**United States**

**Securities and Exchange Commission**

**Washington, D.C. 20549**

#  

**FORM 10-Q**

**x**                              QuarterlyReport Pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934 for the Period Ended April 30, 2006.

 

**o**                                 TransitionReport Pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934 for the Transition Period from                                   to                                   

 

Commission file number **0-24201**

 

**Carreker Corporation**

(Exact name of registrantas 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’s telephone number, including area code)

 

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

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter periods that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. Yes x   No o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act. (Check one)Large Accelerated Filer o         AcceleratedFiler x         Non-AcceleratedFiler o

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).Yes o   No x

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 — 25,425,703 shares as of May 31, 2006.

 

----

**CARREKERCORPORATION**

**Index**
|                   | ** ** | ** **                                                                                                                   | ** ** | **PAGE**   | ** ** |
|-------------------|------------|------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| **PART 1:**  | ** ** | **FINANCIAL  INFORMATION**                                                                                                   | ** ** | ** ** | ** ** |
| ** **        | ** ** | ** **                                                                                                                   | ** ** | ** ** | ** ** |
| **Item 1.**       |       | **Financial  Statements (unaudited)**                                                                                        | ** ** | ** ** | ** ** |
| ** **        |       | ** **                                                                                                                   | ** ** | ** ** | ** ** |
| ** **        |       | **Condensed  Consolidated Balance Sheets at April 30, 2006 and January 31, 2006**                                  | ** ** | ** ** | ** ** |
| ** **        |       | ** **                                                                                                                   | ** ** | ** ** | ** ** |
| ** **        |       | **Condensed  Consolidated Statements of Operations for the three months ended  April 30, 2006 and 2005**                | ** ** | ** ** | ** ** |
| ** **        |       | ** **                                                                                                                   | ** ** | ** ** | ** ** |
| ** **        |       | **Condensed  Consolidated Statements of Stockholders’ Equity for the three months ended  April 30, 2006 and 2005** | ** ** | ** ** | ** ** |
| ** **        |       | ** **                                                                                                                   | ** ** | ** ** | ** ** |
| ** **        |       | **Condensed  Consolidated Statements of Cash Flows for the three months ended  April 30, 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

----

**PART I: FINANCIALINFORMATION**

**Item1. Financial Statements**

**CARREKERCORPORATIONCondensed Consolidated Balance Sheets(Unaudited)(In thousands, except per share amounts)**

**ASSETS**
| ** **                                                                                                                                                | ** ** | **April 30,** | ** ** | **January 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                                                                                                                                | ** ** | **2006**           | ** ** | **2006**             | ** ** |
|                                                                                                                                                      |       |               |       |                 |       |
| Current assets                                                                                                                                            |       |               |       |                 |       |
| Cash and cash equivalents                                                                                                                                 |       | $                  | 34,822     |                 | $          | 29,684 |   |
| Marketable securities                                                                                                                                     |       | 5,900              |       | 4,700                |       |
| Accounts receivable, net of allowance of $571 and  $601 at April 30, 2006 and January 31, 2006, respectively                                    |       | 9,957              |       | 12,225               |       |
| Prepaid expenses and other current assets                                                                                                                 |       | 2,491              |       | 2,940                |       |
| Total current  assets                                                                                                                                     |       | 53,170             |       | 49,549               |       |
|                                                                                                                                                      |       |               |       |                 |       |
| Property and  equipment, net of accumulated depreciation of $23,643 and $23,050 at  April 30, 2006 and January 31, 2006, respectively           |       | 6,217              |       | 5,947                |       |
| Capitalized  software costs, net of accumulated amortization of $14,009 and $13,686 at  April 30, 2006 and January 31, 2006, respectively       |       | 2,965              |       | 2,761                |       |
| Acquired  developed technology, net of accumulated amortization of $21,548 and $20,393  at April 30, 2006 and January 31, 2006, respectively    |       | 4,152              |       | 5,307                |       |
| Goodwill, net of  accumulated amortization of $3,405 at April 30, 2006 and  January 31, 2006                                                    |       | 20,765             |       | 20,765               |       |
| Customer  relationships, net of accumulated amortization of $6,883 and $6,533 at  April 30, 2006 and January 31, 2006, respectively             |       | 1,517              |       | 1,867                |       |
| Deferred loan  costs, net of accumulated amortization of $1,639 and $1,571 at April 30,  2006 and January 31, 2006, respectively                |       | 68                 |       | 136                  |       |
| Other assets                                                                                                                                              |       | 795                |       | 793                  |       |
| Total assets                                                                                                                                              |       | $                  | 89,649     |                 | $          | 87,125 |   |
|                                                                                                                                                      |       |               |       |                 |       |
| Current liabilities                                                                                                                                       |       |               |       |                 |       |
| Accounts payable                                                                                                                                          |       | $                  | 1,103      |                 | $          | 1,168 |   |
| Accrued compensation and benefits                                                                                                                         |       | 5,302              |       | 6,153                |       |
| Other accrued expenses                                                                                                                                    |       | 3,635              |       | 4,608                |       |
| Income tax payable                                                                                                                                        |       | 110                |       | 220                  |       |
| Deferred revenue                                                                                                                                          |       | 23,218             |       | 19,151               |       |
| Accrued merger and restructuring costs                                                                                                                    |       | 247                |       | 334                  |       |
| Total current  liabilities                                                                                                                                |       | 33,615             |       | 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; 25,367 and 25,319 shares issued at April 30,  2006 and January 31, 2006, respectively |       | 254                |       | 254                  |       |
| Additional paid-in capital                                                                                                                                |       | 112,938            |       | 112,316              |       |
| Accumulated deficit                                                                                                                                       |       | (53,882            | )          | (53,848              | )          |
| Less treasury stock, at cost: 648 and 641 common  shares at April 30, 2006 and January 31, 2006, respectively                                   |       | (3,276             | )          | (3,231               | )          |
| Total  stockholders’ equity                                                                                                                          |       | 56,034             |       | 55,491               |       |
| Total liabilities and  stockholders’ equity                                                                                                          |       | $                  | 89,649     |                 | $          | 87,125 |   |

 

See accompanyingnotes.

3

----

**CARREKERCORPORATION**Condensed Consolidated Statements of Operations(Unaudited)(In thousands, except per share amounts)
| ** **                                                  | ** ** | **Three Months Ended  April 30,** | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                  | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
|                                                        |       |                                             |       |   |   |
| **Revenues:**                                               | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Consulting                                                  |       | $                                                | 8,558      |   | $ | 8,318 |   |
| Software license                                            |       | 2,557                                            |       | 3,359 |   |
| Software maintenance                                        |       | 10,752                                           |       | 11,312 |   |
| Software implementation and other services                  |       | 4,135                                            |       | 4,134 |   |
| Outsourcing service                                         |       | 510                                              |       | 257 |   |
| Out-of-pocket expense reimbursements                        |       | 733                                              |       | 818 |   |
| Total revenues                                              |       | 27,245                                           |       | 28,198 |   |
|                                                        |       |                                             |       |   |   |
| **Cost of revenues:**                                       | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Consulting                                                  |       | 4,872                                            |       | 4,241 |   |
| Software license                                            |       | 1,840                                            |       | 1,536 |   |
| Software maintenance                                        |       | 3,172                                            |       | 3,975 |   |
| Software implementation and other services                  |       | 3,076                                            |       | 2,973 |   |
| Outsourcing service                                         |       | 476                                              |       | 579 |   |
| Out-of-pocket expenses                                      |       | 774                                              |       | 790 |   |
| Total cost of revenues                                      |       | 14,210                                           |       | 14,094 |   |
| Gross profit                                                |       | 13,035                                           |       | 14,104 |   |
|                                                        |       |                                             |       |   |   |
| **Operating costs and expenses:**                           | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Selling, general and administrative                         |       | 10,780                                           |       | 10,904 |   |
| Research and development                                    |       | 2,205                                            |       | 2,521 |   |
| Amortization of customer relationships                      |       | 350                                              |       | 350 |   |
| Restructuring and other charges                             |       | —                                           |       | 95 |   |
| Total operating costs and expenses                          |       | 13,335                                           |       | 13,870 |   |
| Income (loss)  from operations                              |       | (300                                             | )          | 234 |   |
|                                                        |       |                                             |       |   |   |
| **Other income (expense):**                                 | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Interest income                                             |       | 271                                              |       | 144 |   |
| Interest expense                                            |       | (105                                             | )          | (105 | ) |
| Other income                                                |       | 200                                              |       | 306 |   |
| Total other income, net                                     |       | 366                                              |       | 345 |   |
| Income before  provision for income taxes                   |       | 66                                               |       | 579 |   |
| Provision for  income taxes                                 |       | 100                                              |       | 81 |   |
| Net income  (loss)                                          |       | $                                                | (34        | ) | $ | 498 |   |
| Basic earnings  (loss) per share                            |       | $                                                | 0.00       |   | $ | 0.02 |   |
| Diluted earnings  (loss) per share                          |       | $                                                | 0.00       |   | $ | 0.02 |   |
| Shares used in  computing basic earnings (loss) per share   |       | 23,916                                           |       | 24,425 |   |
| Shares used in  computing diluted earnings (loss) per share |       | 23,916                                           |       | 24,867 |   |

 

See accompanying notes.

4

----

**CARREKERCORPORATIONCONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY(Unaudited)(In thousands, except per share amounts)**
| ** **                                                    | ** ** | **Common Stock**    | ** ** | **Additional**         | ** ** | ** ** | ** ** | **Treasury Stock** | ** ** | **Total**                | ** ** |
|---------------------------------------------------------------|------------|--------------------------|------------|------------------------|------------|------------|------------|-------------------------|------------|--------------------------|------------|
| ** **                                                    | ** ** | **Unrestricted  Shares** | ** ** | **Restricted  Shares** | ** ** | **Amount** | ** ** | **Paid-In  Capital**    | ** ** | **Accumulated  Deficit** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Stockholders’  Equity** | ** ** |
|                                                          |       |                     |       |                   |       |       |       |                    |       |                     |       |   |   |   |   |   |   |
| Balance at January 31, 2006                              |       | 24,587                   |       | 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                     | )          | —     |       | —                  |       | —                   |       | 7 |   | (45 | ) | (45 | ) |
| Conversion of  restricted common stock to unrestricted        |       | 15                       |       | (15                    | )          | —     |       | —                  |       | —                   |       | — |   | — |   | — |   |
| Net loss                                                      |       | —                   |       | —                 |       | —     |       | —                  |       | (34                      | )          | — |   | — |   | (34 | ) |
| Balance at April 30, 2006                           |       | 24,602                   |       | 749                    |       | $          | 254        |                    | $          | 112,938                  |       | $ | (53,882 | ) | 648 |   | $ | (3,276 | ) | $ | 56,034 |   |

 

See accompanying notes.

5

----

**CARREKERCORPORATIONCondensed Consolidated Statements of Cash Flows(Unaudited)(In thousands)**
| ** **                                                                         | ** ** | **Three Months Ended  April 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| **Operating Activities:**                                                          | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Net income (loss)                                                                  |       | $                                                | (34        | ) | $ | 498 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                             |       |   |   |
| Depreciation and amortization of property and  equipment                           |       | 779                                              |       | 793 |   |
| Amortization of capitalized software costs                                         |       | 322                                              |       | 266 |   |
| Amortization of acquired developed technology                                      |       | 1,155                                            |       | 1,155 |   |
| Amortization of customer relationships                                             |       | 350                                              |       | 350 |   |
| Amortization of deferred loan costs                                                |       | 68                                               |       | 68 |   |
| Stock based compensation                                                           |       | 622                                              |       | 128 |   |
| Minority share of loss in Carretek LLC                                             |       | (133                                             | )          | (318 | ) |
| Non-cash charge for merger costs                                                   |       | —                                           |       | (32 | ) |
| Allowance for doubtful accounts                                                    |       | (48                                              | )          | 7 |   |
| Changes in  operating assets and liabilities:                                      |       |                                             |       |   |   |
| Accounts receivable                                                                |       | 2,316                                            |       | 401 |   |
| Prepaid expenses and other assets                                                  |       | 447                                              |       | (324 | ) |
| Accounts payable and accrued expenses                                              |       | (1,888                                           | )          | (2,692 | ) |
| Income taxes payable/receivable                                                    |       | (110                                             | )          | 10 |   |
| Deferred revenue                                                                   |       | 4,067                                            |       | 1,800 |   |
| Net cash  provided by operating activities                                         |       | 7,913                                            |       | 2,110 |   |
|                                                                               |       |                                             |       |   |   |
| **Investing Activities:**                                                          | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Purchases of property and equipment                                                |       | (1,049                                           | )          | (698 | ) |
| Purchases of marketable securities                                                 |       | (3,500                                           | )          | — |   |
| Sales of marketable securities                                                     |       | 2,300                                            |       | — |   |
| Computer software costs capitalized                                                |       | (526                                             | )          | (437 | ) |
| Net cash used in  investing activities                                             |       | (2,775                                           | )          | (1,135 | ) |
|                                                                               |       |                                             |       |   |   |
| **Financing Activities:**                                                          | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Proceeds from exercises of stock options                                           |       | —                                           |       | 52 |   |
| Purchase of treasury stock                                                         |       | —                                           |       | (349 | ) |
| Proceeds from minority shareholder equity  contributions to Carretek LLC           |       | —                                           |       | 551 |   |
| Net cash  provided by financing activities                                         |       | —                                           |       | 254 |   |
| Net increase in  cash and cash equivalents                                         |       | 5,138                                            |       | 1,229 |   |
| Cash and cash  equivalents at beginning of period                                  |       | 29,684                                           |       | 34,516 |   |
| Cash and cash  equivalents at end of period                                        |       | $                                                | 34,822     |   | $ | 35,745 |   |
|                                                                               |       |                                             |       |   |   |
| Supplemental  disclosures of cash flow information:                                |       |                                             |       |   |   |
| Cash paid for interest                                                             |       | $                                                | 38         |   | $ | 38 |   |
| Cash paid for  income taxes, net                                                   |       | $                                                | 198        |   | $ | 76 |   |

 

See accompanying notes.

6

----

**Carreker CorporationNotes to Condensed Consolidated Unaudited Financial StatementsFor the Three Months Ended April 30, 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. Morerecently, we have introduced a business process outsourcing solution to ourcustomers. Our products and services address a broad spectrum of paymentactivities and are designed to help our clients enhance the performance oftheir payments businesses; improve operational efficiency in paymentsprocessing; enhance revenue and profitability from payments-oriented productsand services; reduce losses associated with fraudulent payment transactions;facilitate compliance with risk-related laws and regulations; and/or maximizeclients’ customer income streams by aligning their customer interactions andproducts with customer needs. See Note 9 for a description of our businesssegments.

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

**Principles of Consolidation**

The condensed consolidated unaudited financialstatements include the accounts of the Company and its wholly owned subsidiaries.All significant intercompany balances and transactions have been eliminated inconsolidation.

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

The accompanying condensed consolidated unaudited financialstatements and notes have been prepared in accordance with the rules andregulations of the Securities and Exchange Commission for Form 10-Qand include all of the information and disclosures required by generallyaccepted accounting principles for interim financial reporting. Theaccompanying financial statements reflect all adjustments (consisting of normalrecurring entries) which in the opinion of management are necessary for a fairpresentation of the results for the interim periods presented. The results ofoperations for the three months ended April 30, 2006 are not necessarilyindicative 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 Companymakes significant estimates and assumptions in the areas of accountsreceivable, impairment of intangibles and revenue 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 Company considers all highly liquid investmentswith maturities of three months or less when purchased to be cash equivalents. Cashand cash equivalents consist primarily of demand deposit accounts and demandmoney market accounts with nationally recognized financial institutions, alongwith domestic commercial paper.

7

----

 

**Marketable Securities**

We classify our investments in marketable securitiesas “available-for-sale” in accordance with the provisions of Statement ofFinancial Accounting Standards No. 115, *“Accountingfor Certain Investments in Debt and Equity Securities”* (“SFAS 115”).We currently have no investments that we intend to hold for more than one yearand therefore all investments are classified 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-maturity securities are recorded at amortizedcost. Unrealized losses considered to be “other-than-temporary” are recognizedcurrently in earnings. The cost of securities sold is based on the specificidentification method. The fair value of most investment securities isdetermined by currently available market prices. Where quoted market prices arenot available, we use the market price of similar types of securities that aretraded in the market to estimate fair value.

Marketable securities at April 30, 2006 consistof insured municipal bonds and guaranteed student loan backed debt securitieswith a cost of $5.9 million which approximates fair value.

All original maturities of debt securities classifiedas available for sale at April 30, 2006 were due after 10 years. All thedebt securities are auction rate securities and the interest rates for theseinvestments will adjust to current market rates at each interest reset date,which is typically on at least a monthly basis.

**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 remeasurementadjustments are recorded in the 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. The Company places temporary cash investmentswith major banks and limits its exposure with any one financial institution,commercial issuer, municipal issuer or government agency issuer. The Companyhas 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’s accounts receivable are typicallyunsecured, the Company periodically evaluates the collectibility of itsaccounts based on a combination of factors, including a particular customer’sability to pay as well as the age of receivables. In cases where the evidencesuggests a customer may not be able to satisfy its obligation to the Company orif the collection of the receivable becomes doubtful due to a dispute thatarises subsequent to the delivery of the Company’s products and services, theCompany sets up a reserve in an amount determined appropriate for the perceivedrisk. Most of the Company’s contracts include multiple payment milestones, someof which occur in advance of revenue recognition, which mitigates the risk bothin terms of collectibility and adjustments to recorded revenue. During thethree months ended April 30, 2006, recoveries of receivables were $18,000and during the three months ended April 30, 2005 write-offs of receivableswere $32,000.

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

8

----

**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 theCosts of Computer Software Developed or Obtained for Internal Use”.*TheCompany capitalizes software costs incurred after the preliminary project stageis complete, the Company has committed to the project and it is probable thatthe software will be used to perform the function intended. Capitalizedsoftware costs are amortized on an individual basis using the estimatedeconomic life of the product on a straight-line basis, generally three to fiveyears. These capitalized software costs are included in “Equipment and Software”.Costs incurred during preliminary project and post-implementation stages arecharged to expense.

The components ofproperty and equipment are as follows (in thousands):

|                                                 | ** ** | **April 30,** | ** ** | **January 31,** | ** ** |
|-------------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                      | ** ** | **2006**           | ** ** | **2006**             | ** ** |
|                                            |       |               |       |                 |       |
| Furniture                                       |       | $                  | 5,043      |                 | $          | 5,070 |   |
| Equipment and  software                         |       | 23,549             |       | 22,643               |       |
| Leasehold  improvements                         |       | 1,268              |       | 1,284                |       |
| Total cost                                      |       | 29,860             |       | 28,997               |       |
|                                            |       |               |       |                 |       |
| Less accumulated  depreciation and amortization |       | (23,643            | )          | (23,050              | )          |
| Net property and  equipment                     |       | $                  | 6,217      |                 | $          | 5,947 |   |

** **

**Long Lived Assets**

The Company accounts for goodwill and other intangibleassets in accordance with Statement of Financial Accounting Standards No. 142,*“Goodwill and Other Intangible Assets”*(“SFAS 142”). Under the provisions of SFAS 142, an annual assessment ofgoodwill 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 assessment of goodwill impairment in the futurewill be impacted if future operating cash flows of the Company’s reportingunits decline significantly, which could result in decreases in the relatedestimate of fair market value. The Company performs its annual impairmentanalysis as of November 1st ofeach year and whenever 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 purchasedintangibles subject to amortization are tested for recoverability wheneverevents or changes in circumstances indicate that the carrying amount of anasset may not be recoverable. Recoverability of assets to be held and used ismeasured by a comparison of the carrying amount of an asset to estimatedundiscounted future cash flows expected to be generated by the asset. If thecarrying amount of an asset exceeds its estimated future cash flows, animpairment charge is recognized by the amount by which the carrying amount ofthe asset exceeds the estimated fair value of the asset.

**Deferred Loan Costs**

Deferred loan costs consist of loan closing costsassociated with the Revolving Credit Agreement. These costs are being amortizedto interest expense over the 36 month life of the Revolving Credit Agreementand are to be fully amortized by July 31, 2006.

9

----

**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 capitalize software development costsincurred in developing a product once technological feasibility of the producthas been established. Technological feasibility of the product is determinedafter completion of a detailed program design and a determination has been madethat any uncertainties related to high-risk development issues have beenresolved. If the process of developing the product does not include a detailprogram design, technological feasibility is determined only after completionof a working model. All capitalized software development costs are amortizedusing an amount determined as the greater of: (1) the ratio that currentgross revenues for a capitalized software project bears to the total of currentand estimated future gross revenues for that project or (2) thestraight-line method over the estimated remaining economic life of the product(generally three to five years). The Company capitalized $526,000 and $437,000in the three months ended April 30, 2006 and 2005, respectively. Thesoftware development efforts in both periods were related to several new Cashand Risk solutions within the Global Payments Technologies business segment.

The Company recorded amortization relating to softwaredevelopment costs capitalized of $322,000 and $266,000 in the three monthsended April 30, 2006 and 2005, respectively. Amortization expense isrecorded 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 purchasedtechnology intangibles are initially recorded based on the fair value ascribedat the time of acquisition.

Acquired developed technology with a useful life of 3-6years is amortized on a straight-line basis, resulting in amortization expenseof $1.2 million for the three months ended April 30, 2006 and 2005. Amortizationexpense is recorded as a component of cost of software license fees in theaccompanying consolidated statements of operations.

The following table setsforth the estimated amortization expense of capitalized software costs andacquired developed technology for the indicated fiscal years ending January 31(in thousands):

| Year               | ** ** | **Capitalized  Software  Costs** | ** ** | **Acquired  Developed  Technology** | ** ** |
|--------------------|------------|----------------------------------|------------|-------------------------------------|------------|
|               |       |                             |       |                                |       |
| Remainder of  2007 |       | $                                | 902        |                                | $          | 2,952 |   |
| 2008               |       | 830                              |       | 1,200                               |       |
| 2009               |       | 331                              |       | —                              |       |
|               |       |                             |       |                                |       |
|                    |            |                                  |            |                                     |            |  |  |

 

The table does not include the estimated amortizationexpense for $902,000 of capitalized software products that are currently beingdeveloped, and for which amortization 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 the quarterly period ended January 31, 2006,the Company performed its annual formal evaluation for impairment anddetermined that the carrying amount of these assets was not impaired and hassubsequently noted no factors in the three months ended April 30, 2006that would indicate impairment.

10

----

**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, “*Modification of SOP 97-2,**SoftwareRevenue Recognition with Respect to Certain Transactions,”* StaffAccounting Bulletin (“SAB”) No. 104,*“Revenue Recognition,”* and Emerging Issues Task Force (“EITF”) No. 00-21,*“Revenue Arrangements with Multiple Deliverables.”* In the case of software arrangements thatrequire significant production, modification, or customization of software, orthe license agreement requires the Company to provide implementation servicesthat are determined to be essential to other elements of the arrangement, theCompany follows the guidance in SOP 81-1, *“Accountingfor Performance of Construction—Type and Certain Production—Type Contracts.”*

In the case of non-software arrangements, we applyEITF No. 00-21 and revenues related to arrangements with multipleelements are allocated to each element based on the element’s relative fairvalue. Revenue allocated to separate elements is recognized for each element inaccordance with our accounting policies described 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 orpursuant to an agreed upon payment schedule, and the Company recognizes revenues on a proportionate performancebasis. The Company believes that thismethod is appropriate because of its ability to determine performancemilestones and determine dependable estimates of its costs applicable to eachphase of a contract. Because financial reporting of these contracts depends onestimates, which are assessed continually during the term of the contract,costs are subject to revisions as the contract progresses. Anticipated losseson fixed-price contracts are 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) theactual increased revenues and/or decreased costs experienced by the customergenerally over a period of up to twelve months following implementation of itssolution, subject in either case to a maximum, if any is agreed to, on thetotal amount of payments to be made to the Company. The Company must firstcommit time and resources to develop projections associated with value-pricingcontracts before a customer will commit to purchase its solutions, and theCompany therefore assumes the risk of making these commitments with noassurance that the customer will purchase the solution. Costs associated withthese value-pricing contracts are expensed as incurred. These contractstypically include payments to be made to the Company pursuant to an agreed uponschedule ranging from one to twelve months in length. The Company recognizes revenues generated from consultingservices in connection with value-priced contracts once customeracknowledgement is obtained that confirms fees have become fixed anddeterminable. In some cases, these acknowledgements contain future deliverablesor services, in which case the revenue from these engagements is recognized ona proportionate performance basis based on efforts to be incurred following thecustomer acknowledgement. In an effort to allow customers to more closely matchexpected benefits from services with payments to the Company, the Company on occasion, may offer payment terms which extend beyond 12months. When the Company enters into an agreement which has a significantcomponent of the total amount payable under the agreement due beyond 12 monthsor if it is determined payments are not fixed and determinable at the date theagreement was entered into, revenue under the arrangement will be recognized aspayments become due and payable. When fees are to be paid based on a percentageof 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.

*SoftwareLicense.*A perpetualsoftware license is sold either together with implementation services or on astand-alone basis. The Company isusually paid software license fees in one or more installments, as provided inthe customer’s contract 

11

----

but not to exceed twelve months. TheCompany recognizes software license revenue upon execution of a contract anddelivery of the software, provided that the license fee is fixed anddeterminable, no significant production, modification or customization of thesoftware is required and collection is considered 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 is sold either together with implementationservices and/or with maintenance services. These term licenses are usually paidin annual installments over the term of the license. If the term softwarelicense is sold without essential implementation services, the revenue isrecognized ratably over the non-cancelable license term. If the term license issold with essential implementation services, the license revenue is recognizedas the lesser of the amount of license revenue recognized as services areperformed 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 thefirst two installations of a recently developed 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. The Company determines whether there is vendorspecific objective evidence of fair value (“VSOEFV”) for each elementidentified in the arrangement to determine whether the total arrangement feescan be allocated to each element. If VSOEFV exists for each element, the totalarrangement fee is allocated based on the relative fair value of each element. Incases where there is not VSOEFV for each element, or if it is determinedservices are essential to the functionality of the software being delivered, orif significant production, modification or customization of the software isrequired, the Company initially defers revenue recognition of the softwarelicense fees until VSOEFV is established or the services are performed. However,if VSOEFV is determinable for all of the undelivered elements, and assuming theundelivered elements are not essential to the delivered elements, the Companywill defer recognition of the full fair value related to the undeliveredelements and recognize the remaining portion of the arrangement value throughapplication 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. Evidenceof VSOEFV is determined for software products based on actual sales prices forthe product sold to a similar class of customer and based on pricing strategiesset forth in the Company’s price book. 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 VSOEFV for maintenance agreements using thepercentage method such that VSOEFV for maintenance is a percentage of thelicense fee charged annually for a specific software product, which in mostinstances is 20% of the portion of arrangement fees allocated to the softwarelicense 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. Thelevel of license fees earned by the Company under these arrangements will varybased on the actual amount of use by the customer. Revenue under thesearrangements is recognized on a monthly basis as the usage becomesdeterminable.

*SoftwareMaintenance.*In connectionwith the sale of a software license, a customer may elect to purchase softwaremaintenance services. Most of the customers that purchase software licensesfrom the Company also purchasesoftware maintenance services, which typically 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 annual maintenance fee is not paid at thebeginning of the maintenance period, the Company defers revenue recognitionuntil the time that the maintenance fee is paid by the customer. The Companynormally continues to provide maintenance service while awaiting payment fromcustomers. When the payment is received, revenue is recognized for the periodthat 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 a software license, a customer may electto purchase software implementation services, including software enhancementsand other software services. Most of the customers that purchase software licensesfrom the Company also purchasesoftware implementation services. The Company prices its implementation services on a time-and-materialsor on a fixed-price basis, and the Company recognizes the related revenues as services are performed. Costs associatedwith these engagements are expensed as incurred.

*OutsourcingServices.*We currentlyrecognize revenue based on the number of items processed. These services arebilled currently on a monthly basis.

12

----

*ReturnProvisions.*The Company’s contractstypically do not include right of return clauses, and as a result, the Companydoes 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 expensewhen the associated revenue is recognized. For current product offerings, theroyalty percentages generally range from 20% to 50% of the associated revenues.Approximately $439,000 and $214,000 of royalty expense was recorded under theseagreements in the three months ended April 30, 2006 and 2005, respectively.Royalty expense is primarily included as a component of the cost of softwarelicense revenues; however, certain amounts are also included in cost ofconsulting revenues and cost of software maintenance revenues in the accompanyingconsolidated 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):

|                                                    | ** ** | **April 30,** | ** ** | **January 31,** | ** ** |
|----------------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                         | ** ** | **2006**           | ** ** | **2006**             | ** ** |
|                                               |       |               |       |                 |       |
| Deferred  software maintenance fees                |       | $                  | 31,378     |                 | $          | 39,343 |   |
| Deferred  software implementation and license fees |       | 14,511             |       | 15,769               |       |
|                                               |       | 45,889             |       | 55,112               |       |
| Less amounts not  yet collected                    |       | (22,671            | )          | (35,961              | )          |
| Net deferred  revenue                              |       | $                  | 23,218     |                 | $          | 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 ComputerSoftware to be Sold, Leased, or Otherwise Marketed”* (“SFAS 86”), areexpensed as incurred and relate mainly to the development of new products, newapplications, new features or enhancements for existing products orapplications. Sustaining maintenance activities are expensed as incurred andcharged to cost of revenues — software maintenance fees.

**Other income (expense)**

Otherincome (expense) is comprised of the following (in thousands):

 

|                                            | ** ** | **Three Months Ended  April 30,** | ** ** |
|--------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                 | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
|                                       |       |                                             |       |   |   |
| Minority share of net loss of Carretek LLC |       | $                                                | 133        |   | $ | 318 |   |
| Foreign exchange (losses) / gains          |       | 70                                               |       | (17 | ) |
| Other                                      |       | (3                                               | )          | 5 |   |
| Total                                      |       | $                                                | 200        |   | $ | 306 |   |

 

The Company owns a 51% interest in Carretek LLC (“Carretek”),which offers financial institutions offshore-centric outsourcing of theirbusiness processes. The minority interest in this loss was recorded in otherincome (expense) and was $133,000 and $318,000 for the three months ended April 30,2006 and 2005, respectively.

13

----

**Income Taxes**

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 ofdeferred tax assets is adjusted by a valuation allowance, if necessary, torecognize the extent to which, based on available evidence, it is more likelythan not that the future tax benefits will not be realized.

**Earnings Per Share**

Basic earnings per share is computed, in accordancewith the provisions of SFAS No. 128, *“Earnings per Share,”*(“SFAS 128”) using the weighted average number of shares of common stockoutstanding during each period. Diluted earnings per share is computed usingthe weighted average number of shares of common stock outstanding during eachperiod and common equivalent shares consisting of stock options and unvestedrestricted stock (using the treasury stock method), if such stock options andunvested restricted stock have 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 on Form 10-Kfor the year ended January 31, 2006.

On February 1,2006, the Company adopted, on a modified prospective basis, SFAS 123(R), “ShareBased Payment” (“SFAS 123(R)”). SFAS 123(R) requires all share-basedpayments to employees, including grants of employee stock options and sharespurchased under an employee stock purchase plan (if certain parameters are notmet), to be 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 newstock option grants after our adoption date. The compensation cost to berecorded is based on the fair value at the grant date. The adoption of SFAS 123(R) didnot have an effect on our recognition of compensation expense relating to thevesting 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 theStatement of Cash Flows of the Income Tax Benefit Received by a Company uponExercise of a Nonqualified Employee Stock Option” (“EITF 00-15”). SFAS123(R) superseded EITF 00-15, amended SFAS 95, “Statement of CashFlows,” and requires tax benefits relating to excess equity-based compensationdeductions to be prospectively presented in the statement of cash flows asfinancing cash inflows.

Prior to the adoption of SFAS 123(R), weaccounted for equity-based compensation under the provisions and relatedinterpretations of Accounting Principles Board (“APB”) Opinion No. 25, “Accountingfor Stock Issued to Employees” (“APB 25”). Accordingly, we were not required torecord compensation expense when stock options were granted to our employees aslong as the exercise price was not less than the fair market value of the stockat the grant date.

The following table presents the impactof SFAS 123(R) on selected line items for our condensed consolidatedfinancial statements for the three months ended April 30, 2006 (inthousands, except per share amounts):

|                                           | ** ** | **Three Months Ended  April 30, 2006** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                | ** ** | **As reported  following  SFAS 123(R)**          | ** ** | **If reported  following  APB No. 25** | ** ** |
| Income (loss)  from operations            |       | $                                                          | (300       | ) | $ | 82 |   |
| Income before  provision for income taxes |       | 66                                                         |       | 448 |   |
| Net income  (loss)                        |       | (34                                                        | )          | 348 |   |
| Net income per share:                     |       |                                                       |       |   |   |
| Basic                                     |       | 0.00                                                       |       | 0.01 |   |
| Diluted                                   |       | 0.00                                                       |       | 0.01 |   |
| Cash flow from  operating activities      |       | 7,913                                                      |       | 7,913 |   |
| Cash flow from  financing activities      |       | $                                                          | —     |   | $ | — |   |

 

14

----

DeterminingFair Value Under SFAS No. 123(R)

*Valuation and Amortization Method.*TheCompany estimates the fair value of share-based awards granted using theBlack-Scholes option evaluation model. The Company amortizes the fair value ofall awards on a straight-line basis over the requisite service periods, whichare generally the vesting periods.

*Expected Life.*The expectedlife of awards granted represents the period of time that they are expected tobe outstanding. The Company determines the expected life using the “simplifiedmethod” in accordance with Staff Accounting Bulletin No. 107.

*Expected Volatility.*Using theBlack-Scholes option valuation model, the Company estimates the volatility ofits common stock at the date of grant based on the historical volatility of ourcommon stock.

*Risk-Free Interest Rate.*The Companybases the risk-free interest rate used in the Black-Scholes option valuationmodel on the implied yield currently available on U.S. Treasury zero-couponissues with an equivalent remaining term equal to the expected life of theaward.

*Expected Dividend Yield.*The Companyhas not paid any cash dividends on its common stock in the last ten years anddoes not anticipate paying any cash dividends in the foreseeable future. Consequently,the Company uses an expected dividend yield of zero in the Black-Scholes optionvaluation model.

*Expected Forfeitures.*The Companyuses historical data to estimate pre-vesting option forfeitures and recordedstock-based compensation only for those awards that are expected to vest.

The fair value of each option grant isestimated on the date of grant using the Black-Scholes option pricing model. Asummary of the weighted average assumptions and results for options grantedduring the three months ended April 30, 2006 are as follows:

|                                                 | ** ** | **Three Months Ended  April 30,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                      | ** ** | **2006**                                         | ** ** |
| Volatility                                      |       | .741                                             |       |
| Weighted-average  expected lives                |       | 4.21 years                                       |       |
| Expected  dividend yields                       |       | —                                           |       |
| Weighted-average  risk-free interest rates      |       | 4.90                                             | %          |
| Weighted-average  fair value of options granted |       | $                                                | 3.62       |   |
|                                                 |            |                                                  |            |  |

 

Share-Based CompensationUnder SFAS No. 123(R)

The following table summarizesshare-based compensation expense related to share-based awards under SFAS No. 123(R) forthe three months ended April 30, 2006 which is recorded in the statementof operations as follows (in thousands):

|                                              | ** ** | **Three Months Ended  April 30, 2006** | ** ** |
|----------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                   | ** ** | **Unvested  Stock Options**                           | ** ** | **Unvested Restricted  Common Stock** | ** ** | **Total** | ** ** |
| Cost of revenues                             |       | $                                                          | 70         |   | $ | 86 |   | $ | 156 |   |
| Selling, general  and administrative expense |       | 303                                                        |       | 141 |   | 444 |   |
| Research and  development expense            |       | 9                                                          |       | 13 |   | 22 |   |
| Total share-based  compensation              |       | $                                                          | 382        |   | $ | 240 |   | $ | 622 |   |

 

At April 30, 2006, the Company hadunvested options to purchase 666,825 shares with a weighted average grant datefair value of $3.75. Additionally, the Company had 748,820 shares of unvestedrestricted common stock with a weighted average fair value on the date theaward was granted of $6.11.

15

----

The unrecognized compensation costs areexpected to be amortized over the following indicated fiscal years ending January 31(in thousands):

|                    | ** ** | **Unvested Stock  Options** | ** ** | **Unvested Restricted  Common Stock** | ** ** | **Total** | ** ** |
|--------------------|------------|----------------------------------|------------|-------------------------------------------------|------------|-----------|------------|
| Remainder of  2007 |       | $                                | 657        |                                            | $          | 741       |       | $ | 1,398 |   |
| 2008               |       | 498                              |       | 988                                             |       | 1,486     |       |
| 2009               |       | 244                              |       | 898                                             |       | 1,142     |       |
| 2010               |       | 22                               |       | 617                                             |       | 639       |       |
| 2011               |       | —                           |       | 232                                             |       | 232       |       |
| 2012               |       | —                           |       | 9                                               |       | 9         |       |
| Total              |       | $                                | 1,421      |                                            | $          | 3,485     |       | $ | 4,906 |   |

 

Stock Option Activity

In the quarter ended January 31, 2006, theCompany accelerated the vesting of all unvested stock options, except thoseoptions granted to the CEO, with a grant price in excess of $7.50. Thisacceleration was accomplished to reduce the stock option expense in futureyears. This acceleration will result in approximately $1.9 million of expensesavings in future years.

On March 10, 2006, the Compensation Committee ofthe Board of Directors of the Company (the “Committee”) voted to provide forthe automatic accelerated vesting of all outstanding stock options andrestricted stock of the Company upon the occurrence of certain specifiedtriggering events deemed to constitute a change in control of the Company. Thisprovision will require the Company to accelerate unrecognized stock-basedcompensation expense if a change in control event occurs prior to the originalvesting schedule of the stock options or restricted stock.

Stock option transactions during the three monthsended April 30, 2006 were as follows (dollars and share data inthousands):
| ** **                                                           | ** ** | **April 30, 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                                                              |       | 62                           |       | 6.13 |   | — |   | — |   |
| Exercised                                                            |       | —                       |       | — |   | — |   | — |   |
| Forfeited                                                            |       | (10                          | )          | 7.44 |   | — |   | — |   |
| Stock options  outstanding at the end of the period                  |       | 3,833                        |       | $ | 8.41 |   | 4.50 |   | $ | 1,948 |   |
|                                                                 |       |                         |       |   |   |   |   |   |   |
| Stock options  vested and exercisable at the end of the period  |       | 3,166                        |       | $ | 9.04 |   | 4.50 |   | $ | 1,291 |   |

 

Other information pertaining to option activity duringthe three months ended April 30, 2006 was as follows (dollars inthousands, except per share data):

| Weighted average grant-date  fair value of options granted |   | $ | 3.62   |   |
|------------------------------------------------------------|--------|---|--------|--------|
| Total fair value  of stock options vested                  |   | $ | 637    |   |
| Total intrinsic value  of stock options exercised          |   | $ | — |   |

 

16

----

Information related to options outstanding at April 30,2006 is summarized below (option amounts in thousands):
| **Range of Exercise Price** | ** ** | **Options  Outstanding at  April 30, 2006** | ** ** | **Weighted Average  Remaining   Contractual Life** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Options  Vested and  Exercisable at  April 30, 2006** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|--------------------------------------------|------------|------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| $2.97 to $4.97                             |       | 1,085                                                      |       | 4.54                                                              |       | $                                          | 4.62       |                                                                        | 773        |                                       | $          | 4.72 |   |
| $5.06 to $8.90                             |       | 1,225                                                      |       | 4.92                                                              |       | 7.28                                       |       | 888                                                                         |       | 7.72                                       |       |
| $9.19 to $11.00                            |       | 943                                                        |       | 3.60                                                              |       | 9.97                                       |       | 925                                                                         |       | 9.97                                       |       |
| $11.05 to $25.44                           |       | 580                                                        |       | 5.04                                                              |       | 15.33                                      |       | 580                                                                         |       | 15.33                                      |       |
|                                       |       | 3,833                                                      |       | 4.50                                                              |       | $                                          | 8.41       |                                                                        | 3,166      |                                       | $          | 9.04 |   |

 

As of April 30, 2006, the Company has reservedfor issuance under the Plans 5,412,756 shares of common stock, of which3,832,587 shares are subject to currently outstanding options to employees anddirectors, and 1,580,169 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 $240,000and $128,000 of compensation expense related to the restricted common stockduring the three months ended April 30, 2006 and 2005, respectively. Restrictedcommon stock transactions during the three months ended April 30, 2006were as follows (number of shares in thousands):

|                                                                  | ** ** | **April 30, 2006** | ** ** |
|------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                       | ** ** | **Number  of Shares**   | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
| Restricted common stock unvested at the beginning of the  period |       | 732                          |       | $ | 6.14 |   |
| Granted                                                          |       | 46                           |       | 6.15 |   |
| Vested  and released                                             |       | (22                          | )          | 7.22 |   |
| Forfeited                                                        |       | (7                           | )          | 6.43 |   |
| Restricted common stock  unvested at the end of the period       |       | 749                          |       | $ | 6.11 |   |

 

17

----

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** | ** ** |
|----------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                 | ** ** | **April 30, 2005**     | ** ** |
| Net income, as  reported                                                   |       | $                                | 498        |   |
| Stock  compensation expense recorded under the intrinsic value method      |       | 128                              |       |
| Pro forma stock  compensation expense computed under the fair value method |       | (767                             | )          |
| Pro forma net  loss                                                        |       | $                                | (141       | ) |
|                                                                       |       |                             |       |
| Basic earnings  per common share, as reported                              |       | $                                | 0.02       |   |
| Diluted earnings  per common share, as reported                            |       | $                                | 0.02       |   |
| Pro forma basic  loss per common share                                     |       | $                                | (0.01      | ) |
| Pro forma  diluted loss per common share                                   |       | $                                | (0.01      | ) |

 

**Risks and Uncertainties**

The Company’s future results of operations andfinancial condition could be impacted by the following factors, among others:dependence on the banking industry, decline in check volumes, fluctuations inoperating results, relatively fixed costs, product and service mix, lack oflong-term agreements, dependence on key personnel, rapid technological changeand dependence on new products, strategic alliances or acquisitions, focus onproviding business process outsourcing with a significant offshore component,ability to attract and retain qualified personnel, customer concentration,competition, proprietary rights, infringement claims, dependence on thirdparties for technology licenses, liability claims, defects in our software andsolutions, our ability to protect our information technology infrastructure,international operations, changing government and tax regulations, stock pricefluctuations, impairment of goodwill or intangible assets, realization ofrevenue from contracted sales, potential sales, backlog and deferred revenue,the resolution of a pending class action lawsuit, anti-takeover provisions andthe restatement of prior period financial statements.

18

----

**Financial Guarantees**

In November 2002, the FASB issued Interpretation No. 45(“FIN 45”), *“Guarantor’s Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees ofIndebtedness of Others.”*  FIN45 requires that a guarantor recognize, at the inception of a guarantee, aliability for the fair value of the obligation undertaken in issuing theguarantee or indemnification. FIN 45 also requires additional disclosure by aguarantor in its interim and annual consolidated financial statements about itsobligations under certain guarantees and indemnifications. The following is asummary of the agreements that the Company has determined are within the scopeof 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. The Company includes this infringementindemnification in most of its software license 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. TheCompany has recorded no liability associated with this indemnification, as itis not aware of any pending or threatened infringement actions that areprobable losses. The Company believes the estimated fair value of theseintellectual property indemnification clauses is minimal.

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 and all expenses and liabilities of anytype whatsoever (including but not limited to, judgments, fines and amountspaid in settlement) actually and reasonably incurred by the directors, officersand key employees in connection with the investigation, defense, settlement orappeal of such proceeding, provided they acted in good faith. The Companymaintains insurance coverage for directors and officers liability (“D&Oinsurance”). No maximum liability is stipulated in these agreements thatinclude indemnifications of members of the board of directors, officers andcertain 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. As a result of the insurance policy coverage, the Company believesthe estimated fair value of these indemnification agreements is minimal.

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

Goodwill and intangible assets deemed to haveindefinite lives are not amortized but are subject to annual impairment tests. Otherintangible assets, which include acquired developed technology and customerrelationships, are amortized over their estimated useful lives.

Customer relationships, obtained in the acquisition ofCheck Solutions in June 2001, with finite useful lives are amortized on astraight-line basis, which resulted in amortization expense of $350,000 duringthe three months ended April 30, 2006 and 2005, respectively.

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 |       | $          | 1,050      |       |
| 2008               |       | 467        |       |
|                    |            |            |            |            |            |  |

 

During the fourth quarter of the year ended January 31,2006, the Company performed its annual evaluation for goodwill impairment anddetermined that the carrying amount of goodwill was not impaired andsubsequently have noted no factors that would indicate impairment.

19

----

**4.    RevolvingCredit Agreement**

The Company is a party to a revolvingcredit agreement with a group of banks providing for a commitment amount of$30.0 million and a maturity date of July 31, 2006. The Company did nothave any borrowings outstanding under the revolving credit agreement at April 30,2006. Borrowings under the credit agreement bear interest equal to either thegreater of prime or federal funds rate plus a margin ranging from 1.25% to2.25% depending on the Company’s ratio of funded debt to Earnings beforeInterest, Taxes, Depreciation and Amortization (“EBITDA”), or LIBOR plus amargin equal to 2.75% to 3.75% depending on the Company’s ratio of funded debtto EBITDA. Interest payments are due quarterly. The Company is required to payan annual commitment fee equal to 0.50% on the unused amount of the revolvingcredit agreement. The revolving credit agreement contains customary affirmativeand negative covenants, including financial covenants requiring the maintenanceof specified interest coverage, ratio of EBITDA to funded debt, and ratio of80% of accounts receivable, cash and short term investments to funded debt. Additionally,the payment of dividends and the purchase of treasury stock is precluded andsubject to the approval of the banks. Substantially all of the Company’s assetscollateralize the revolving credit agreement. As of April 30, 2006, theCompany is in compliance with the covenants of the revolving credit agreementas amended.

Interest expense, including thecommitment fee and exclusive of the amortization of deferred loan costs on thecredit agreement, was $37,000 for the three months ended April 30, 2006and 2005.

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

The Company has established a valuation allowance toreserve its net deferred tax assets at April 30, 2006 because of theCompany’s inconsistent history of generating profitable operations and taxableincome. The tax provision was computed based on actual results by jurisdictionwhich resulted in a foreign tax provision of $100,000 and $81,000 for the threemonths ended April 30, 2006 and 2005, respectively.

**6.****           Benefit Plans**

**401(k) Plan**

The Company has adopted a plan pursuant to Section 401(k) ofthe Internal Revenue Code (“the Code”) whereby participants may contribute apercentage of compensation not in excess of the maximum allowed under the Code.Employer matching contributions amounted to $286,000 and $338,000 for the threemonths ended April 30, 2006 and 2005, respectively. The Company may makeadditional contributions at the discretion of the Board of Directors. Nodiscretionary contributions were made during the three months ended April 30,2006 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 all employees are eligible to receive cashawards under the CIBP. Awards from this plan are paid to employees subsequentto the end of the fiscal year. The Company’s Compensation Committee of theBoard of Directors has the authority to determine the final amount of the bonusthat is ultimately paid to the officers of the Company. In the three monthsended April 30, 2006 and 2005, the Company recorded expense under thisplan of approximately $0 and $244,000, respectively.

The Company pays discretionary bonuses to keyemployees based primarily on the extent to which individuals meet agreed-uponobjectives for the year. The Company recorded discretionary bonus expense ofapproximately $0 and $265,000 for the three months ended April 30, 2006and 2005, respectively.

20

----

 

**7.****           Earnings Per Share**

The following table sets forth the computation ofbasic and diluted earnings (loss) per share (in thousands, except per shareamounts):

|                                                                             | ** ** | **Three Months Ended  April 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                  | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| Basic earnings  (loss) per share:                                           |       |                                             |       |   |   |
| Net income (loss)                                                           |       | $                                                | (34        | ) | $ | 498 |   |
|                                                                        |       |                                             |       |   |   |
| Weighted average shares outstanding                                         |       | 23,916                                           |       | 24,425 |   |
|                                                                        |       |                                             |       |   |   |
| Basic earnings (loss) per share                                             |       | $                                                | 0.00       |   | $ | 0.02 |   |
|                                                                        |       |                                             |       |   |   |
| Diluted earnings  (loss) per share:                                         |       |                                             |       |   |   |
| Net income (loss)                                                           |       | $                                                | (34        | ) | $ | 498 |   |
|                                                                        |       |                                             |       |   |   |
| Weighted average shares outstanding                                         |       | 23,916                                           |       | 24,425 |   |
| Assumed conversion of employee stock options and  unvested restricted stock |       | —                                           |       | 442 |   |
| Shares used in diluted earnings per share  calculation                      |       | 23,916                                           |       | 24,867 |   |
|                                                                        |       |                                             |       |   |   |
| Diluted earnings (loss) per share                                           |       | $                                                | 0.00       |   | $ | 0.02 |   |

 

Options for 3,832,587 shares and 2,614,595 shares forthe three months ended April 30, 2006 and 2005, respectively, have beenexcluded from the diluted earnings per share computation as the options wereanti-dilutive.

21

----

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

*Shareholder Derivative Suit.*

On June 15, 2004, by mutual agreement between theparties, *Smith v. Carreker Corporation, et. al*,Civil Action No. 303CV1211-M was reinstated in the United StatesDistrict Court for the Northern District of Texas, Dallas Division. This actionwas originally filed on May 29, 2003, in the United States District Courtfor the Northern District of Texas, Dallas Division as Civil Action no.303CV1211-D. On January 15, 2004, the Court, acting upon the jointmotion of the parties, dismissed the action without prejudice. This action wasbrought as a shareholders’ derivative action pursuant to Rule 23.1,Fed.R.Civ.P. for the benefit of Nominal Defendant Carreker Corporation againstcertain of its current and former officers and directors, i.e., John D.Carreker, Jr., James D. Carreker, Richard R. Lee, Jr., James L.Fischer, Donald L. House, David K. Sias, Terry L. Gage, James R. Erwin, RonaldG. Steinhart and Ronald Antinori, seeking to remedy their individual breachesof fiduciary duty, including their knowing violations of Generally AcceptedAccounting Principles (“GAAP”), knowing violations of federal and statesecurities laws, acts of bad faith and other breaches of fiduciary duty. Theplaintiff sought redress (the form of which includes, among others, unspecifiedamounts of compensatory damages, interest and costs, including legal fees) forinjuries to the Company and its shareholders caused by Defendants’ misfeasanceand/or malfeasance during the period from May 20, 1998 through December 10,2002. In May 2006, the District Court approved the final settlement of thederivative claims brought in this action, pursuant to which the Company agreedto adopt certain corporate governance enhancements and cover plaintiffs’attorney’s fees and litigation expenses up to $300,000 and the litigation wasterminated. Neither the Company nor any of its current or former officers anddirectors made any admission of wrongdoing.

*Shareholder Class Action.*

## On April 16,2003 the United States District Court for the Northern District of Texas,Dallas Division, issued an order consolidating a number of purported classaction lawsuits into a Consolidated Action styled *In re Carreker Corporation Securities Litigation*, CivilAction No. 303CV0250-M. On October 14, 2003 the plaintiffsfiled their Consolidated Class Action Complaint. The complaint, filed onbehalf of purchasers of the Company’s common stock between May 20, 1998and December 10, 2002, inclusive, alleged violations of Section 10(b) ofthe Securities Exchange Act of 1934 and Rule 10b-5 against alldefendants (the Company, John D. Carreker Jr., Ronald Antinori, Terry L. Gageand Ernst & Young, the Company’s auditors), violations of Section 20(a) ofthe Exchange Act against the individual defendants, and violation of Section 20Aof the Securities Exchange Act against defendants John D. Carreker, Jr.and Ronald Antinori. The complaint also alleges, among other things, thatdefendants artificially inflated the value of Carreker stock by knowingly orrecklessly misrepresenting the Company’s financial results during the purportedclass period. On March 22, 2005 the Court dismissed the action withoutprejudice and allowed the plaintiffs 60 days in which to file an amendedcomplaint. Also the Court dismissed, with prejudice, all claims by shareholdersrelating to periods prior to July 31, 1999.

## On May 31,2005, the plaintiffs filed an Amended Consolidated Class Action Complainton behalf of purchasers of the Company’s common stock between July 30,1999 and December 10, 2002, inclusive, which reiterates the allegations inthe first complaint, and alleges violations of Section 10(b) of theSecurities Exchange Act of 1934 and Rule 10b-5 against alldefendants (the Company, John D. Carreker Jr., Ronald Antinori and Terry L.Gage) except Ernst & Young LLP, violations of Section 20(a) ofthe Exchange Act against the individual defendants, and violations of Section 20Aof the Securities Exchange Act against defendants John D. Carreker, Jr.and Ronald Antinori. The plaintiffs are seeking unspecifiedamounts of compensatory damages, interest and costs, including legal fees.

On April 21, 2006, counsel for the plaintiffs anddefendants executed and submitted to the Court a stipulation of settlementwhereby they have agreed to settle the class action litigation for a payment of$5,250,000. The proposed settlement was preliminarily approved by the DistrictCourt on May 5, 2006 but remains subject to final court approval. At thistime, there can be no assurance that the settlement will receive final courtapproval.

The settlement payments in both the shareholderderivative suit and the class action are fully covered by the Company’sdirectors and officer’s insurance policies.

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

22

----

 

**9.****           Business Segments andRevenue Concentration**

The tables below show revenues and income (loss) fromoperations for the periods indicated for our four reportable business segments:Revenue Enhancement, Global Payments Technologies, Global Payments Consultingand Business Process Outsourcing. Certain prior year amounts have beenreclassified to conform with the current year business segment presentation. Ourcustomer projects are sold on a solution basis, so it is necessary to break themdown by segment and allocate accordingly. Included in “Corporate Unallocated”are costs related to selling and marketing, and certain unallocated corporateoverhead expense such as executive management, finance, accounting, humanresources, legal and certain IT and facility functions. Business segmentresults, which include costs for research and development as well as productroyalty expense, the amortization and impairment of goodwill and intangibleassets, the write-off of capitalized software costs and restructuring and othercharges, were as follows (in thousands):
| ** **                                 | ** ** | **Three months ended April 30, 2006** | ** ** |
|--------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                 | ** ** | **Revenue  Enhancement**                                       | ** ** | **Global  Payments  Technologies** | ** ** | **Global  Payments  Consulting** | ** ** | **Business  Process  Outsourcing** | ** ** | **Corporate  Unallocated** | ** ** | **Total** | ** ** |
| Revenues                                   |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |
| Consulting                                 |       | $                                                              | 7,517      |   | $ | 142 |   | $ | 899 |   | $ | — |   | $ | — |   | $ | 8,558 |   |
| Software license                           |       | 179                                                            |       | 2,135 |   | 243 |   | — |   | — |   | 2,557 |   |
| Software maintenance                       |       | 96                                                             |       | 10,425 |   | 231 |   | — |   | — |   | 10,752 |   |
| Software implementation and other services |       | 535                                                            |       | 3,205 |   | 395 |   | — |   | — |   | 4,135 |   |
| Outsourcing services                       |       | —                                                         |       | — |   | — |   | 510 |   | — |   | 510 |   |
| Out-of-pocket expense reimbursements       |       | 271                                                            |       | 311 |   | 151 |   | — |   | — |   | 733 |   |
| Total revenues                             |       | $                                                              | 8,598      |   | $ | 16,218 |   | $ | 1,919 |   | $ | 510 |   | $ | — |   | $ | 27,245 |   |
|                                       |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |
| Income (loss)  from operations             |       | $                                                              | 3,393      |   | $ | 1,655 |   | $ | 453 |   | $ | (291 | ) | $ | (5,510 | ) | $ | (300 | ) |

 
| ** **                                 | ** ** | **Three months ended April 30, 2005** | ** ** |
|--------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                 | ** ** | **Revenue  Enhancement**                                       | ** ** | **Global  Payments  Technologies** | ** ** | **Global  Payments  Consulting** | ** ** | **Business  Process  Outsourcing** | ** ** | **Corporate  Unallocated** | ** ** | **Total** | ** ** |
| Revenues                                   |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |
| Consulting                                 |       | $                                                              | 7,722      |   | $ | 50 |   | $ | 546 |   | $ | — |   | $ | — |   | $ | 8,318 |   |
| Software license                           |       | 301                                                            |       | 3,058 |   | — |   | — |   | — |   | 3,359 |   |
| Software maintenance                       |       | 114                                                            |       | 10,970 |   | 228 |   | — |   | — |   | 11,312 |   |
| Software implementation and other services |       | 475                                                            |       | 3,550 |   | 109 |   | — |   | — |   | 4,134 |   |
| Outsourcing services                       |       | —                                                         |       | — |   | — |   | 257 |   | — |   | 257 |   |
| Out-of-pocket expense reimbursements       |       | 387                                                            |       | 340 |   | 91 |   | — |   | — |   | 818 |   |
| Total revenues                             |       | $                                                              | 8,999      |   | $ | 17,968 |   | $ | 974 |   | $ | 257 |   | $ | — |   | $ | 28,198 |   |
|                                       |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |
| Income (loss)  from operations             |       | $                                                              | 3,938      |   | $ | 2,073 |   | $ | (300 | ) | $ | (626 | ) | $ | (4,851 | ) | $ | 234 |   |

 

During the three months ended July 31, 2003, theCompany formed Carretek LLC (Carretek), in which it owns a 51% interest, tooffer financial institutions offshore-centric outsourcing of their businessprocesses and IT services needs. During July 2004, Carretek signed itsfirst contract to perform outsourced services with a customer.

The 49% share relating to the minority interest in theCarretek losses, which was $133,000 and $318,000 for the three months ended April 30,2006 and 2005, respectively, was recorded in other income in the accompanyingconsolidated statements of operations. The Company and its partner have fundedCarretek to date in the aggregate amount of $4.5 million of equity. Carretek’soperations are included in our business process outsourcing segment.

23

----

The following table summarizes revenues, exclusive ofout-of-pocket expense reimbursements, derived from the Company’s largestcustomer and top five customers during the periods indicated.

|                     | ** ** | **Three Months Ended  April 30,** | ** ** |
|---------------------|------------|--------------------------------------------------|------------|
| ** **          | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| Single customer     |       | 21                                               | %          | 14 | % |
| Top five  customers |       | 47                                               | %          | 44 | % |

 

U.S. Bank accounted for approximately 21% and WellsFargo accounted for approximately 10% of total revenues during the three monthsended April 30, 2006 and Wells Fargo accounted for approximately 14% of totalrevenues during the three months ended April 30, 2005.

The Company markets itssolutions in several foreign countries. Revenues, exclusive of out-of-pocketexpense reimbursements, attributed to countries based on the location of thecustomers were as follows (in thousands):
| ** **     | ** ** | **Three Months Ended** | ** ** | **Three Months Ended**               | ** ** |
|----------------|------------|----------------------------------|------------|------------------------------------------------|------------|
| ** **     | ** ** | **April 30,  2006**         | ** ** | **April 30,  2005**                       | ** ** |
| ** **     | ** ** | **Amount**                       | ** ** | **Percent of   total revenues** | ** ** | **Amount** | ** ** | **Percent of   total revenues** | ** ** |
| United States  |       | $                                | 21,507     |                                           | 81         | % | $ | 20,043 |   | 73 | % |
| Europe         |       | 1,099                            |       | 4                                              |       | 2,334 |   | 9 |   |
| Canada         |       | 1,972                            |       | 8                                              |       | 1,861 |   | 7 |   |
| Asia Pacific   |       | 1,101                            |       | 4                                              |       | 1,062 |   | 4 |   |
| South Africa   |       | 211                              |       | 1                                              |       | 2,010 |   | 7 |   |
| Other          |       | 622                              |       | 2                                              |       | 70 |   | — |   |
| Total revenues |       | $                                | 26,512     |                                           | 100        | % | $ | 27,380 |   | 100 | % |

 

24

----

**10.  Restructuring and Other Charges**

**There were no restructuring and other charges recordedduring the three months ended April 30, 2006. However,**the Company recorded $127,000 in restructuring and other charges duringthe three month period ended April 30, 2005, principally associated withthe separation of 6 employees. The Company also lowered its estimate by $32,000for the costs associated with the discontinuance of one of its softwareofferings originally recorded in January 2004.

The activity related to the accruedmerger and restructuring costs during the three months ended April 30, 2006is as follows (in thousands):
| ** **                                | ** ** | **Workforce  Reductions** | ** ** | **Check Flow  Suite** | ** ** | **Other** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|---------------------------|------------|----------------------------|------------|-----------|------------|-----------|------------|
| Reserve balance  at January 31, 2006 |       | $                         | 87         |                       | $          | 200       |       | $         | 47         |   | $ | 334 |   |
| Additions to  reserve balance:            |       |                      |       |                       |       |      |       |      |       |
| Severance charges                         |       | —                    |       | —                     |       | —    |       | —    |       |
| Reductions to  reserve balances:          |       |                      |       |                       |       |      |       |      |       |
| Change in estimate                        |       | —                    |       | —                     |       | —    |       | —    |       |
| Cash paid                                 |       | (87                       | )          | —                     |       | —    |       | (87       | )          |
| Reserve balance  at April 30, 2006   |       | $                         | —     |                       | $          | 200       |       | $         | 47         |   | $ | 247 |   |

 

The Company anticipates the remaining reserve accrualsat April 30, 2006 will be paid or remaining customer obligations completedwithin the next 3 months.

**Item 2.**Management’sDiscussion and Analysis of Financial Condition and Results of 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-looking statements.Although we believe that the expectations reflected in such forward-lookingstatements are reasonable, no assurance can be given that such expectationswill prove correct. Factors that could cause our results to differ materiallyfrom the results discussed in, or contemplated by, such forward-lookingstatements include the risks described under “Risk Factors” contained in our Form 10-Kfor the year ended January 31, 2006, as filed with the Securities andExchange Commission (“SEC”). Such risks include, without limitation: dependenceon the banking industry, decline in check volumes, fluctuations in operatingresults, relatively fixed costs, product and service mix, lack of long-termagreements, dependence on key personnel, rapid technological change anddependence on new products, strategic alliances or acquisitions, focus onproviding business process outsourcing with a significant offshore component,ability to attract and retain qualified personnel, customer concentration,competition, proprietary rights, infringement claims, dependence on thirdparties for technology licenses, liability claims, defects in our software andsolutions, our ability to protect our information technology infrastructure,international operations, changing government and tax regulations, stock pricefluctuations, impairment of goodwill or intangible assets, realization ofrevenue from contracted sales, potential sales, backlog and deferred revenue,the resolution of a pending class action lawsuit, anti-takeover provisions andthe restatement of prior period financial statements. All forward-lookingstatements in this report are expressly qualified in their entirety by thecautionary statements in this paragraph, in the “Risk Factors” included in ourSEC filings and elsewhere in this report.

**Overview**

Since 1978, Carreker Corporation has designed,developed, sold and delivered payments-related software and consultingsolutions to financial institutions and financial service providers. Morerecently, we have introduced a business process outsourcing solution to ourcustomers. Our products and services address a broad spectrum of paymentactivities and are designed to help our clients enhance the performance oftheir payments businesses; improve operational efficiency in paymentsprocessing; enhance revenue and profitability from payments-oriented productsand services; reduce losses associated with fraudulent payment transactions;facilitate compliance with risk-related laws and regulations; and/or maximizeclients’ customer income streams by aligning their customer interactions andproducts with customer needs. Carreker employed a total of 491 employees at April 30,2006.

25

----

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 are operated in distinct yet increasinglysynergistic ways to bring value to our clients.

*Global Payments Technologies*. This division is responsible for design,development, sales, and support of our technology solutions. The division hasthree lines of business with distinct solution offerings:  Risk solutions, Payments solutions and Cash &Logistics solutions. Revenue is primarily derived from license fees,implementation fees and maintenance fees. As of April 30, 2006, GPT had 285employees.

*Revenue Enhancement*. This highly specialized division provides consulting and softwaresolutions focused on increasing clients’ revenue streams. Areas ofexpertise include fee income, market segmentation, management of customer pricestructures, account retention, account acquisitions and profitability. Amajority of the revenue generated by this division is through benefit-sharingagreements with our customers, recorded as consulting revenue along withlicense fees, maintenance fees and implementation fees from our CVE softwareoffering. As of April 30, 2006, RevEhad 83 employees.

*GlobalPayments Consulting*. The objective of this professionalservices division is to provide our clients with “applied thought leadership”related to the business of payments. Revenue in the GPC division is primarilyderived through the delivery of consulting services offered primarily on a timeand materials basis to our clients, along with the license fees, maintenancefees and services fees associated with our Float Pricing System softwareoffering and Payments Clearing Model product offering. As of April 30, 2006, GPC had 23 employees.

*BusinessProcess Outsourcing.*Infiscal 2003 we formed Carretek. Carretek is a transformational businessoutsourcer for payment and transaction processing jointly owned by CarrekerCorporation and Majesco Software, Inc., the U.S. subsidiary of MastekLimited, a leading Indian outsourcing company with global operations. As of April 30,2006, 2 of the Company’s U.S. based employees and 131 offshore personnel ofMastek Limited were seconded to Carretek on a contract basis.

*Cost of Revenues and Gross Margins.*We strive to control our cost of revenues andthereby maintain or improve our gross margins. The major items impacting costof consulting, cost of software maintenance and cost of software implementationare personnel, overhead and related expenses. The major items impacting cost ofsoftware licenses are amortization of both capitalized and acquired softwareand also software royalties for software from third parties. While theamortization expense is relatively fixed, the third party royalty expense canvary significantly based on the relative product mix.

*Operating Expenses.*Operating expenses, including selling, general andadministrative and research and development, are substantially driven bypersonnel and overhead expenses. Other significant operating expenses that wemonitor include professional fees, use of contractors, travel, insurance andoffice services expenses. As of April 30, 2006, the Corporate AccountRelationship Management and Marketing staff had 18 employees, and the Corporate staff which includesExecutive Management, Legal, Finance and Accounting, Human Resources,Facilities and IT had 80 employees.

*Liquidity and Cash Flows.*Cash and cash equivalents at April 30, 2006and January 31, 2006 totaled $34.8 million and $29.7 million, respectively.In addition, we had $5.9 million of marketable debt securities at April 30,2006, as compared to $4.7 million at January 31, 2006. At April 30,2006 and January 31, 2006, there were no borrowings outstanding under ourrevolving credit agreement.

**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 ofchecks in paper and electronic form, identification and mitigation offraudulent payments, handling irregular items such as checks returned unpaid(exceptions), maintaining a record of past transactions (archiving), respondingto related customer inquiries (research), and correcting any errors that arediscovered (adjustments). Global Payments Technologies (“GPT”) solutionsaddress these and other key functions in the context of improving operationalefficiency and a gradual transition from paper to electronic-based paymentsystems. GPT offers risk management solutions that mitigate depository accountrisk through profiling and advanced analytics technology. GPT risk managementsolutions leverage transaction monitoring and filtering capabilities for AMLand OFAC compliance. Finally, we offer technology solutions that optimize theinventory management of a bank’s cash stock levels and logistical servicerequirements, including managing how much is needed, when it is needed andwhere it is needed. Our solutions reduce the 

26

----

amount of cash banks need to hold in reserve accountsand as cash-on-hand while ensuring a high level of customer service throughtimely replenishment of ATM cash supplies at minimal logistical services cost.

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

 

27

----

 
| 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. Aided by Check 21 legislation, these solutions are  designed to reduce and eventually eliminate the movement of paper payments  through the system, improving productivity, reducing errors, increasing  customer satisfaction and reducing fraud.                                                 |       | ExchgLink , IRD Create, IRD Author, Image Inspector,  CheckLink, CheckLink PC, Deposit Manager, Branch Truncation Manager and  Cnotes |
| ** **                                       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                                                                                                                  |
| **Cash &  Logistics Solutions:**        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                                                                                                                  |
| ** **                                       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                                                                                                                  |
| ATM Solutions                                    |       | Advanced ATM monitoring and management, improving  ATM availability and ensuring service levels are met. These solutions include  an automated ATM monitoring and dispatching system for maximizing network  availability; and a real-time Internet-based system for efficient handling of  ATM service requests and responses.                                                                                                                                                                                                           |       | eiManager, ATM Logix                                                                                                                  |
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                                                                                                                  |
| Cash Solutions                                   |       | A product suite, now optimized through Web-based  software solutions, that dramatically reduces the amount of cash banks,  financial institutions and companies need to hold as cash-on-hand throughout  vault, branch and ATM networks. These solutions also enable automation and  standardization of the cash ordering process, including the matching and  reconciliation of invoices and the optimization of transportation. Consulting  solutions can drive further efficiency and automation in vault, branch and  ATM operations. |       | iCom, ReserveLink, Matchpoint and Currency Supply  Chain Consulting                                                                   |
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                                                                                                                  |
| 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 and 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                                                                               |

 

28

----

*RevenueEnhancement.  *Revenue Enhancement (“RevE”) is a highlyspecialized division that provides consulting services focused on tacticalmethods of increasing banks’ fee income. The scope and depth of this practicehas expanded throughout its 14 year history and now includes retail, smallbusiness, and commercial deposits, treasury management, consumer and commerciallending, credit card lending and trust and investment services. Our solutionsinvolve developing strategies that enable our clients to take advantage ofelectronification trends, often gaining first mover advantages for our clients.In addition to developing strategies, our business model ensures that wecontinue to translate those strategies into tactical implementations withmeasurable revenue streams. Our client base has continued to expand with veryhigh penetration rates in the markets in which we operate. Thus, we haveexperienced a trend of becoming longer term strategic partners with ourclients.

Another component of 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 thefinancial payments environment. The division provides strategic planning,program management, specialized tools, business applications and implementationadvisory services for financial institutions and 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 form, clearingpartners and funds availability optimization)

·                  Consolidationand merger/integration planning

·                  Paymentchannel risk mitigation

·                  Imageexchange planning

·                  StrategicSourcing evaluation

·                  IssueRecovery Services

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

·                  FloatManagement software products — Float Analysis System and Float ManagementSystem — for managing a bank’s float through float analysis and pricing toimprove profitability, reporting, workflow and check clearing operations. 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 transformationalbusiness outsourcer for payment and transaction processing jointly owned byCarreker Corporation (51%) and Majesco Software Inc. (49%), the U.S. subsidiaryof Mastek Limited, a leading Indian outsourcing company with global operations.Carretek was formed in fiscal 2003.

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

 

29

----

Initially, Carretek is focused on offshoring payments-relatedbusiness processes. Through Carretek, financial institutions can leverage theglobal work force at this critical period when Check 21 and other paymentelectronification trends are pressuring financial institutions to reduce theirpayment per item costs beyond the power of traditional cost managementpractices. Carretek has designed and built specific product offerings targetedat payment and transaction processing functions for this express purpose. Withinthis area of expertise, the Carretek offering includes a flexible array ofoffshore outsourcing services to financial institutions.

**Executive Summary**

***Comparisonof Three Months Ended April 30, 2006 (“Q1 2006”) to Three Months Ended April 30,2005 (“Q1 2005”)***

Our consolidated revenues declined 3.4% to $27.2million in the three months ended April 30, 2006. We generated a net lossof $34,000 in the three months ended April 30, 2006, compared to netincome of $498,000 in the three months ended April 30, 2005. The decreasein net income was primarily the result of a decline in revenue within both ourRevE and GPT business segments, offset by increased revenue within our GPCbusiness segment and by a slight decline in operating costs and expenses. Ourcash balance increased $5.1 million and our marketable securities increased$1.2 million during the three months ended April 30, 2006. This increasein cash and marketable securities is primarily the result of the collection ofour calendar year maintenance renewals.

The decline in our revenue was primarily associatedwith our GPT business segment. Revenue within this segment declined $1.7million, or 9.7%, for the three months ended April 30, 2006. The declineis primarily in software license revenue within the Payments group. ThePayments group includes such products as Image Archive and Exception Managementapplications as well as Source Capture, ExchgLink and Image ReplacementDocument (“IRD”) solutions. The decline was primarily the result of continuedtechnology investment delays by our customers and the intensification ofcompetition in this particular market space. However, some traction has beengained in recent months as GPT’s initial Source Capture Branch installation wasaccepted by our customer in the three months ended January 31, 2006 and twosmaller Source Capture installations were in progress during the three monthsended April 30, 2006. Additionally, one large customer did not pay theirfiscal 2006 maintenance renewal by April 30, 2006, which resulted in thedeferral of approximately $374,000 of revenue from Q1 2006 to future periods. Finally,we signed an agreement with IBM on May 15, 2006 under which IBM will serveas a key channel to the larger North American financial institutions.

In absolute dollars, our cost of revenues increased $116,000to $14.2 million for the three months ended April 30, 2006 as compared to$14.1 million for the three months ended April 30, 2005. This slightincrease in costs, along with the decline in revenue discussed above, loweredour gross margin to 48.0% for the three months ended April 30, 2006 ascompared to 50.0% for the three months ended April 30, 2005.

Operating expenses includes selling, general andadministrative, research and development, amortization of customerrelationships and restructuring and other charges. Overall, operating expensesdeclined $535,000 for the three months ended April 30, 2006 as compared tothe three months ended April 30, 2005. Selling, general and administrativeexpenses have declined $124,000 for the three months ended April 30, 2006as compared to the three months ended April 30, 2005. This reduction wasprimarily related to reductions in expenses in both corporate and businesssegment sales and marketing functions. These reductions have been partiallyoffset by increased legal fees in lawsuits in which we are the plaintiff alongwith increased professional fees. Additionally, the three months ended April 30,2006 was the first period that contains stock option expense which totaled$382,000, of which $303,000 is contained in selling, general and administrativeexpense.

During the three months ended April 30, 2006, wedid not record any restructuring and other charges, which compares to $95,000recorded in the three months ended April 30, 2005.

We continue to focus on increasing research anddevelopment, particularly within GPT, to enhance our existing product offeringsand develop new product offerings, and incurred research and developmentexpenses of $2.2 million in the three months ended April 30, 2006 comparedwith $2.5 million in the three months ended April 30, 2005. In the threemonths ended April 30, 2006, we continued to focus on enhancing ourPayments offerings and introducing several new Cash and Risk solutions withinGPT.

 

30

----

We anticipate revenue growth during the 2006 fiscalyear due to the availability and anticipated acceptance of several new productsand service offerings, which were developed during 2005, as well as newproducts and services expected to be introduced in 2006. Overall annual revenuegrowth is anticipated to be in the latter half of the year due to variousfactors including the timing of revenue realization in our RevE businesssegment as well as a lengthened decision cycle and longer timelines forimplementation and customer acceptance associated with certain new products. Weexpect that revenue and net income (loss) for the second quarter of fiscal 2006will be down from the corresponding quarter in fiscal 2005 but believe that wewill achieve improved revenue and net income in fiscal 2006 as compared tofiscal 2005. We also believe that we are well positioned for improvedprofitability in fiscal 2007 as a result of anticipated revenue growth, ongoingcost containment efforts, and the decrease in scheduled amortization expenseassociated with certain acquisition-related intangible assets.

### **Resultsof Operations**

***Comparisonof Three Months Ended April 30, 2006 (“Q1 2006”) to Three Months Ended April 30,2005 (“Q1 2005”)***

***Revenues***

*Revenuesby Segment ($ in thousands):*

|                               | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|-------------------------------|------------|--------------------------------------------------|------------|--------------|------------|
| ** **                    | ** ** | **2006**                                         | ** ** | **2005**     | ** ** | **$** | ** ** | **%** | ** ** |
|                          |       |                                             |       |         |       |   |   |   |   |
| Revenue  Enhancement          |       | $                                                | 8,598      |         | $          | 8,999 |   | $ | (401 | ) | (4.4 | )% |
| Global Payments  Technologies |       | 16,218                                           |       | 17,968       |       | (1,750 | ) | (9.7 | ) |
| Global Payments  Consulting   |       | 1,919                                            |       | 974          |       | 945 |   | 97.0 |   |
| Business Process  Outsourcing |       | 510                                              |       | 257          |       | 253 |   | 98.4 |   |
|                          |       |                                             |       |         |       |   |   |   |   |
| Total Revenues                |       | $                                                | 27,245     |         | $          | 28,198 |   | $ | (953 | ) | (3.4 | )% |

 

Our decline in total revenues of 3.4% in Q1 2006, ascompared to Q1 2005, is concentrated primarily within the GPT segment.

The decline in GPT segment revenue is primarily withinits Payment Solution offerings. The market’s adoption of post-Check 21 relatedtechnology has been much slower than expected. We experienced isolated successwith our ExchgLink solution while our IRD authoring software and remote SourceCapture solution have experienced greater success with several major banks andthe Federal Reserve. For instance, GPT gained acceptance of its initial SourceCapture Branch installation in the quarter ended January 31, 2006 and hastwo smaller Source Capture engagements in progress as of April 30, 2006.

Our RevE segment revenues declined $401,000, or 4.4%,in Q1 2006, as compared to Q1 2005. RevE’s traditional contingent consultingrevenues declined $205,000, or 2.7%, to $7.5 million in Q1 2006 as compared to$7.7 million in Q1 2005. In Q1 2006, approximately $5.2 million, or 69.0%, ofRevE’s contingent consulting revenue was derived from a single engagement atU.S. Bank. The number of revenue producing engagements decreased to 9 in Q12006 from 13 in Q1 2005 and this also led to a decline in out-of-pocket expensereimbursements of approximately $115,000 in Q1 2006 as compared to Q1 2005. Thesoftware license and software implementation and other services revenue derivedfrom RevE’s CVE software and proprietary sales management offering declinedapproximately $80,000 in Q1 2006 as compared to Q1 2005 as the number of activeengagements declined from 3 to 2.

GPC revenues increased $945,000, or 97.0%, to $1.9million in Q1 2006 as compared to $1.0 million in Q1 2005. GPC has intensifiedits sales focus as we completed the repositioning of this business to focus onenterprise-wide payment electronification strategies, image enablement planningand integration and risk mitigation. The revenue increase can be attributed toan increase in the average deal size for consulting engagements and an increasein the number of engagements. Additionally, our second Payments FinancialModeling application installation gained customer acceptance in Q1 2006 andyielded approximately $175,000 in software license revenue.

Our outsourcing revenue is derived through Carretek,our 51% owned business which offers outsourcing for payment and transactionprocessing. Carretek was formed in fiscal 2003 and signed its first customeragreement in the second quarter of fiscal 2004. In 2005, we increased staffingunder our initial contract and expanded our scope with this single customer toinclude a second and third set of transaction processing functions which hassignificantly increased revenue.

* *

31

----

*Consulting($ in thousands):*

|            | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|------------|------------|--------------------------------------------------|------------|--------------|------------|
| ** ** | ** ** | **2006**                                         | ** ** | **2005**     | ** ** | **$** | ** ** | **%** | ** ** |
|       |       |                                             |       |         |       |   |   |   |   |
| Consulting |       | $                                                | 8,558      |         | $          | 8,318 |   | $ | 240 |   | 2.9 | % |
|            |            |                                                  |            |              |            |  |  |  |  |  |  |  |

 

Most of our consulting revenues are derived from ourRevE business segment. Consulting revenues derived from our RevE segmentdeclined 2.7% to $7.5 million in Q1 2006, as compared to $7.7 million in Q12005. Of the $7.5 million of RevE consulting revenues recorded in Q1 2006, $5.2million were derived from one customer, U.S. Bank. Within RevE, we continue tofocus on maximizing the value to our existing customer base while expanding ourexpertise to new customers, both domestically and internationally. However,there were no revenue producing international consulting engagements in Q12006, as compared to $1.8 million derived from a single internationalengagement in Q1 2005.

Consulting revenues derived from our GPC segmentincreased 64.6% to $899,000 in Q1 2006 as compared to $546,000 in Q1 2005. Theincrease is primarily the result of an increase in the number of activeengagements along with an increase in deal size.

*Software License ($ in thousands):*

|                  | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|------------------|------------|--------------------------------------------------|------------|--------------|------------|
| ** **       | ** ** | **2006**                                         | ** ** | **2005**     | ** ** | **$** | ** ** | **%** | ** ** |
|             |       |                                             |       |         |       |   |   |   |   |
| Software License |       | $                                                | 2,557      |         | $          | 3,359 |   | $ | (802 | ) | (23.9 | )% |
|                  |            |                                                  |            |              |            |  |  |  |  |  |  |  |

 

Most of our software license revenues are derived fromour GPT business segment. Software license revenues from our GPT businesssegment decreased 30.2% to $2.1 million in Q1 2006 from $3.1 million in Q12005.

Within GPT, the software license decline is within thePayment Solutions suite of products, which includes products designed toaddress the Check 21 legislation. Check 21 permits U.S. banks to accept digitalimages of checks the same way they accept 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 andfinally, Source Capture which allows customers to capture deposits at branches,ATM’s and bank customer sites. Delayed industry adoption rates and intensifiedcompetition have dampened results relative to our expectations. Our firstSource Capture Branch customer accepted our software in Q4 2005 and we have twoother smaller Source Capture engagements currently in progress. We believe thatindustry adoption and corresponding IT spending in this area will acceleratelater in 2006 and into 2007.

The GPC business segment software license revenuesincreased $243,000 in Q1 2006, as compared to Q1 2005, primarily due to theacceptance of its Payments Financial Modeling application at a major domestic bank.This acceptance resulted in $175,000 of software license revenue. The GPCincrease in software license revenue was partially offset by software licenserevenue from our CVE product offering within the RevE business segmentdeclining $122,000, or 40.4%, in Q1 2006 as compared to Q1 2005.

* *

32

----

*Software Maintenance ($ inthousands):*

|                       | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|-----------------------|------------|--------------------------------------------------|------------|--------------|------------|
| ** **            | ** ** | **2006**                                         | ** ** | **2005**     | ** ** | **$** | ** ** | **%** | ** ** |
|                  |       |                                             |       |         |       |   |   |   |   |
| Software  Maintenance |       | $                                                | 10,752     |         | $          | 11,312 |   | $ | (560 | ) | (5.0 | )% |
|                       |            |                                                  |            |              |            |  |  |  |  |  |  |  |

 

As with software license fees, most of our maintenancefees are derived from our GPT business segment. Software maintenance fees arepaid pursuant to annually renewable product and telephone support agreementswith our software customers. The annual maintenance fee is generally paid bythe customer at the beginning of the maintenance period and we recognize thismaintenance revenue ratably over the term of the related contract. If theannual maintenance fee is not paid at the beginning of the maintenance period,we defer revenue recognition until the time that the maintenance fee iscollected. When the payment is received, maintenance revenue is recognized forthe period that maintenance revenue was previously deferred. Also, maintenancecontracts usually carry annual maintenance fee escalation clauses typicallybased on an index, such as the consumer price index. Because our revenuerecognition policy requires the collection of cash before revenue can begin tobe recognized, our software maintenance revenue will fluctuatequarter-to-quarter. For our GPT business segment, one large customer did notpay their maintenance renewal by April 30, 2006 and this resulted in thedeferral of approximately $374,000 in revenue to future periods. Typically, oursoftware maintenance revenue fluctuates between $10.0 million and $11.0 millionper quarter.

*SoftwareImplementation and Other Services ($ in thousands):*

|                                              | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------|------------|--------------|------------|
| ** **                                   | ** ** | **2006**                                         | ** ** | **2005**     | ** ** | **$** | ** ** | **%** | ** ** |
|                                         |       |                                             |       |         |       |   |   |   |   |
| Software Implementation  and  Other Services |       | $                                                | 4,135      |         | $          | 4,134 |   | $ | 1 |   | 0.0 | % |
|                                              |            |                                                  |            |              |            |  |  |  |  |  |  |  |

 

In the majority of our software customer arrangements,installation services are provided to the customer. Most of our softwareimplementation fees are derived from our GPT business segment. The software implementationand other services revenue derived from GPT declined 9.7%, or $344,000, to $3.2million in Q1 2006 as compared to $3.5 million in Q1 2005. This decline wasprimarily within the Payments solutions group and is related to the decreasedsoftware license revenue discussed above. This decline in softwareimplementation and other services revenue within GPT was completely offset byincreases within GPC driven by the new Payments Financial Modeling application,and with a rise in interest rates there has been increased demand for servicesrelated to our legacy Float Analysis and Management Systems application.

*OutsourcingServices ($ in**thousands):*

|                       | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|-----------------------|------------|--------------------------------------------------|------------|--------------|------------|
| ** **            | ** ** | **2006**                                         | ** ** | **2005**     | ** ** | **$** | ** ** | **%** | ** ** |
|                  |       |                                             |       |         |       |   |   |   |   |
| Outsourcing  Services |       | $                                                | 510        |         | $          | 257 |   | $ | 253 |   | 98.4 | % |
|                       |            |                                                  |            |              |            |  |  |  |  |  |  |  |

 

Our outsourcing service revenue is derived throughCarretek, our 51% owned business which outsources payment and transactionprocessing. Carretek was formed in fiscal 2003 and signed its first agreementin the second quarter of fiscal 2004. In fiscal 2005, we expanded our scope ofbusiness with this customer to include a second and third set of transactionprocessing functions which resulted in the increased revenue. While we continueto pursue opportunities to expand the scope of the services we provide to ourexisting customer, we do not expect significant growth on an absolute dollarbasis until additional outsourcing customers are obtained.

* *

33

----

*Out-of-PocketExpense Reimbursements ($ in thousands)*:

|                                       | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|---------------------------------------|------------|--------------------------------------------------|------------|--------------|------------|
| ** **                            | ** ** | **2006**                                         | ** ** | **2005**     | ** ** | **$** | ** ** | **%** | ** ** |
|                                  |       |                                             |       |         |       |   |   |   |   |
| Out-of-Pocket Expense  Reimbursements |       | $                                                | 733        |         | $          | 818 |   | $ | (85 | ) | (10.4 | )% |
|                                       |            |                                                  |            |              |            |  |  |  |  |  |  |  |

 

These reimbursementstend to fluctuate period to period and the decrease is primarily related toreduced international travel within the RevE business segment.

***Cost of Revenues***

*Cost of Revenues by Segment ($ inthousands):*
| ** **                    | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|-------------------------------|------------|--------------------------------------------------|------------|--------------|------------|
| ** **                    | ** ** | **2006**                                         | ** ** | **2005**     | ** ** | **$** | ** ** | **%** | ** ** |
|                          |       |                                             |       |         |       |   |   |   |   |
| Revenue  Enhancement          |       | $                                                | 4,922      |         | $          | 4,471 |   | $ | 451 |   | 10.1 | % |
| % of revenue                  |       | 57.2                                             | %          | 49.7         | %          |   |   |   |   |
|                          |       |                                             |       |         |       |   |   |   |   |
| Global Payments  Technologies |       | $                                                | 7,744      |         | $          | 8,143 |   | $ | (399 | ) | (4.9 | )% |
| % of revenue                  |       | 47.7                                             | %          | 45.3         | %          |   |   |   |   |
|                          |       |                                             |       |         |       |   |   |   |   |
| Global Payments  Consulting   |       | $                                                | 1,068      |         | $          | 901 |   | $ | 167 |   | 18.5 | % |
| % of revenue                  |       | 55.7                                             | %          | 92.5         | %          |   |   |   |   |
|                          |       |                                             |       |         |       |   |   |   |   |
| Business Process  Outsourcing |       | $                                                | 476        |         | $          | 579 |   | $ | (103 | ) | (17.8 | )% |
| % of revenue                  |       | 93.3                                             | %          | 225.3        | %          |   |   |   |   |
|                          |       |                                             |       |         |       |   |   |   |   |
| Total Cost of  Revenues       |       | $                                                | 14,210     |         | $          | 14,094 |   | $ | 116 |   | 0.8 | % |
| % of revenue                  |       | 52.2                                             | %          | 50.0         | %          |   |   |   |   |

 

Overall, total cost of revenues on an absolute dollarbasis remained relatively flat in Q1 2006, as compared to Q1 2005, and theincrease in cost of revenues as a percentage of total revenue is the result ofthe decline in total revenue in Q1 2006 as compared to Q1 2005 that isdiscussed above. RevE’s cost of revenues increased primarily within the cost ofconsulting, as this group begins to change its focus around its CVE productoffering from software license and services to consulting. GPT’s cost ofrevenues declined primarily within cost of software maintenance and is theresult of GPT reducing its workforce by 29 employees in the quarter ended October 31,2005.

*Cost of Consulting ($ in thousands):*

 
| ** **              | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|-------------------------|------------|--------------------------------------------------|------------|--------------|------------|
| ** **              | ** ** | **2006**                                         | ** ** | **2005**     | ** ** | **$** | ** ** | **%** | ** ** |
|                    |       |                                             |       |         |       |   |   |   |   |
| Cost of  Consulting     |       | $                                                | 4,872      |         | $          | 4,241 |   | $ | 631 |   | 14.9 | % |
| % of consulting revenue |       | 56.9                                             | %          | 51.0         | %          |   |   |   |   |
|                         |            |                                                  |            |              |            |  |  |  |  |  |  |  |

 

The cost of consulting consists primarily of personnelcosts related to our consulting engagements within both our RevE and GPCbusiness segments. In Q1 2006, RevE’s cost of consulting increased $498,000 dueto a reallocation of staff to a large consulting engagement. There has not beenan increase in headcount or other costs. The increase in cost of consultingwithin RevE, without an increase in consulting revenue, has increased the costof consulting as a percentage of consulting revenue.

* *

34

----

*Cost of Software Licenses ($ inthousands):*

 

|                                | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|--------------------------------|------------|--------------------------------------------------|------------|--------------|------------|
| ** **                     | ** ** | **2006**                                         | ** ** | **2005**     | ** ** | **$** | ** ** | **%** | ** ** |
|                           |       |                                             |       |         |       |   |   |   |   |
| Cost of Software  Licenses     |       | $                                                | 1,840      |         | $          | 1,536 |   | $ | 304 |   | 19.8 | % |
| % of software  license revenue |       | 72.0                                             | %          | 45.7         | %          |   |   |   |   |
|                                |            |                                                  |            |              |            |  |  |  |  |  |  |  |

 

The cost of software licenses consists principally ofamortization of capitalized and acquired software costs along with royaltiespayable to third parties. The increase in the cost of software licenses in Q12006 is primarily the result of increased royalty expense due to product mix.

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 thesearrangements, we recognize royalty expense when the associated revenue isrecognized. The royalty percentages generally range from 20% to 50% of theassociated revenue. Approximately $346,000 and $92,000 of royalty expense wasrecorded under these agreements and charged to cost of software licenses in Q12006 and Q1 2005, respectively. Depending on our future product mix, ourmargins from software license fees may be negatively impacted by increasedsoftware royalty expense.

*Cost ofSoftware Maintenance ($ in thousands):*

|                                   | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|-----------------------------------|------------|--------------------------------------------------|------------|--------------|------------|
| ** **                        | ** ** | **2006**                                         | ** ** | **2005**     | ** ** | **$** | ** ** | **%** | ** ** |
|                              |       |                                             |       |         |       |   |   |   |   |
| Cost of Software  Maintenance     |       | $                                                | 3,172      |         | $          | 3,975 |   | $ | (803 | ) | (20.2 | )% |
| % of software maintenance revenue |       | 29.5                                             | %          | 35.1         | %          |   |   |   |   |
|                                   |            |                                                  |            |              |            |  |  |  |  |  |  |  |

 

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 its marketability. Thesecosts are primarily contained within our GPT business segment. The decline incosts of maintenance in absolute dollars of $803,000 or 20.2% in Q1 2006, ascompared to Q1 2005, is primarily the result of reduced personnel and personnelrelated costs within the GPT business segment which began primarily in the lasthalf of fiscal 2005 and was the result of the personnel reductions carried outat the beginning of the quarter ended October 31, 2005.

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 theannual maintenance fee is not paid at the beginning of the maintenance period,we defer revenue recognition until the time that the maintenance fee is paid bythe customer. When the payment is received, maintenance revenue is recognizedfor the period that maintenance revenue was previously deferred. As a result,our cost of software maintenance as a percentage of related maintenance revenuewill fluctuate.

* *

35

----

*Cost ofSoftware Implementation and Other Services ($ in thousands):*

|                                                          | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------|------------|--------------|------------|
| ** **                                               | ** ** | **2006**                                         | ** ** | **2005**     | ** ** | **$** | ** ** | **%** | ** ** |
|                                                     |       |                                             |       |         |       |   |   |   |   |
| Cost of Software  Implementation and Other Services      |       | $                                                | 3,076      |         | $          | 2,973 |   | $ | 103 |   | 3.5 | % |
| % of software implementation and other services  revenue |       | 74.4                                             | %          | 71.9         | %          |   |   |   |   |
|                                                          |            |                                                  |            |              |            |  |  |  |  |  |  |  |

 

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 cost of software implementation and other serviceswas relatively flat in Q1 2006 as compared to Q1 2005.

*Cost of Outsourcing Service ($ in thousands):*

|                                   | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|-----------------------------------|------------|--------------------------------------------------|------------|--------------|------------|
| ** **                        | ** ** | **2006**                                         | ** ** | **2005**     | ** ** | **$** | ** ** | **%** | ** ** |
|                              |       |                                             |       |         |       |   |   |   |   |
| Cost of  Outsourcing Service      |       | $                                                | 476        |         | $          | 579 |   | $ | (103 | ) | (17.8 | )% |
| % of outsourcing services revenue |       | 93.3                                             | %          | 225.3        | %          |   |   |   |   |
|                                   |            |                                                  |            |              |            |  |  |  |  |  |  |  |

 

The cost of outsourcing service fees relates to theoperation of Carretek, our 51% owned business outsourcer for payment andtransaction processing. To date, this business only had a single customer. Earlyin fiscal 2005, we expanded our scope with this single customer fromoutsourcing one function to three functions, which resulted in increased costsin this area due to more training, travel and other up front costs beingincurred in Q1 2005. Costs have returned to normalized levels in Q1 2006.

*Out-of-PocketExpenses ($ in thousands):*

|                                           | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|-------------------------------------------|------------|--------------------------------------------------|------------|--------------|------------|
| ** **                                | ** ** | **2006**                                         | ** ** | **2005**     | ** ** | **$** | ** ** | **%** | ** ** |
|                                      |       |                                             |       |         |       |   |   |   |   |
| Cost of  Out-of-Pocket Expenses           |       | $                                                | 774        |         | $          | 790 |   | $ | (16 | ) | (2.0 | )% |
| % of out-of-pocket expense reimbursements |       | 105.6                                            | %          | 96.6         | %          |   |   |   |   |
|                                           |            |                                                  |            |              |            |  |  |  |  |  |  |  |

 

These costs represent travel, meals and other sundryexpenses incurred by our employees. These costs are invoiced to the customer,without mark-up, usually on a monthly basis. The costs have remained relativelyflat for Q1 2006 as compared to Q1 2005. In addition, certain customercontracts contain expense maximums, so in certain cases not all expensesincurred can be passed along to the customer without contractual revisions orthe customer’s express written approval, which can increase the volatility ofthe cost of out-of-pocket expense as a percentage of out-of-pocket expensereimbursements.

36

----

***Operating Costs and Expenses:***

*Selling, Generaland Administrative Expenses ($ in thousands):*

|                                               | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------------|------------|--------------|------------|
| ** **                                    | ** ** | **2006**                                         | ** ** | **2005**     | ** ** | **$** | ** ** | **%** | ** ** |
|                                          |       |                                             |       |         |       |   |   |   |   |
| Selling, General  and Administrative Expenses |       | $                                                | 10,780     |         | $          | 10,904 |   | $ | (124 | ) | (1.1 | )% |
| % of total  revenue                           |       | 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 fordoubtful accounts, insurance, including directors and officers liabilityinsurance, as well as professional services, such as legal and accountingexpenses, and other related costs are classified within selling, general andadministrative expense. Although our selling, general and administrativeexpenses were essentially flat in absolute dollars in Q1 2006, as compared toQ1 2005, there were significant changes within the underlying expensecategories:  corporate sales andmarketing declined $493,000, along with a $664,000 decline in sales-relatedcosts within our three primary business segments. These declines were partiallyoffset by increases in general and administrative costs related to professionalfees of $703,000 resulting from legal fees arising out of lawsuits in which weare the plaintiff and increased accounting and other professional fees relatedto the restatement of our financial statements which was announced in April 2006.See Item 4. Controls and Procedures. Additionally, in Q1 2006, we began toexpense stock-based compensation and approximately $303,000 of expense wascharged to selling, general and administrative expense.

*Research and Development**($ in thousands):*

|                                    | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|------------------------------------|------------|--------------------------------------------------|------------|--------------|------------|
| ** **                         | ** ** | **2006**                                         | ** ** | **2005**     | ** ** | **$** | ** ** | **%** | ** ** |
|                               |       |                                             |       |         |       |   |   |   |   |
| Research and  Development Expenses |       | $                                                | 2,205      |         | $          | 2,521 |   | $ | (316 | ) | (12.5 | )% |
| % of total  revenue                |       | 8.1                                              | %          | 8.9          | %          |   |   |   |   |
|                                    |            |                                                  |            |              |            |  |  |  |  |  |  |  |

 

Research and development expenses consist primarilyof personnel, contract labor, travel and facilities expenses. Research anddevelopment costs are typically limited to development of new softwareproducts, or enhancements to existing software products, which extend theproduct’s life cycle and/or substantially increase its marketability. In bothQ1 2006 and Q1 2005, the majority of research and development costs related tonew product development within our GPT Payment Solutions group.

In accordance with SFAS No. 86, “*Accounting for Costs of Software**to be Sold, Leased or Otherwise Marketed,”*we capitalized $526,000 of software development costs in Q1 2006 as compared to$437,000 in Q1 2005. Software development costs of a product are capitalizedfrom the time technological feasibility is reached until the general release ofthe product. We establish technological feasibility through the process ofcreating a detailed program design and reviewing the detailed program designfor any high risk development issues or through the creation of a working model.Capitalization only occurs if we believe costs capitalized are recoverablethrough future sales of the software product under development. We currentlyhave six projects underway in which costs were capitalized in Q1 2006. Three ofthese projects are within Risk solutions and three are within Cash &Logistics solutions. All six solutions are scheduled to be completed in late Q22006 or early Q3 2006.

37

----

*Amortization of Customer Relationships:*  Amortization of customer relationships was$350,000 in both Q1 2006 and Q1 2005. The amortization results from theperiodic recognition of amortization expense of intangible customerrelationships acquired in the Check Solutions acquisition in fiscal 2001, andthis amortization will continue until May 2007.

*Restructuringand Other Charges:*  There were no restructuring and other chargesrecorded during Q1 2006. However, we recorded $127,000 in restructuringand other charges during Q1 2005, principally associated with the separation of6 employees. We also lowered our estimate by $32,000 for the costs associatedwith the discontinuance of one of our software offerings originally recorded inJanuary 2004.

The activity related to the accruedmerger and restructuring costs during Q1 2006 is as follows (in thousands):

|                                           | ** ** | **Workforce  Reductions** | ** ** | **CheckFlow  Suite** | ** ** | **Other** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|---------------------------|------------|----------------------|------------|-----------|------------|-----------|------------|
|                                      |       |                      |       |                 |       |      |       |      |       |
| Reserve balance  at January 31, 2006 |       | $                         | 87         |                 | $          | 200       |       | $         | 47         |   | $ | 334 |   |
| Additions to  reserve balance:            |       |                      |       |                 |       |      |       |      |       |
| Severance charges                         |       | —                    |       | —               |       | —    |       | —    |       |
| Reductions to  reserve balances:          |       |                      |       |                 |       |      |       |      |       |
| Change in estimate                        |       | —                    |       | —               |       | —    |       | —    |       |
| Cash paid                                 |       | (87                       | )          | —               |       | —    |       | (87       | )          |
| Reserve balance  at April 30, 2006   |       | $                         | —     |                 | $          | 200       |       | $         | 47         |   | $ | 247 |   |

 

We anticipate the remaining reserve accruals at April 30,2006 will be paid or remaining customer obligations completed within the next 3months.

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

*Interest Income ($ in thousands):*

|                 | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|-----------------|------------|--------------------------------------------------|------------|--------------|------------|
| ** **      | ** ** | **2006**                                         | ** ** | **2005**     | ** ** | **$** | ** ** | **%** | ** ** |
|            |       |                                             |       |         |       |   |   |   |   |
| Interest Income |       | $                                                | 271        |         | $          | 144 |   | $ | 127 |   | 88.2 | % |
|                 |            |                                                  |            |              |            |  |  |  |  |  |  |  |

 

Interest income consists of interest earned onmarketable securities and cash and cash equivalents. The increase in interestincome in Q1 2006, as compared to Q1 2005, is primarily the result of higheraverage invested balances in Q1 2006 and higher yields on these investments.

*Interest Expense ($ in thousands):*

|                  | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|------------------|------------|--------------------------------------------------|------------|--------------|------------|
| ** **       | ** ** | **2006**                                         | ** ** | **2005**     | ** ** | **$** | ** ** | **%** | ** ** |
|             |       |                                             |       |         |       |   |   |   |   |
| Interest Expense |       | $                                                | (105       | )            | $          | (105 | ) | $ | — |   | — | % |
|                  |            |                                                  |            |              |            |  |  |  |  |  |  |  |

 

Interest expense is primarily the result of thecommitment fees associated with the maintenance of our $30.0 million revolvingcredit agreement. Additionally, the amortization of the deferred loan costs isalso included in interest expense. There have been no borrowings outstandingunder this credit agreement since the quarter ended April 30, 2004.

38

----

*Other income ($ in thousands):*

|                                             | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|---------------------------------------------|------------|--------------------------------------------------|------------|--------------|------------|
| ** **                                  | ** ** | **2006**                                         | ** ** | **2005**     | ** ** | **$** | ** ** | **%** | ** ** |
|                                        |       |                                             |       |         |       |   |   |   |   |
| Minority share  of net loss of Carretek LLC |       | $                                                | 133        |         | $          | 318 |   | $ | (185 | ) | (58.2 | )% |
| Foreign exchange  (losses) / gains          |       | 70                                               |       | (17          | )          | 87 |   | 511.8 | % |
| Other                                       |       | (3                                               | )          | 5            |       | (8 | ) | (160.0 | )% |
|                                        |       |                                             |       |         |       |   |   |   |   |
| Total                                       |       | $                                                | 200        |         | $          | 306 |   | $ | (106 | ) | (34.6 | )% |

 

We own a 51% interest in Carretek LLC (“Carretek”),through which we offer financial institutions offshore-centric outsourcing oftheir business processes. Carretek has generated approximately $291,000 and$626,000 in losses for Q1 2006 and Q1 2005, respectively. Accordingly, the 49%share in these losses relating to the minority interest held by MajescoSoftware, Inc., or $133,000 and $318,000 was recorded in other income(expense) in Q1 2006 and Q1 2005, respectively.

*Provisionfor Income Taxes:*  The provision for income taxes isbased on the estimated annual effective tax rate, and includes federal, stateand foreign income taxes. In Q1 2006 and Q1 2005, the majority of our taxprovision consisted of foreign taxes incurred that could not be offset withU.S. tax benefits. For us to realize the benefit of our net operating losscarryforward and other deferred tax assets recorded as of April 30, 2006,we must generate substantial future taxable income. Due to our inconsistenthistory of generating profitable operations and taxable income, we maintain avaluation allowance to fully reserve the net deferred tax assets.

**Liquidity and Capital Resources**

Historically, we have funded our operations and cashexpenditures primarily with cash generated from operating activities. At April 30,2006, we had working capital of $19.6 million compared to $17.9 million at January 31,2006. We had $34.8 million in cash and cash equivalents at April 30, 2006,an increase of $5.1 million from $29.7 million in cash and cash equivalents at January 31,2006. However, we also had $5.9 million of “available for sale” marketablesecurities at April 30, 2006, compared to $4.7 million at January 31,2006. At April 30, 2006 and January 31, 2006, we did not have anyborrowings outstanding under our revolving line of credit. We expect thatexisting cash, marketable securities and cash generated from operating activitieswill be sufficient to meet our presently anticipated requirements for theforeseeable future.

Cash provided by operating activities was $7.9 millionfor the three months ended April 30, 2006 compared to cash provided byoperating activities of $2.1 million in the three months ended April 30,2005. The increase was primarily the result of the timing of the collection of2006 calendar year maintenance billings as compared to the collection of the2005 calendar year maintenance billings.

Average days’ sales outstandingfluctuate for a variety of reasons, including the timing of billings specifiedby contractual agreement, and receivables for expense reimbursements. Thefollowing table contains the quarterly days’ sales outstanding (DSO):

| Quarter ended     | ** ** | **DSO** | ** ** |
|------------------------|------------|---------|------------|
|                   |       |    |       |
| April 30,  2006   |       | 33      |       |
| January 31,  2006 |       | 37      |       |
| October 31,  2005 |       | 42      |       |
| July 31,  2005    |       | 49      |       |
| April 30,  2005   |       | 35      |       |

 

39

----

Cash used in investing activities increased to $2.8million during the three months ended April 30, 2006 as compared to $1.1million during the three months ended April 30, 2005. Capital expendituresof $1.0 million were made in the three months ended April 30, 2006, ascompared to $698,000 for the three months ended April 30, 2005 and haveincreased due to costs capitalized in connection with our ERP system upgrade. Purchasesof marketable securities were $3.5 million and sales of marketable securitieswere $2.3 million for the three months ended April 30, 2006. Additionally,the amount of capitalized software increased to $526,000 in the three monthsended April 30, 2006, as compared to $437,000 for the three months ended April 30,2005, due to increased product development activity within our GPT businesssegment.

There were no financing activities in thethree months ended April 30, 2006; however, financing activities providedcash of $254,000 in the three months ended April 30, 2005. At April 30,2005, we purchased $349,000 of our common stock under a program to purchase upto $5.0 million during the period April 18, 2005 through October 14,2005. These treasury stock purchases were offset by $52,000 of proceeds fromthe exercise of stock options and a $551,000 minority shareholder cashinvestment in Carretek LLC.

We are a party to a revolving creditagreement with a group of banks providing for a commitment amount of $30.0million and a maturity date of July 31, 2006. At April 30, 2006 and April 30,2005, the Company did not have any borrowings outstanding. Borrowings under thecredit agreement bear interest equal to either the greater of prime or federalfunds rate plus a margin ranging from 1.25% to 2.25% depending on our ratio offunded debt to Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”);or London Interbank Offered Rate (“LIBOR”) plus a margin equal to 2.75% to3.75% depending on our ratio of funded debt to EBITDA. Interest payments aredue quarterly. We are required to pay an annual commitment fee equal to 0.50%on the unused amount of the revolving credit agreement. The revolving creditagreement contains customary affirmative and negative covenants, some of whichhave been amended, including financial covenants requiring the maintenance ofspecified interest coverage, ratio of EBITDA to funded debt, and ratio of 80%of accounts receivable, cash and short term investments to funded debt. Additionally,the payment of dividends and the purchase of treasury stock is precludedsubject to the approval of the banks. Substantially all of our assetscollateralize this revolving credit agreement. As of April 30, 2006, weare in compliance with the covenants of the revolving credit agreement, asamended.

We are currently discussing the renewal of our creditfacility with our existing lenders. The terms of any renewal are not expectedto be significantly different than the current terms should the facility berenewed by and with our existing lenders. Any renewal is expected to becomplete by July 31, 2006.

The following summarizes our contractual obligationsat April 30, 2006 and the effect these contractual obligations areexpected to have on our liquidity and cash flows in future periods (inthousands):
| ** **       | ** ** | **Payments Due by Period** | ** ** |
|------------------|------------|-------------------------------------------|------------|
| ** **       | ** ** | **Total**                                 | ** ** | **1 Year  or Less** | ** ** | **Years 2-3** | ** ** | **Years 4-5** | ** ** | **After  5 Years** | ** ** |
|             |       |                                      |       |   |   |   |   |   |   |   |   |
| Operating leases |       | $                                         | 11,273     |   | $ | 3,300 |   | $ | 5,581 |   | $ | 2,392 |   | $ | — |   |
|             |       | $                                         | 11,273     |   | $ | 3,300 |   | $ | 5,581 |   | $ | 2,392 |   | $ | — |   |

 

We believe that current cash balances andmarketable securities and expected future cash flows will be sufficient to meetour anticipated cash needs for working capital and routine capital expendituresduring fiscal 2006. However, if current sources are not sufficient to meet ourneeds, we may seek additional equity or debt financing. There can be noassurance that additional financing would be available on acceptable terms, ifat all. Further, we may in the future pursue acquisitions of businesses,products or technologies that could complement or expand our business andproduct offerings, and change our financing needs. Our forecast of the periodof time through which our financial resources will be adequate to support ouroperations are forward looking statements that involve risks and uncertainties,and actual results could vary. The failure to secure additional financing whenneeded could have a material adverse effect on our business, financialcondition and results of operations.

40

----

**CriticalAccounting 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 considerthe following seven accounting policies the most important to the portrayal ofour financial condition and those that require the most subjective judgment. Althoughwe believe that our estimates and assumptions are reasonable, actual resultsmay differ, and such differences could 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, “*Modification of SOP 97-2,**SoftwareRevenue Recognition with Respect to Certain Transactions,”* StaffAccounting Bulletin (“SAB”) No. 104,*“Revenue Recognition,”* and Emerging Issues Task Force (“EITF”) No. 00-21,*“Revenue Arrangements with Multiple Deliverables.”* In the case of software arrangements thatrequire significant production, modification, or customization of software, orthe license agreement requires the Company to provide implementation servicesthat are determined to be essential to other elements of the arrangement, theCompany follows the guidance in SOP 81-1, *“Accountingfor Performance of Construction—Type and Certain Production—Type Contracts.”*

In the case of non-software arrangements, we applyEITF No. 00-21 and revenues related to arrangements with multipleelements are allocated to each element based on the element’s relative fairvalue. Revenue allocated to separate elements is recognized for each element inaccordance with our accounting policies described 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.**  *The Company employs three primary pricing methods inconnection with its delivery of consulting services. First, the Company mayprice its delivery of consulting services on the basis of time and materials,in which case the customer is charged agreed-upon daily rates for servicesperformed and out-of-pocket expenses. In this case, the Company isgenerally paid fees and related amounts usually on a monthly basis, and theCompany recognizes revenues as the services are performed. Second, the Companymay deliver consulting services on a fixed-price basis. In this case, theCompany is paid on a monthly basis or pursuant to an agreed upon paymentschedule, and the Company recognizes revenues on a proportionate performancebasis. The Company believes that this method is appropriate because of itsability to determine performance milestones and determine dependable estimatesof its costs applicable to each phase of a contract. Because financialreporting of these contracts depends on estimates, which are assessed continuallyduring the term of the contract, costs are subject to revisions as the contractprogresses. Anticipated losses on fixed-price contracts are recognized whenestimable. 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 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 andresources to develop projections associated with value-pricing contracts beforea customer will commit to purchase its solutions, and the Company thereforeassumes the risk of making these commitments with no assurance that thecustomer will purchase the solution. Costs associated with these value-pricingcontracts are expensed as incurred. These contracts typically include paymentsto be made to the Company pursuant to an agreed upon schedule ranging from oneto twelve months in length. The Company recognizes revenues generated fromconsulting services in connection with value-priced contracts once customeracknowledgement is obtained that confirms fees have become fixed anddeterminable. In some cases, these acknowledgements contain future deliverablesor services, in which case the revenue from these engagements is recognized ona proportionate performance basis based on the efforts to be incurred followingthe customer acknowledgement. In an effort to allow customers to more closelymatch expected benefits from services with payments to the Company, the Companyon occasion, may offer payment terms which extend 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 paid based on a percentage of actual revenuesand/or savings to customers, the Company 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 are includedas a component of the cost of consulting fees.

41

----

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.**  *Aperpetual software license is sold either together with implementation servicesor on a stand-alone basis. The Company is usually paid software licensefees in one or more installments, as provided in the customer’s contract butnot to exceed twelve months. The Company recognizes software license revenueupon execution of a contract and delivery of the software, provided that thelicense fee is fixed and determinable, no significant production, modificationor customization of the software is required and collection is consideredprobable by management. When the software license arrangement requires theCompany to provide implementation services that are essential to thefunctionality of the software or significant production, customization ormodification of the software is required, both the product license revenue andimplementation fees are recognized as services are performed. A term softwarelicense is sold either together with implementation services and/or withmaintenance services. These term licenses are usually paid in annualinstallments over the term of the license. If the term software license is soldwithout essential implementation services, the revenue is recognized ratablyover the non-cancelable license term. If the term license is sold withessential implementation services, the license revenue is recognized as thelesser of the amount of license revenue recognized as services are performed oron 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 thefirst two installations of a recently developed 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. The Company determines whether there is vendorspecific objective evidence of fair value (“VSOEFV”) for each elementidentified in the arrangement to determine whether the total arrangement feescan be allocated to each element. If VSOEFV exists for each element, the totalarrangement fee is allocated based on the relative fair value of each element. Incases where there is not VSOEFV for each element, or if it is determinedservices are essential to the functionality of the software being delivered, orif significant production, modification or customization of the software isrequired, the Company initially defers revenue recognition of the softwarelicense fees until VSOEFV is established or the services are performed. However,if VSOEFV is determinable for all of the undelivered elements, and assuming theundelivered elements are not essential to the delivered elements, the Companywill defer recognition of the full fair value related to the undeliveredelements and recognize the remaining portion of the arrangement value throughapplication 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. Evidenceof VSOEFV is determined for software products based on actual sales prices forthe product sold to a similar class of customer and based on pricing strategiesset forth in the Company’s price book. 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 VSOEFV for maintenance agreements using thepercentage method such that VSOEFV for maintenance is a percentage of thelicense fee charged annually for a specific software product, which in mostinstances is 20% of the portion of arrangement fees allocated to the softwarelicense 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. Thelevel of license fees earned by the Company under these arrangements will varybased on the actual amount of use by the customer. Revenue under thesearrangements is recognized on a monthly basis as the usage becomesdeterminable.

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

42

----

*SoftwareImplementation and Other Services.**  *Inconnection with the sale of a software license, a customer may elect topurchase software implementation services, including software enhancements andother software services. Most of the customers that purchase software licensesfrom the Company also purchase software implementation services. The Companyprices its implementation services on a time-and-materials or on afixed-price basis, and the Company recognizes the related revenues asservices are performed. Costs associated with these engagements are expensed asincurred.

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

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

Royalties

We are required to pay royalties inconnection with software license, maintenance and consulting agreements enteredinto with certain customers under which we acquired third party softwaretechnology or other intellectual property used in products and services sold toour customers. Under these arrangements, we accrue royalty expense when theassociated revenue is recognized. For current product offerings, the royaltypercentages generally range from 20%-50% of the associated revenues. Royaltyexpense is primarily included as a component of the cost of software licenserevenues; however, certain amounts are also included in cost of consulting andcost of software maintenance in the accompanying consolidated statements ofoperations.

Allowance for DoubtfulAccounts

A large proportion of our revenues and receivables areattributable to our customers in the banking industry. Our trade accountsreceivable balance is recorded net of allowances for amounts not expected to becollected from our customers. Because our accounts receivable are typicallyunsecured, we periodically evaluate the collectibility of our accounts based ona combination of factors, including a particular customer’s ability to pay aswell as the age of receivables. In cases where the evidence suggests a customermay not be able to satisfy its obligation to us or if the collection of thereceivable becomes doubtful due to a dispute that arises subsequent to thedelivery of our products and services, we set up a specific reserve in anamount we determine appropriate for the perceived risk. If circumstanceschange, such as higher than expected defaults or an unexpected material adversechange in a customer’s ability to meet their financial obligations to us, ourestimates of recoverability of amounts due us could be reduced by a materialamount.

Software CostsCapitalized, Acquired Developed Technology, Goodwill, Other Intangible Assetsand 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 softwaredevelopment costs, other than costs for internal-use software, in accordancewith Statement of Financial Accounting Standards No. 86, “*Accounting for Costs of Computer Software to be Sold,Leased or Otherwise Marketed”* (“SFAS 86”). Our policy is tocapitalize software development costs incurred in developing a product oncetechnological feasibility of the product has been established. Softwaredevelopment costs capitalized also include amounts paid for purchased softwareon products that have reached technological feasibility. Technologicalfeasibility of the product is determined after completion of a detailed programdesign and a determination has been made that any uncertainties related tohigh-risk development issues have been resolved. If the process of developingthe product does not include a detailed program design, technologicalfeasibility is determined only after completion of a working model. Allcapitalized software development costs are amortized using an amount determinedas the greater of: (1) the ratio that current gross revenues for acapitalized software project bears to the total of current and future projectedgross revenues for that project or (2) the straight-line method over theestimated remaining economic life of the product (generally three to six years).We continually 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 thequarterly period ended January 31, 2006, we performed our annual formalevaluation for impairment and determined that the carrying amount of theseassets was not impaired and have noted no subsequent factors that wouldindicate impairment.

43

----

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. We perform an annual impairment assessmenton November 1st of each year or when factors indicate thatgoodwill should be evaluated for possible impairment. During the quarterlyperiod ended January 31, 2006, we performed our annual evaluation forgoodwill impairment and determined that the carrying amount of goodwill was notimpaired and have not noted any factors subsequent that would indicateimpairment. Goodwill at April 30, 2006 totaled $20.8 million. Anydeterioration in market conditions, increases in interest rates and changes inour projections with respect to the Global Payments Technologies reporting unitto which goodwill is allocated would result in additional impairment charges inthe 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 wedo not anticipate any significant changes in the future, the actual costs maydiffer from these estimates.

Contingencies

We are subject to proceedings, lawsuits and otherclaims. We are required to assess the likelihood of any adverse judgments oroutcomes to these matters as well as potential ranges of probable losses. Adetermination of the amount or reserves required, if any, for thesecontingencies is made after careful analysis of each individual issue. Therequired reserves may change in the future due to new developments in eachmatter or changes in insurance coverage or approach such as change insettlement strategy.

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 forrecoverability and establish a valuation allowance based on historical taxableincome, projected future taxable income and the expected timing of the reversalsof existing temporary differences. As a result of our recent history ofinconsistent profitability, we have provided a full valuation allowance againstour net deferred tax assets. In addition, we expect to provide a full valuationallowance of any future tax benefits until we can sustain a level ofprofitability that demonstrates our ability to utilize these assets.

**Recently IssuedAccounting Standards**

None.

44

----

**Item 3.**                          Quantitativeand Qualitative Disclosures about Market Risk

**Interest Rate Risk**

We invest our cash in a variety of financialinstruments. The vast majority of these investments are denominated in U.S.dollars and maintained with nationally recognized financial institutions.

Investments in bothfixed rate and floating rate interest earning instruments carry a degree ofinterest rate risk. Fixed rate securities may have their fair market valueadversely impacted due to a rise in interest rates, while floating ratesecurities may produce less income than expected 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 changes in interest rates. At April 30, 2006, we held $5.9million of auction rate securities. The interest rate for these notes willadjust to the current market interest rate at each interest reset date, whichis typically on at least a monthly basis.

We had no outstanding borrowingsunder our revolving credit agreement at April 30, 2006. As described inNote 4 of our Notes to Condensed Consolidated Unaudited Financial Statements,the interest rate under the revolving credit agreement is variable.

**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 assets and liabilities outside the UnitedStates that are subject to fluctuations in foreign currency exchange rates. Dueto the nature of these operations, we currently utilize the U.S. Dollar as thefunctional currency for all international operations. Within Carretek LLC, our51% owned subsidiary which offers financial institutions offshore-centricoutsourcing of their business processes, the majority of the labor costs isdenominated in Indian Rupees while the revenues from this operation aredenominated in U.S. Dollars. As our operations increase, fluctuating laborcosts may increase our foreign currency risk.

Aninsignificant portion of our accounts receivable balance at April 30, 2006was denominated in a foreign currency. We do not currently hedge our foreigncurrency exposure; however, we do try to limit our foreign currency exposure bynegotiating these foreign contracts in U.S. Dollars. In the future we maychange this practice. We will continue to evaluate the need to adopt a hedgestrategy in the future and may implement a formal strategy in future periods.

Foreignexchange gains were $70,000 for the three months ended April 30, 2006 andforeign exchange losses were $17,000 in the three months ended April 30,2005.

45

----

**Item 4.**                          Controlsand Procedures

*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.

As previously reported in our Annual Report on Form 10-Kfor the year ended January 31, 2006, our management, under the supervisionand with the participation of our Chief Executive Officer and Chief FinancialOfficer, carried out an evaluation of our disclosure controls and procedures asof January 31, 2006. Based on their evaluation, a material weakness in ourinternal control over financial reporting was identified, and the ChiefExecutive Officer and Chief Financial Officer concluded that, as of January 31,2006, our disclosure controls and procedures were ineffective.

A material weakness is a control deficiency, or acombination of control deficiencies, that results in more than a remotelikelihood that a material misstatement of our annual or interim financialstatements will not be prevented or detected. In connection with the evaluationdescribed above, it was determined that as of January 31, 2006 we did notmaintain effective controls over the preparation and review of our deferredsoftware maintenance reconciliations. As a result of this material weakness,software maintenance revenue and deferred maintenance revenue were over andunderstated, respectively, by $2.0 million for the year ended January 31,2004, and accumulated deficit and deferred maintenance revenue were over andunderstated, respectively, by $2.0 million for the year ended January 31,2005. We restated our audited consolidated financial statements for the yearsended January 31, 2005 and 2004 to correct these errors, which financialstatements were included in our Annual Report on Form 10-K for theyear ended January 31, 2006.

Following identification of the material weaknessdescribed above, we took certain remediation steps more fully described below,and management believes that the implementation of these steps has remediatedthe identified material weakness.

Our management, under the supervision and with the participationof our Chief Executive Officer and Chief Financial Officer, has again evaluatedthe effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) of the Exchange Act). As of April 30, 2006, theycarried out an evaluation of our disclosure controls and procedures, and theChief Executive and Chief Financial Officers believe that these disclosure****controls and procedures are effective to ensure that we areable to collect, process and disclose the information we are required todisclose in the reports we file with 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*

As described above, as of January 31, 2006 ourmanagement identified a material weakness in our internal control overfinancial reporting. In response to this material weakness, we establishedspecific processes and controls and modified others to provide reasonableassurance that reconciliations are performed as a part of standardizedprocedures and reconciling items are properly identified and reported on aperiodic basis. As a result of the implementation of these measures, managementbelieves as of April 30, 2006 that this material weakness has beenremediated. Except for the referenced remediation steps, there have been noother changes in our internal control over financial reporting during theperiod covered by this report that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

46

----

**PART II: OTHERINFORMATION**

**ITEM 1.**                    LEGALPROCEEDINGS

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 to the information contained in Part I,Item 3. Legal Proceedings in our Form 10-K for the period ended January 31,2006.

*Shareholder Derivative Suit.*

In May 2006, the District Court approved thefinal settlement of the pending shareholder derivative suit, and the litigationwas terminated.

*Shareholder Class Action.*

The proposed settlement was preliminarily approved bythe District Court on May 5, 2006, but remains subject to final courtapproval.

**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, 2006and summarized in this report under “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.” These risks and uncertainties may affect our current position and futureprospects, and should be considered carefully in evaluating us and aninvestment in our common stock.

**ITEM 2.**                    UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

**ITEM 3.**                    DEFAULTS UPONSENIOR SECURITIES

None.

**ITEM 4.**                    SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS

None

**ITEM 5.**                    OTHERINFORMATION

None.

47

----

**ITEM6.**EXHIBITS

| Number | ** ** | **Exhibit Description**                                                                                                                                                                                                                                                        | ** ** |
|--------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| 10.1   |       | Board  Representation Agreement dated March 24, 2006 between the Company,  Prescott Group Capital Management, L.L.C., Phil Frohlich and Jeffrey D.  Watkins (incorporated by reference to Exhibit 10.1 of the Company’s  Form 8-K filed on March 27, 2006) |       |
|   |       |                                                                                                                                                                                                                                                                                |       |
| 10.2   |       | Employment  Agreement dated April 19, 2006 between the Company and Blake A. Williams                                                                                                                                                                                           |       |
|   |       |                                                                                                                                                                                                                                                                                |       |
| 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                                                                                                                                                  |       |

 

48

----

**SIGNATURES**

Pursuant to the requirements of the Securities Act of1934, the Registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.
| CARREKER CORPORATION |
|----------------------|
|                 |   |   |
| By:                  | /s/ John D. Carreker, Jr. |       Date: June 8, 2006 |
|                 | John D. Carreker, Jr. |   |
|                 | Chairman of the Board and Chief Executive Officer |   |
|                 |   |   |
| By:                  | /s/ Lisa K. Peterson |       Date: June 8, 2006 |
|                 | Lisa K. Peterson |   |
|                 | Chief Financial Officer |   |

 

49

----