fees including legal fees arising outof lawsuits in which we are the plaintiff, and increased accounting and otherprofessional fees related to the restatement of our financial statements thatwas announced in April 2006. Additionally, in Q1 2006, we began to expense stock-based compensationand approximately $212,000 on a quarterly basis and $437,000 YTD 2006 wascharged to general and administrative expense. Finally, $347,000 of bonus expense was recorded within general andadministrative expense in Q2 2006.

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

*Research and Development**($ in thousands):*
| ** **                         | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|------------------------------------|------------|-------------------------------------------------|------------|--------------|------------|-----------------------------------------------|------------|--------------|------------|
| ** **                         | ** ** | **2006**                                        | ** ** | **2005**     | ** ** | **$**                                         | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|                               |       |                                            |       |         |       |                                          |       |         |       |   |   |   |   |   |   |   |   |
| Research and  Development Expenses |       | $                                               | 2,453      |         | $          | 2,516                                         |       | $            | (63        | ) | (2.5 | )% | $ | 4,658 |   | $ | 5,037 |   | $ | (379 | ) | (7.5 | )% |
| % of total  revenue                |       | 8.5                                             | %          | 8.4          | %          |                                          |       |         |       | 8.3 | % | 8.7 | % |   |   |   |   |
|                                    |            |                                                 |            |              |            |                                               |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Research and development expenses consist primarilyof personnel, contract labor, travel and facilities expenses.  Research and development costs are typicallylimited to development of new software products, or enhancements to existingsoftware products, which extend the product’s life cycle and/or substantiallyincrease its marketability.  The majorityof research and development costs were related to new product developmentwithin our GPT Payment Solutions group, although in Q2 2006 a new CVE offeringwithin the RevE business segment reached technological feasibility andcapitalization of development costs commenced.

In accordance with SFAS No.86, “*Accounting for Costs of Software**to be Sold, Leased or Otherwise Marketed,”*we capitalized $718,000 and $271,000 in Q2 2006 and Q2 2005, respectively, and$1.2 million and $708,000 in YTD 2006 and YTD 2005, respectively.  Software development costs of a product arecapitalized from the time technological feasibility is reached until thegeneral release of the product.  Weestablish technological feasibility through the process of creating a detailedprogram design and reviewing the detailed program design for any high riskdevelopment issues or through the creation of a working model.  Capitalization only occurs if we believecosts capitalized are recoverable through future sales of the software productunder development.  At July 31, 2006, wehad seven projects underway for which costs were capitalized in Q2 2006.  Three of these projects are within Risksolutions; three are within Cash & Logistics solutions and one is a CVE solution.  All development projects are scheduled to becompleted by the end of fiscal 2006.

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*Amortization of Customer Relationships:*  Amortization of customer relationships was$350,000 in both Q2 2006 and Q2 2005, and$700,000 for YTD 2006 and YTD 2005. The amortization results from the periodic recognition of amortizationexpense of intangible customer relationships acquired in the Check Solutionsacquisition in fiscal 2001, and this amortization will continue until May 2007.

*Restructuringand Other Charges:*  There were no restructuring and other chargesrecorded to date in fiscal 2006. However, we recorded $127,000 in restructuring and other chargesduring Q1 2005, principally associated with the separation of 6 employees, and we recorded $28,000 in restructuringand other charges during Q2 2005, principally associated with the separation of2 employees.  In Q1 2005, we also loweredour estimate by $32,000 for the costs associated with the discontinuance of oneof our software offerings originally recorded in January 2004.

Theactivity related to the accrued merger and restructuring costs to date infiscal 2006 is as follows (in thousands):

|                                                      | ** ** | **Workforce  Reductions** | ** ** | **CheckFlow  Suite** | ** ** | **Other** | ** ** | **Total** | ** ** |
|------------------------------------------------------|------------|---------------------------|------------|----------------------|------------|-----------|------------|-----------|------------|
|                                                 |       |                      |       |                 |       |      |       |      |       |
| Reserve balance  at January 31, 2006                 |       | $                         | 87         |                 | $          | 200       |       | $         | 47         |   | $ | 334 |   |
| Cash paid                                            |       | (87                       | )          | —               |       | —    |       | (87       | )          |
| Reserve balance  at April 30, 2006 and July 31, 2006 |       | $                         | —     |                 | $          | 200       |       | $         | 47         |   | $ | 247 |   |

 

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

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

*Interest Income ($ in thousands):*
| ** **      | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|-----------------|------------|-------------------------------------------------|------------|--------------|------------|-----------------------------------------------|------------|--------------|------------|
| ** **      | ** ** | **2006**                                        | ** ** | **2005**     | ** ** | **$**                                         | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|            |       |                                            |       |         |       |                                          |       |         |       |   |   |   |   |   |   |   |   |
| Interest Income |       | $                                               | 407        |         | $          | 166                                           |       | $            | 241        |   | 145.2 | % | $ | 678 |   | $ | 310 |   | $ | 368 |   | 118.7 | % |
|                 |            |                                                 |            |              |            |                                               |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

*Interest Expense ($ in thousands):*
| ** **       | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|------------------|------------|-------------------------------------------------|------------|--------------|------------|-----------------------------------------------|------------|--------------|------------|
| ** **       | ** ** | **2006**                                        | ** ** | **2005**     | ** ** | **$**                                         | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|             |       |                                            |       |         |       |                                          |       |         |       |   |   |   |   |   |   |   |   |
| Interest Expense |       | $                                               | (106       | )            | $          | (107                                          | )          | $            | (1         | ) | (0.9 | )% | $ | (211 | ) | $ | (212 | ) | $ | (1 | ) | (0.5 | )% |
|                  |            |                                                 |            |              |            |                                               |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Interest expense is primarily the result of thecommitment fees associated with the maintenance of our $30.0 million revolvingcredit agreement.  As discussed below in “Liquidityand Capital Resources,” we did not renew our credit facility following itsexpiration on July 31, 2006. Additionally, the amortization of the deferred loan costs is alsoincluded in interest expense and this amortization concluded on July 31, 2006.  There have been no borrowings outstandingunder this credit agreement since Q1 2004.

40

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*Other income ($ in thousands):*
| ** **                                  | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|---------------------------------------------|------------|-------------------------------------------------|------------|--------------|------------|-----------------------------------------------|------------|--------------|------------|
| ** **                                  | ** ** | **2006**                                        | ** ** | **2005**     | ** ** | **$**                                         | ** ** | **%**        | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
|                                        |       |                                            |       |         |       |                                          |       |         |       |   |   |   |   |   |   |   |   |
| Minority share  of net loss of Carretek LLC |       | 194                                             |       | 213          |       | (19                                           | )          | (8.9         | )%         | 327 |   | 531 |   | (203 | ) | (38.3 | )% |
| Foreign exchange  gains (losses)            |       | 123                                             |       | (84          | )          | 207                                           |       | 246.4        | %          | 193 |   | (101 | ) | 294 |   | 291.1 | % |
| Other                                       |       | (2                                              | )          | —       |       | (2                                            | )          | —       | %          | (5 | ) | 5 |   | (11 | ) | (183.3 | )% |
|                                        |       |                                            |       |         |       |                                          |       |         |       |   |   |   |   |   |   |   |   |
| Total                                       |       | $                                               | 315        |         | $          | 129                                           |       | $            | 186        |   | 144.2 | % | $ | 515 |   | $ | 435 |   | $ | 80 |   | 18.4 | % |
|                                             |            |                                                 |            |              |            |                                               |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

We own a 51% interest in Carretek LLC (“Carretek”),through which we offer financial institutions offshore-centric outsourcing oftheir business processes.  Carretek hasgenerated approximately $368,000 and $434,000 in losses in Q2 2006 and Q2 2005,respectively, and $667,000 and $1.1 million in losses YTD 2006 and YTD2005.  Accordingly, the 49% share inthese losses relating to the minority interest held by Majesco Software, Inc.,or $194,000 and $213,000 in Q2 2006 and Q2 2005, respectively, and $327,000 and$531,000 in YTD 2006 and 2005, respectively, was recorded in other income(expense).

*Provisionfor Income Taxes:*  We have established a valuationallowance to reserve our net deferred tax assets at July 31, 2006 because ofour inconsistent history of generating profitable operations and taxableincome.  The tax provision was computedbased on actual results by jurisdiction which resulted in a foreign taxprovision of $134,000 and $102,000 for the three months ended July 31, 2006 and2005, respectively, and $234,000 and $183,000 for the six months ended July 31,2006 and 2005, respectively.  In additionto the provision for foreign taxes, we recorded $20,000 and $15,000 of U.S.Federal and State tax expense in the three and six months ended July 31, 2006and 2005, respectively, for alternative minimum tax purposes.

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**Liquidity and Capital Resources**

Historically, we have funded our operations and cashexpenditures primarily with cash generated from operating activities.  At July 31, 2006, we had working capital of$22.0 million compared to $17.9 million at January 31, 2006.  We had $27.6 million in cash and cashequivalents at July 31, 2006, a decrease of $2.1 million from $29.7 million incash and cash equivalents at January 31, 2006. However, we also had $5.9 million of “available for sale” marketablesecurities at July 31, 2006, compared to $4.7 million at January 31, 2006.  We expect that existing cash and cashequivalents, marketable securities and our cash projected to be generated fromoperating activities will be sufficient to meet our presently anticipated liquidityrequirements for the foreseeable future.

Cash used in operating activities was $5.8 million forQ1 2006 compared to cash used in operating activities of $5.9 million in Q12005.  Cash provided by operatingactivities was $2.1 million in YTD 2006 as compared to cash used in operatingactivities of $3.8 million in YTD 2005.

Average days’ sales outstandingfluctuate for a variety of reasons, including the timing of billings specifiedby contractual agreement, and receivables for expense reimbursements.  The following table contains the quarterlydays’ sales outstanding (DSO):
| Quarter ended | ** ** | **DSO** | ** ** |
|--------------------|------------|---------|------------|
|               |       |    |       |
| July 31, 2006      |       | 54      |       |
| April 30, 2006     |       | 33      |       |
| January 31, 2006   |       | 37      |       |
| October 31, 2005   |       | 42      |       |
| July 31, 2005      |       | 49      |       |

The increase inDSO is primarily the result of our RevE business segment providing paymentterms for several large contracts recorded in Q1 and Q2 2006 which extendedinto Q3 and Q4 2006.

Cash used in investing activities decreased to $1.9million in Q2 2006 as compared to $5.5 million in Q2 2005 and decreased to $4.6million in YTD 2006 as compared to $6.6 million in YTD 2005.  The reduction in both the quarterly and YTDperiods reflected a reduction in the purchase of marketable securities offsetpartially by increased purchases of property and equipment and increasedcapitalized software.  The increase inproperty and equipment is primarily the result of leasehold improvementsperformed in Charlotte, N.C., along with costs capitalized in connection withour ERP upgrade.  Additionally,capitalized computer software costs increased due to more product developmentactivity within our GPT and RevE business segments.

Financing activities provided cash of$484,000 in Q2 2006 as compared to a use of cash of $2.7 million in Q22005.  Financing activities provided cashof $484,000 in YTD 2006 as compared to a use of cash of $2.4 million in YTD2005.  The cash provided by financingactivities in both Q2 2006 and YTD 2006 was related to proceeds from stockoption exercises along with a minority shareholder cash investment in CarretekLLC.  The cash used in financingactivities in Q2 2005 and YTD 2005 was related to $2.9 million and $3.2 millionof treasury stock purchases in Q2 2005 and YTD 2005, respectively.  These common stock purchases were performedunder a program to purchase $5.0 million of the Company’s outstanding commonstock during the period April 18, 2005 through October 15, 2005.  The cash used for these treasury stockpurchases was partially offset by proceeds from exercise of stock options andadditional minority shareholder equity contributions in Carretek LLC.

Wewere a party to a revolving credit agreement with a group of banks providingfor a commitment amount of $30.0 million and a maturity date of July 31,2006.  There have been no borrowingsoutstanding under the credit facility since Q1 2004 and we believe our currentcash and cash equivalents, marketable securities and our cash projected to begenerated from operations to be sufficient to meet our cash requirements for theforeseeable future.  Therefore, we chosenot to renew the credit facility which expired by its terms on July 31, 2006.

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The following summarizes our contractual obligationsat July 31, 2006 and the effect these contractual obligations are expected tohave on our liquidity and cash flows in future periods (in thousands):
| ** **       | ** ** | **Payments Due by Period** | ** ** |
|------------------|------------|-------------------------------------------|------------|
| ** **       | ** ** | **Total**                                 | ** ** | **1 Year  or Less** | ** ** | **Years 2-3** | ** ** | **Years 4-5** | ** ** | **After  5 Years** | ** ** |
|             |       |                                      |       |   |   |   |   |   |   |   |   |
| Operating leases |       | $                                         | 10,376     |   | $ | 3,142 |   | $ | 5,367 |   | $ | 1,867 |   | $ | — |   |
|             |       | $                                         | 10,376     |   | $ | 3,142 |   | $ | 5,367 |   | $ | 1,867 |   | $ | — |   |

Webelieve that current cash and cash equivalents, marketable securities andexpected future cash flows will be sufficient to meet our anticipated cashneeds for working capital and routine capital expenditures during fiscal 2006.  However, if current sources are notsufficient to meet our needs, we may seek new equity or debt financing.  There can be no assurance that additionalfinancing would be available on acceptable terms, if at all.  Further, we may in the future pursueacquisitions of businesses, products or technologies that could complement orexpand our business and product offerings, and change our financing needs.  Our forecast of the period of time throughwhich our financial resources will be adequate to support our operations is aforward looking statement that involves risks and uncertainties, and actualresults could vary.  The failure tosecure new financing when needed could have a material adverse effect on ourbusiness, financial condition and results of operations.

**Critical Accounting Policies**

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

Revenue Recognition

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

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

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

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

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

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

*SoftwareLicense.*  A perpetual software license is sold eithertogether with implementation services or on a stand-alone basis.  The Company is usually paid software license fees in one or more installments, asprovided in the customer’s contract but not to exceed twelve months.  The Company recognizes software licenserevenue upon execution of a contract and delivery of the software, providedthat the license fee is fixed and determinable, no significant production,modification or customization of the software is required and collection isconsidered probable by management.  Whenthe software license arrangement requires the Company to provide implementationservices that are essential to the functionality of the software or significantproduction, customization or modification of the software is required, both theproduct license revenue and implementation fees are recognized as services areperformed.  A term software license issold either together with implementation services and/or with maintenanceservices.  These term licenses areusually paid in annual installments over the term of the license.  If the term software license is sold withoutessential implementation services, the revenue is recognized ratably over thenon-cancelable license term.  If the termlicense is sold with essential implementation services, the license revenue isrecognized as the lesser of the amount of license revenue recognized asservices are performed or on a ratable basis.

Incertain instances, especially with recently developed software, the Companydefers software license revenue recognition until the earlier of the product beingdetermined to be generally available and subject to revenue recognition or whenthe services are completed and the project is accepted by the customer.  This practice is followed for the first twoinstallations of a recently developed software product.  After two successful implementations, theproduct is considered generally available (“GA”).

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

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

*SoftwareMaintenance.*  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 purchase software maintenance services, whichtypically are renewed annually.  TheCompany charges an annual maintenance fee,which is typically a percentage of the initial software license fee. The annualmaintenance fee generally is paid to the Company at the beginning of the maintenance period, and the Company recognizes these revenues ratably over the term ofthe related contract.  If the annualmaintenance fee is not paid at the beginning of the maintenance period, theCompany defers revenue recognition until the time that the maintenance fee ispaid by the customer.  The Companynormally continues to provide maintenance service while awaiting payment from customers.  When the payment is received, revenue isrecognized for the period that revenue was previously deferred.  This may result in volatility in softwaremaintenance revenue from period to period.

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

*OutsourcingServices.*  While outsourcing revenue has been minimal todate, we currently recognize revenue based on the number of itemsprocessed.  These services are billedcurrently on a monthly basis.

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

Royalties

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

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Allowance for Doubtful Accounts

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

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

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

Goodwill is assessed on an annual basis for impairmentat the reporting unit level by applying a fair value based test utilizing theresults of a third party appraisal.  Weperform an annual impairment assessment on November 1st of each year or when factors indicate that goodwillshould be evaluated for possible impairment. During the quarterly period ended January 31, 2006, we performed ourannual evaluation for goodwill impairment and determined that the carryingamount of goodwill was not impaired and have not noted any factors subsequentthat would indicate impairment.  Goodwillat July 31, 2006 totaled $20.8 million. Any deterioration in market conditions, increases in interest rates andchanges in our projections with respect to the Global Payments Technologiesreporting unit to which goodwill is allocated would result in additionalimpairment charges in the future.

Restructuringand Other Charges

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

Contingencies

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

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IncomeTaxes

We recognize deferred tax assets or liabilities forthe expected future tax consequences of temporary differences between the bookand tax basis of assets and liabilities. We review our deferred tax assets for recoverability and establish avaluation allowance based on historical taxable income, projected futuretaxable income and the expected timing of the reversals of existing temporarydifferences.  As a result of our recenthistory of inconsistent profitability, we have provided a full valuationallowance against our net deferred tax assets. In addition, we expect to provide a full valuation allowance of anyfuture tax benefits until we can sustain a level of profitability thatdemonstrates our ability to utilize these assets.

**Recently Issued AccountingStandards**

In June 2006, the Financial Accounting StandardsBoard (“FASB”) issued Interpretation No. 48, “*Accountingfor Uncertainty in Income Taxes”* – an interpretation of FAS 109, *“Accounting for Income Taxes”* (“FIN 48”) to create a singlemodel to address accounting for uncertainty in tax positions.  FIN 48 clarifies the accounting for incometaxes, by prescribing a minimum recognition threshold a tax position isrequired to meet before being recognized in the financial statements.  FIN 48 also provides guidance onderecognition, measurement, classification, interest and penalties, accountingin interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15,2006.  We will adopt FIN 48 as ofFebruary 1, 2007, as required.  Thecumulative effect of adopting FIN 48 will be recorded in retained earnings andother accounts as applicable.  We havenot determined the effect, if any, that the adoption of FIN 48 will have on ourfinancial position and results of operations.

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

**Interest Rate Risk**

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

Investments in bothfixed rate and floating rate interest earning instruments carry a degree ofinterest rate risk.  Fixed ratesecurities may have their fair market value adversely impacted due to a rise ininterest rates, while floating rate securities may produce less income thanexpected if interest rates fall.  Due inpart to these factors, our future investment income may fall short ofexpectations due to changes in interest rates, or we may suffer losses inprincipal if forced to sell securities which have seen a decline in marketvalue due to various factors including changes in interest rates.  At July 31, 2006, we held $5.9 million ofauction rate securities.  The interestrate for these notes will adjust to the current market interest rate at eachinterest reset date, which is typically on at least a monthly basis.

**Foreign Currency Risk**

We currently have sales and marketing operations inseveral international locations including Canada, United Kingdom, South Africaand Australia.  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.  Within Carretek LLC, our 51% owned subsidiarywhich offers financial institutions offshore-centric outsourcing of theirbusiness processes, the majority of the labor costs is denominated in IndianRupees while the revenues from this operation are denominated in U.S.Dollars.  As our operations increase,fluctuating labor costs may increase our foreign currency risk.

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

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

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**Item 4.  Controls andProcedures**

*Disclosure Controls and Procedures*

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

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

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

*Changes in Internal Control over Financial Reporting*

There have been nochanges in our internal control over financial reporting during the periodcovered by this report that have materially affected, or are reasonably likelyto materially affect, our internal control over financial reporting.

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####  

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

**ITEM 1.          LEGAL PROCEEDINGS**

The information with respect to certainlegal proceedings set forth under “Contingencies” in Note 8 of the Notes toCondensed Consolidated Unaudited Financial Statements, is hereby incorporatedby reference.  Reference is also made tothe information contained in Part II, Item 1. Legal Proceedings in our Form10-Q for the period ended April 30, 2006.

*Shareholder Derivative Suit.*

In May 2006, the District Court approved the finalsettlement of the pending shareholder derivative suit and the litigation wasterminated.

*Shareholder Class Action.*

There were no material developments in this caseduring the fiscal quarter ended July 31, 2006. On August 17, 2006, the District Court entered a Final Judgment andOrder of Dismissal with Prejudice, concluding the litigation.

**ITEM 1A.       RISK FACTORS**

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

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

On June 12, 2006, we announced that our Board ofDirectors had authorized that we explore various strategic alternativesdesigned to increase our scale and capabilities in the marketplace.  These strategic alternatives include, but arenot limited to, a merger with a strategic partner, a sale of the company andother possible transactions.  There canbe no assurance that any particular strategic alternative will be pursued orthat any transaction will occur, or on what terms.  If we choose to continue to execute ouroperating plan instead of pursuing a strategic alternative, our stock pricecould decline.  In addition, we may beunsuccessful in implementing an alternative that is chosen by our Board ofDirectors or we may implement an alternative that yields unexpectedresults.  The process of continuing toreview, and potentially executing, strategic alternatives is likely to becostly and time-consuming and may distract our management and otherwise disruptour operations, which could have a material adverse effect on our business,financial condition and results of operations.

**ITEM 2.          UNREGISTERED SALES OF EQUITY SECURITIESAND USE OF PROCEEDS**

None.

**ITEM 3.          DEFAULTS UPON SENIOR SECURITIES**

None.

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** **

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

At our Annual Meeting of Stockholdersheld on July 13, 2006, two proposals were adopted by our stockholders: (1) the electionof three directors as Class II directors for terms expiring at the AnnualMeeting of Stockholders in 2009 as described in our Proxy Statement for theAnnual Meeting (Messrs. J. Coley Clark, William C. Hammett, Jr. and Gregory B.Tomlinson were elected as directors), and (2) the ratification of theappointment of Ernst & Young LLP as independent registered publicaccountants of the Company for the fiscal year ending January 31, 2007.  The number of shares cast for and against aswell as the number of abstentions as to each of these matters (other than theelection of directors) are as follows:
| Election of Directors | ** ** | **Shares For** | ** ** | **Shares Withheld** | ** ** |
|---------------------------------|------------|---------------------|------------|--------------------------|------------|
| ** **                      | ** ** | ** **          | ** ** | ** **               | ** ** |
| J. Coley Clark                  |       | 22,812,502          |       | 493,365                  |       |
| William C.  Hammett, Jr.        |       | 22,813,568          |       | 492,299                  |       |
| Gregory B. Tomlinson            |       | 22,813,980          |       | 491,887                  |       |

 
| Proposal                     | ** ** | **Shares For** | ** ** | **Shares Against** | ** ** | **Abstentions** | ** ** |
|------------------------------|------------|---------------------|------------|-------------------------|------------|-----------------|------------|
| ** **                   | ** ** | ** **          | ** ** | ** **              | ** ** | ** **      | ** ** |
| Ratification of  accountants |       | 23,217,991          |       | 84,180                  |       | 3,696           |       |

**ITEM 5.          OTHER INFORMATION**

None.

**ITEM 6.          EXHIBITS**

| Number     | ** ** | **Exhibit Description**                                                                                                                                                                                                                              |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                                                                                                           |
| 10.1       |       | Board Representation Agreement dated June 26, 2006  between the Company, Riley Investment Management LLC, SACC Partners LP, and  Bryant R. Riley, (incorporated by reference to Exhibit 10.1 of the Company’s  Form 8-K filed on June 27, 2006) |
|       |       |                                                                                                                                                                                                                                                 |
| 10.2       |       | Employment Agreement dated May 19, 2006 between the  Company and John D. Carreker, III                                                                                                                                                               |
|       |       |                                                                                                                                                                                                                                                 |
| 10.3       |       | First Amendment to Employment Agreement dated August  10, 2006 between the Company and John D. Carreker, III                                                                                                                                         |
|       |       |                                                                                                                                                                                                                                                 |
| 31.1       |       | Certification Pursuant to Section 302(a) of the  Sarbanes-Oxley Act of 2002                                                                                                                                                                          |
|       |       |                                                                                                                                                                                                                                                 |
| 31.2       |       | Certification Pursuant to Section 302(a) of the  Sarbanes-Oxley Act of 2002                                                                                                                                                                          |
|       |       |                                                                                                                                                                                                                                                 |
| 32.1       |       | Certification Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                              |
|       |       |                                                                                                                                                                                                                                                 |
| 32.2       |       | Certification Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                              |

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**SIGNATURES**

Pursuant to the requirements of the Securities Act of1934, the Registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

CARREKERCORPORATION
| By:    |   | /s/ John D.  Carreker, Jr. |   | Date:  | September 8, 2006 |   |
|--------|--------|----------------------------|--------|--------|-------------------|--------|
|   |   | John D. Carreker, Jr.      |   |   |
|   |   | Chairman of the Board and  |   |   |
|   |   | Chief Executive Officer    |   |   |
|   |   |                       |   |   |
|   |   |                       |   |   |
| By:    |   | /s/ Lisa K.  Peterson      |   | Date:  | September 8, 2006 |   |
|   |   | Lisa K. Peterson           |   |   |
|   |   | Chief Financial Officer    |   |   |

 

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