**United StatesSecurities and Exchange Commission**

**Washington,D.C.  20549**

 

# **FORM10-Q**

 

**ý****Quarterly Report Pursuant to Section 13or 15(d) of the Securities Exchange Act of 1934 for the Period Ended April 30,2005.**

 

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

 

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

 

**Carreker Corporation**

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

 

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

Yes  ý    No  o

 

Indicate the number of shares outstandingof each of the issuer’s classes of common stock, as of the latest practicaldate.

 

Common Stock, $.01 par value --- 24,539,636 shares as of May 31, 2005.

 

 

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**CARREKERCORPORATIONIndex**

 
| **PART 1:**    | ** ** | **FINANCIAL INFORMATION**                                                                                          | ** ** | ** ** |
|----------------|------------|--------------------------------------------------------------------------------------------------------------------|------------|------------|
| ** **     | ** ** | ** **                                                                                                         | ** ** | ** ** |
| **Item 1.**    | ** ** | **Financial Statements (unaudited)**                                                                               | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                         | ** ** | ** ** |
| ** **     | ** ** | **Condensed Consolidated Balance Sheets at April 30,  2005 and January 31, 2005**                        | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                         | ** ** | ** ** |
| ** **     | ** ** | **Condensed Consolidated Statements of  Operations for the three months ended April 30, 2005 and 2004**  | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                         | ** ** | ** ** |
| ** **     | ** ** | **Condensed Consolidated Statements of  Stockholders’ Equity for the three months ended April 30, 2005** | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                         | ** ** | ** ** |
| ** **     | ** ** | **Condensed Consolidated Statements of Cash  Flows for the three months ended April 30,  2005 and 2004** | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                         | ** ** | ** ** |
| ** **     | ** ** | **Notes to Condensed Consolidated Unaudited  Financial Statements**                                                | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                         | ** ** | ** ** |
| **Item 2.**    | ** ** | **Management’s Discussion and Analysis of  Financial Condition and Results of Operations**                    | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                         | ** ** | ** ** |
| **Item 3.**    | ** ** | **Quantitative and Qualitative Disclosures  about Market Risk**                                                    | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                         | ** ** | ** ** |
| **Item 4.**    | ** ** | **Controls and Procedures**                                                                                        | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                         | ** ** | ** ** |
| **PART II:**   | ** ** | **OTHER INFORMATION**                                                                                              | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                         | ** ** | ** ** |
| **Item 1.**    | ** ** | **Legal Proceedings**                                                                                              | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                         | ** ** | ** ** |
| **Item 2.**    | ** ** | **Unregistered Sales of Equity Securities and  Use of Proceeds**                                                   | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                         | ** ** | ** ** |
| **Item 3.**    | ** ** | **Defaults Upon Senior Securities**                                                                                | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                         | ** ** | ** ** |
| **Item 4.**    | ** ** | **Submission of Matters to a Vote of Security  Holders**                                                           | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                         | ** ** | ** ** |
| **Item 5.**    | ** ** | **Other Information**                                                                                              | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                         | ** ** | ** ** |
| **Item  6.**   | ** ** | **Exhibits**                                                                                                       | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                         | ** ** | ** ** |
| **SIGNATURES** | ** ** | ** **                                                                                                         | ** ** | ** ** |

 

2

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**PART I:  FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

 

**CARREKERCORPORATIONCondensed ConsolidatedBalance Sheets(Unaudited)(In thousands, except pershare amounts)**

 
| ** **                                                                                                                                             | ** ** | **April 30,** | ** ** | **January 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                                                                                                                             | ** ** | **2005**           | ** ** | **2005**             | ** ** |
| ** **                                                                                                                                             | ** ** | ** **         | ** ** | ** **           | ** ** |
| **ASSETS**                                                                                                                                             | ** ** | ** **         | ** ** | ** **           | ** ** |
| Current  assets                                                                                                                                        |       |               |       |                 |       |
| Cash and  cash equivalents                                                                                                                             |       | $                  | 35,745     |                 | $          | 34,516 |   |
| Accounts receivable,  net of allowance of $504 and $529 at April 30, 2005 and January 31,  2005, respectively                                |       | 10,736             |       | 11,144               |       |
| Prepaid  expenses and other current assets                                                                                                             |       | 3,216              |       | 2,595                |       |
| Total  current assets                                                                                                                                  |       | 49,697             |       | 48,255               |       |
|                                                                                                                                                   |       |               |       |                 |       |
| Property and  equipment, net of accumulated depreciation of $20,785 and $20,194 at April 30,  2005 and January 31, 2005, respectively        |       | 6,509              |       | 6,604                |       |
| Capitalized  software costs, net of accumulated amortization of $12,692 and $12,426 at April 30,  2005 and January 31, 2005, respectively    |       | 3,416              |       | 3,245                |       |
| Acquired  developed technology, net of accumulated amortization of $16,928 and $15,773  at April 30, 2005 and January 31, 2005, respectively |       | 8,772              |       | 9,927                |       |
| Goodwill,  net of accumulated amortization of $3,405 at April 30, 2005 and January 31,  2005                                                 |       | 20,765             |       | 20,765               |       |
| Customer  relationships, net of accumulated amortization of $5,483 and $5,133 at April 30,  2005 and January 31, 2005, respectively          |       | 2,917              |       | 3,267                |       |
| Deferred  loan costs, net of accumulated amortization of $1,368 and $1,300 at April 30,  2005 and January 31, 2005, respectively             |       | 340                |       | 407                  |       |
| Other assets                                                                                                                                           |       | 829                |       | 835                  |       |
| Total assets                                                                                                                                           |       | $                  | 93,245     |                 | $          | 93,305 |   |
|                                                                                                                                                   |       |               |       |                 |       |
| Current  liabilities                                                                                                                                   |       |               |       |                 |       |
| Accounts  payable                                                                                                                                      |       | $                  | 874        |                 | $          | 992 |   |
| Accrued  compensation and benefits                                                                                                                     |       | 5,953              |       | 7,818                |       |
| Other  accrued expenses                                                                                                                                |       | 3,639              |       | 3,609                |       |
| Income tax  payable                                                                                                                                    |       | 350                |       | 339                  |       |
| Deferred  revenue                                                                                                                                      |       | 23,981             |       | 22,181               |       |
| Accrued  merger and restructuring costs                                                                                                                |       | 561                |       | 1,004                |       |
| Total  current liabilities                                                                                                                             |       | 35,358             |       | 35,943               |       |
| Other  long-term liabilities                                                                                                                           |       | 196                |       | —               |       |
| Total liabilities                                                                                                                                      |       | 35,554             |       | 35,943               |       |
|                                                                                                                                                   |       |               |       |                 |       |
| 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; 24,857 and 24,852 shares issued at April 30, 2005 and  January 31, 2005, respectively                            |       | 249                |       | 249                  |       |
| Additional  paid-in capital                                                                                                                            |       | 111,172            |       | 110,992              |       |
| Accumulated  deficit                                                                                                                                   |       | (53,378            | )          | (53,876              | )          |
| Less  treasury stock, at cost                                                                                                                          |       | (352               | )          | (3                   | )          |
| Total  stockholders’ equity                                                                                                                       |       | 57,691             |       | 57,362               |       |
| Total  liabilities and stockholders’ equity                                                                                                       |       | $                  | 93,245     |                 | $          | 93,305 |   |

 

See accompanying notes.

 

3

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**CARREKERCORPORATION****Condensed Consolidated Statements of Operations****(Unaudited)(In thousands, except per share amounts)**

 
| ** **                                                  | ** ** | **Three Months Ended  April 30,** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                  | ** ** | **2005**                               | ** ** | **2004** | ** ** |
|                                                        |       |                                   |       |   |   |
| **Revenues:**                                               |       |                                   |       |   |   |
| Consulting  fees                                            |       | $                                      | 8,318      |   | $ | 9,057 |   |
| Software  license fees                                      |       | 3,359                                  |       | 5,856 |   |
| Software  maintenance fees                                  |       | 11,312                                 |       | 11,084 |   |
| Software  implementation fees                               |       | 4,134                                  |       | 2,879 |   |
| Outsourcing  service fees                                   |       | 257                                    |       | — |   |
| Out-of-pocket  expense reimbursements                       |       | 818                                    |       | 890 |   |
| Total  revenues                                             |       | 28,198                                 |       | 29,766 |   |
|                                                        |       |                                   |       |   |   |
| **Cost of  revenues:**                                      |       |                                   |       |   |   |
| Consulting  fees                                            |       | 4,241                                  |       | 4,529 |   |
| Software license  fees                                      |       | 1,536                                  |       | 1,598 |   |
| Software  maintenance fees                                  |       | 3,975                                  |       | 3,798 |   |
| Software  implementation fees                               |       | 2,973                                  |       | 3,369 |   |
| Outsourcing  service fees                                   |       | 579                                    |       | — |   |
| Out-of-pocket  expenses                                     |       | 790                                    |       | 943 |   |
| Total cost  of revenues                                     |       | 14,094                                 |       | 14,237 |   |
| Gross profit                                                |       | 14,104                                 |       | 15,529 |   |
|                                                        |       |                                   |       |   |   |
| **Operating  costs and expenses:**                          |       |                                   |       |   |   |
| Selling,  general and administrative                        |       | 10,904                                 |       | 12,192 |   |
| Research and  development                                   |       | 2,521                                  |       | 1,708 |   |
| Amortization  of customer relationships                     |       | 350                                    |       | 350 |   |
| Restructuring  and other charges                            |       | 95                                     |       | 2,515 |   |
| Total  operating costs and expenses                         |       | 13,870                                 |       | 16,765 |   |
| Income  (loss) from operations                              |       | 234                                    |       | (1,236 | ) |
|                                                        |       |                                   |       |   |   |
| **Other  income (expense):**                                |       |                                   |       |   |   |
| Interest  income                                            |       | 144                                    |       | 48 |   |
| Interest  expense                                           |       | (105                                   | )          | (108 | ) |
| Other income                                                |       | 306                                    |       | 484 |   |
| Total other  income (expense), net                          |       | 345                                    |       | 424 |   |
| Income  (loss) before provision for income taxes            |       | 579                                    |       | (812 | ) |
| Provision  for income taxes                                 |       | 81                                     |       | — |   |
| Net income  (loss)                                          |       | $                                      | 498        |   | $ | (812 | ) |
| Basic  earnings (loss) per share                            |       | $                                      | 0.02       |   | $ | (0.03 | ) |
| Diluted  earnings (loss) per share                          |       | $                                      | 0.02       |   | $ | (0.03 | ) |
| Shares used  in computing basic earnings (loss) per share   |       | 24,425                                 |       | 24,376 |   |
| Shares used  in computing diluted earnings (loss) per share |       | 24,867                                 |       | 24,376 |   |

 

See accompanying notes.

 

4

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**CARREKERCORPORATIONCondensed ConsolidatedStatements of Stockholders’ Equity(Unaudited)(In thousands, except per share amounts)**

 
| ** **                                                          | ** ** | **Common Stock** | ** ** | **Additional  Paid-In** | ** ** | **Accumulated** | ** ** | **Treasury Stock** | ** ** | **Total  Stockholders’** | ** ** |
|---------------------------------------------------------------------|------------|------------------|------------|-------------------------|------------|-----------------|------------|--------------------|------------|-------------------------------|------------|
| ** **                                                          | ** ** | **Shares**       | ** ** | **Amount**              | ** ** | **Capital**     | ** ** | **Deficit**        | ** ** | **Shares**                    | ** ** | **Amount** | ** ** | **Equity** | ** ** |
| Balance at January 31,  2005                                   |       | 24,852           |       | $                       | 249        |            | $          | 110,992            |       | $                             | (53,876    | ) | 1 |   | $ | (3 | ) | $ | 57,362 |   |
|                                                                |       |             |       |                    |       |            |       |               |       |                          |       |   |   |   |   |
| Cancellation  of restricted stock                                   |       | (5               | )          | —                  |       | (12             | )          | —             |       | —                        |       | — |   | (12 | ) |
| Compensation  expense related to issuance of restricted stock       |       | —           |       | —                  |       | 140             |       | —             |       | —                        |       | — |   | 140 |   |
| Issuance of  shares of common stock upon exercises of stock options |       | 10               |       | —                  |       | 52              |       | —             |       | —                        |       | — |   | 52 |   |
| Common stock  repurchases                                           |       | —           |       | —                  |       | —          |       | —             |       | 70                            |       | (349 | ) | (349 | ) |
| Net income                                                          |       | —           |       | —                  |       | —          |       | 498                |       | —                        |       | — |   | 498 |   |
| Balance at April 30,  2005                                     |       | 24,857           |       | $                       | 249        |            | $          | 111,172            |       | $                             | (53,378    | ) | 71 |   | $ | (352 | ) | $ | 57,691 |   |

 

See accompanying notes.

 

5

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**CARREKERCORPORATIONCondensed Consolidated Statements of CashFlows(Unaudited)(In thousands)**

 
| ** **                                                                                | ** ** | **Three Months Ended  April 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| **Operating  Activities:**                                                                |       |                                   |       |   |   |
| Net income  (loss)                                                                        |       | $                                      | 498        |   | $ | (812 | ) |
| Adjustments  to reconcile net income (loss) to net cash provided by operating activities: |       |                                   |       |   |   |
| Depreciation  and amortization of property and equipment                                  |       | 793                                    |       | 822 |   |
| Amortization  of capitalized software costs and acquired developed technology             |       | 1,421                                  |       | 1,394 |   |
| Amortization  of customer relationships                                                   |       | 350                                    |       | 350 |   |
| Amortization  of deferred loan costs                                                      |       | 68                                     |       | 68 |   |
| Compensation  earned under restricted stock plan                                          |       | 128                                    |       | 35 |   |
| Minority  share of loss in Carretek LLC                                                   |       | (318                                   | )          | (86 | ) |
| Non-cash  charge for merger costs                                                         |       | (32                                    | )          | — |   |
| EPG  Litigation settlement                                                                |       | —                                 |       | 1,686 |   |
| Allowance  for doubtful accounts                                                          |       | 7                                      |       | (180 | ) |
| Gain on sale  of Cash Services Australia Pty. Limited                                     |       | —                                 |       | (539 | ) |
| Changes in  operating assets and liabilities:                                             |       |                                   |       |   |   |
| Accounts  receivable                                                                      |       | 401                                    |       | 6,773 |   |
| Prepaid  expenses and other assets                                                        |       | (324                                   | )          | 301 |   |
| Accounts  payable and accrued expenses                                                    |       | (2,692                                 | )          | (3,273 | ) |
| Income taxes  payable/receivable                                                          |       | 10                                     |       | (33 | ) |
| Deferred  revenue                                                                         |       | 1,800                                  |       | 3,244 |   |
| Net cash  provided by operating activities                                                |       | 2,110                                  |       | 9,750 |   |
|                                                                                      |       |                                   |       |   |   |
| **Investing  Activities:**                                                                |       |                                   |       |   |   |
| Purchases of  property and equipment                                                      |       | (698                                   | )          | (231 | ) |
| Computer  software costs capitalized                                                      |       | (437                                   | )          | (910 | ) |
| Net cash  used in investing activities                                                    |       | (1,135                                 | )          | (1,141 | ) |
|                                                                                      |       |                                   |       |   |   |
| **Financing  Activities:**                                                                |       |                                   |       |   |   |
| Payments on  long-term debt                                                               |       | —                                 |       | (6,250 | ) |
| Proceeds  from exercises of stock options                                                 |       | 52                                     |       | 375 |   |
| Purchase of  treasury stock                                                               |       | (349                                   | )          | — |   |
| Proceeds of  minority shareholder cash advances to Carretek LLC                           |       | 551                                    |       | 147 |   |
| Net cash  provided by (used in) financing activities                                      |       | 254                                    |       | (5,728 | ) |
| Net increase  in cash and cash equivalents                                                |       | 1,229                                  |       | 2,881 |   |
| Cash and  cash equivalents at beginning of period                                         |       | 34,516                                 |       | 28,605 |   |
| Cash and  cash equivalents at end of period                                               |       | $                                      | 35,745     |   | $ | 31,486 |   |
|                                                                                      |       |                                   |       |   |   |
| Supplemental  disclosures of cash flow information:                                       |       |                                   |       |   |   |
| Cash paid  for interest                                                                   |       | $                                      | 38         |   | $ | 71 |   |
| Cash paid  for income taxes, net                                                          |       | $                                      | 76         |   | $ | 33 |   |

 

See accompanying notes.

 

6

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**CarrekerCorporationNotes to CondensedConsolidated Unaudited Financial StatementsFor the Three Months Ended April 30, 2005 and 2004**

 

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

 

Carreker Corporation (“the Company,” “Carreker,”“our,” “we”) provides payments-related software, consulting and businessprocess outsourcing solutions to financial institutions and financial serviceproviders.  These solutions help theCompany’s customers set winning strategies in their payment businesses; improveoperational efficiency in how payments are processed; enhance revenue andprofitability from payments-oriented products and services; reduce lossesassociated with fraudulent payment transactions; and/or improve the alignmentof product offerings with customer needs.

 

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

 

**Principles of Consolidation and Presentation**

 

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

 

The consolidated financial statements alsoreflect the operations of Carretek LLC, which is a 51% owned subsidiary.  The minority interest and minority interestin income (loss) of Carretek LLC represent the 49% minority stockholder’sinvestment and share of the loss of this consolidated subsidiary.

 

The accompanying condensed consolidatedunaudited financial statements and notes have been prepared in accordance withthe rules and regulations of the Securities and Exchange Commission for Form10-Q and include all of the information and disclosures required by generallyaccepted accounting principles for interim financial reporting.  The accompanying financial statements reflectall adjustments (consisting of normal recurring entries) which in the opinionof management are necessary for a fair presentation of the results for theinterim periods presented.  The resultsof operations for the three months ended April 30, 2005 are not necessarilyindicative of full-year results.

 

The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesrequires the use of estimates and assumptions that affect the amounts reportedin the financial statements and accompanying notes.  As discussed below, the Company makessignificant estimates and assumptions in the areas of accounts receivable,impairment of intangibles and revenue recognition.  Although the Company believes that theestimates and assumptions are reasonable, actual results may differ, and suchdifferences could be significant to the Company’s financial results.

 

**Cash and Cash Equivalents**

 

The Company considers all highly liquidinvestments with original maturities of three months or less when purchased tobe cash equivalents. Cash and cash equivalents consist primarily of demanddeposit accounts and shares in a demand money market account comprised ofdomestic and foreign commercial paper, certificates of deposit and U.S. governmentobligations which are maintained with nationally recognized financialinstitutions.

 

**Foreign Currency Translation**

 

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

 

7

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

 

Financial instruments which potentiallysubject the Company to concentration of credit risk consist principally oftemporary cash investments and accounts receivable.  The Company places temporary cash investmentswith major banks and limits its exposure with any one financial institution.

 

A significant portion of the Company’sbusiness consists of providing consulting services and licensing software tomajor domestic and international banks, which gives rise to a concentration ofcredit risk in receivables.  Because theCompany’s accounts receivable are typically unsecured, the Company periodicallyevaluates the collectibility of its accounts based on a combination of factors,including a particular customer’s ability to pay as well as the age ofreceivables.  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 contractsinclude multiple payment milestones, some of which occur in advance of revenuerecognition, which mitigates the risk both in terms of collectibility andadjustments to recorded revenue. Write-offs of receivables during the threemonths ended April 30, 2005 and 2004 were $32,000 and $0, respectively.

 

The fair value of accounts receivableapproximates the carrying amount of accounts receivable.

 

Accounts receivable, net of related deferredrevenue and allowances, consist of the following (in thousands):

 
| ** **                            | ** ** | **April 30,** | ** ** | **January 31,** | ** ** |
|---------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                            | ** ** | **2005**           | ** ** | **2005**             | ** ** |
|                                  |       |               |       |                 |       |
| Gross  accounts receivable            |       | $                  | 32,504     |                 | $          | 47,000 |   |
| Less related  deferred revenue        |       | (21,264            | )          | (35,327              | )          |
| Less  allowance for doubtful accounts |       | (504               | )          | (529                 | )          |
| Net accounts  receivable              |       | $                  | 10,736     |                 | $          | 11,144 |   |

 

**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. Leaseholdimprovements are amortized using the straight-line method over the shorter ofthe terms of the related leases or the respective useful lives of theassets.   The components of property andequipment are as follows (in thousands):

 
| ** **                                      | ** ** | **April 30,** | ** ** | **January 31,** | ** ** |
|-------------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                      | ** ** | **2005**           | ** ** | **2005**             | ** ** |
| ** **                                      | ** ** | ** **         | ** ** | ** **           | ** ** |
| Furniture                                       |       | $                  | 5,071      |                 | $          | 5,069 |   |
| Equipment  and software                         |       | 20,939             |       | 20,446               |       |
| Leasehold  improvements                         |       | 1,284              |       | 1,283                |       |
| Total cost                                      |       | 27,294             |       | 26,798               |       |
|                                            |       |               |       |                 |       |
| Less  accumulated depreciation and amortization |       | (20,785            | )          | (20,194              | )          |
| Net property  and equipment                     |       | $                  | 6,509      |                 | $          | 6,604 |   |

 

The Company accounts for the costs ofcomputer software developed or obtained for internal use in accordance withStatement of Position 98-1, *“Accounting forthe Costs of Computer Software Developed or Obtained for Internal Use”.*  The Company capitalizes costs of consultants,and payroll and payroll-related costs for employees incurred in developinginternal-use computer software.  Thesecosts are included in “Equipment and Software”. Costs incurred during preliminary project and post-implementation stagesare charged to expense.

 

8

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**Long Lived Assets**

 

The Company accounts for goodwill and otherintangible assets in accordance with Statement of Financial AccountingStandards No. 142, *“Goodwill and OtherIntangible Assets,”* (“SFAS 142”). Under the provisions of SFAS 142, an annual assessment of goodwillimpairment is performed.  This assessmentinvolves the use of estimates related to fair market values of the Company’sreporting units with which the goodwill is associated.  The assessment of goodwill impairment in thefuture will be impacted if future operating cash flows of the Company’sreporting units decline significantly, which could result in decreases in therelated estimate of fair market value. The Company performs its annual impairment analysis as of November 1stof each year and whenever facts and circumstances indicate impairment mayexist.

 

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

 

**Deferred Loan Costs**

 

Deferred loan costs consist of loan closingcosts and other administrative expenses associated with the Revolving CreditAgreement.  On July 31, 2003, theRevolving Credit Agreement was amended as described in Note 4.  In connection with this amendment, theCompany incurred approximately $456,000 of deferred loan costs.  These costs, along with the net book value ofthe original deferred loan costs, are being amortized to interest expense overthe 36 month life of the Revolving Credit Agreement.

 

**Capitalized Software Costs and AcquiredDeveloped Technology**

 

The Company capitalizes the development costsof software, other than internal-use software, in accordance with Statement ofFinancial Accounting Standards No. 86, *“Accountingfor Costs of Computer Software to be Sold, Leased or Otherwise Marketed”*(“SFAS 86”).  The Company’s policy is tocapitalize software development costs incurred in developing a product oncetechnological feasibility of the product has been established. 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 detail program design, technological feasibilityis determined only after completion of a working model. All softwaredevelopment costs capitalized are amortized using an amount determined as thegreater of: (1) the ratio that current gross revenues for a capitalizedsoftware project bears to the total of current and estimated future grossrevenues for that project or (2) the straight-line method over the estimatedremaining economic life of the product (generally three to five years). TheCompany capitalized $437,000 and $910,000 in the three months ended April 30,2005 and 2004, respectively.  The Companydeveloped software for sending and receiving check images, and is currentlydeveloping software for distributed capture of checks and check images andextending the functionality of its anti-money laundering software and otherRisk solutions.  In the three monthsended April 30, 2005, the Company also began development of a product toverify cash logistic invoices with automated precision and an internet-basedtrack and trace system that streamlines the cash delivery management process.

 

The Company recorded amortization relating tosoftware development costs capitalized of $266,000 and $239,000 in the threemonths ended April 30, 2005 and 2004, respectively.  Amortization expense is recorded as acomponent of cost of software license fees in the accompanying consolidatedstatements of operations.

 

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

 

9

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Acquired developed technology with a usefullife of 3-6 years is amortized on a straight-line basis, resulting inamortization expense of $1.2 million for the three months ended April 30,2005 and 2004, respectively. Amortization expense is recorded as a component of cost of softwarelicense fees in the accompanying consolidated statements of operations.

 

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

 
| **Year** | ** ** | **Capitalized  Software  Costs** | ** ** | **Acquired  Developed  Technology** | ** ** |
|----------|------------|----------------------------------|------------|-------------------------------------|------------|
| 2006     |       | $                                | 429        |                                | $          | 3,465 |   |
| 2007     |       | 573                              |       | 4,107                               |       |
| 2008     |       | 410                              |       | 1,200                               |       |
|          |            |                                  |            |                                     |            |  |  |

 

The table does not include the estimatedamortization expense for $2.0 million of capitalized software products that arecurrently being developed, and for which amortization has not commenced.

 

The Company continually monitors the netrealizable value of software capitalized and acquired developed technology forfactors that would indicate impairment such as a decline in demand or a loss ofa significant customer.  During thequarterly period ended January 31, 2005, the Company performed its annualformal evaluation for impairment and determined that the carrying amount ofthese assets was not impaired and has subsequently noted no factors that wouldindicate impairment.

 

**Revenue Recognition**

 

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

 

*Consulting Fees.*  The Company employs three primary pricingmethods in connection with its delivery of consulting services. First, theCompany may price its delivery of consulting services on the basis of time andmaterials, in which case the customer is charged agreed-upon daily rates forservices performed and out-of-pocket expenses. In this case, the Company isgenerally paid fees and related amounts usually on a monthly basis, and theCompany recognizes revenues as the services are performed. Second, the Companymay deliver consulting services on a fixed-price basis. In this case, theCompany is paid on a monthly basis or pursuant to an agreed upon paymentschedule, and the Company recognizes revenues on a proportionate performancebasis.  The Company believes that thismethod is appropriate because of its ability to determine performancemilestones and determine dependable estimates of its costs applicable to eachphase of a contract.  Because financialreporting of these contracts depends on estimates, which are assessedcontinually during the term of the contract, costs are subject to revisions asthe contract progresses.  Anticipatedlosses on fixed-price contracts are recognized when estimatable.  Third, the Company may deliver consultingservices pursuant to a value-priced contract with the customer. In this case,the Company is paid, on an agreed upon basis with the customer, either aspecified percentage of (1) the projected increased revenues and/ordecreased costs that are expected to be derived by the customer generally overa period of up to twelve months following implementation of its solution or (2)the actual increased revenues and/or decreased costs experienced by thecustomer generally over a period of up to twelve months followingimplementation of its solution, subject in either case to a maximum, if any isagreed to, on the total amount of payments to be made to the Company.  The Company must first commit time andresources to develop projections associated with value-pricing contracts beforea customer will commit to purchase its solutions, and the Company thereforeassumes the risk of making these commitments with no assurance that thecustomer will purchase the solution. Costs associated with these value-pricing contracts are expensed asincurred.  These contracts typicallyinclude payments to be made to the Company pursuant to an agreed upon schedule rangingfrom one to twelve months in length.  TheCompany recognizes revenues generated from consulting services in connectionwith value-priced contracts based upon projected results only upon completionof all services and agreement upon the actual fee to be paid (even thoughbillings for these services may be delayed by mutual agreement for periods notto exceed twelve months). In an effort to allow

 

10

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customers to more closely match expected benefits from services withpayments to the Company, the Company on occasion, may offer payment terms whichextend beyond 12 months.  When theCompany enters into an agreement which has a significant component of the totalamount payable under the agreement due beyond 12 months or if it is determinedpayments are not fixed and determinable at the date the agreement was enteredinto, revenue under the arrangement will be recognized as payments become dueand payable.  When fees are to be paidbased on a percentage of actual revenues and/or savings to customers, theCompany recognizes revenues only upon completion of all services and as theamounts of actual revenues or savings are confirmed by the customer with afixed payment date.

 

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

 

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

 

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

 

*Software License Fees.*  A software license is sold either togetherwith implementation services or on a stand-alone basis.  The Company is usually paid software licensefees in one or more installments, as provided in the customer’s contract butnot to exceed twelve months.  The Companyrecognizes software license revenue upon execution of a contract and deliveryof the software, provided that the license fee is fixed and determinable, nosignificant production, modification or customization of the software isrequired and collection is considered probable by management.  When the software license arrangementrequires the Company to provide implementation services that are essential tothe functionality of the software or significant production, customization ormodification of the software is required, both the product license revenue andimplementation fees are recognized as services are performed.

 

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

 

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

 

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

 

11

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

 

*Software Implementation Fees.*  In connection with the sale of a softwarelicense, a customer may elect to purchase software implementation services,including software enhancements and other software services. Most of thecustomers that purchase software licenses from the Company also purchasesoftware implementation services.  TheCompany prices its implementation services on a time-and-materials or on afixed-price basis, and the Company recognizes the related revenues as servicesare performed.  Costs associated withthese engagements are expensed as incurred.

 

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

 

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

 

**Royalties**

 

In connection with software license,maintenance, and consulting agreements, entered into with certain banks andpurchase agreements with vendors under which the Company acquired softwaretechnology used in products sold to its customers, the Company is required topay royalties on sales of certain software products.  Under these arrangements, the Companyrecognizes royalty expense when the associated revenue is recognized.  For current product offerings, the royaltypercentages generally range from 20% to 50% of the associated revenues.  Approximately $214,000 and $256,000 of royaltyexpense was recorded under these agreements in the three months ended April 30,2005 and 2004, respectively.  Royaltyexpense is included as a component of the cost of consulting fees, cost ofsoftware license fees and cost of software maintenance fees in the accompanyingconsolidated statements of operations.

 

**Deferred Revenue**

 

Deferred revenue represents amounts paid bycustomers under terms specified in consulting, software licensing, andmaintenance contracts for which completion of contractual terms or delivery ofthe software has not occurred.

 

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

 
| ** **                                         | ** ** | **April 30,** | ** ** | **January 31,** | ** ** |
|----------------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                         | ** ** | **2005**           | ** ** | **2005**             | ** ** |
|                                               |       |               |       |                 |       |
| Deferred  software maintenance fees                |       | $                  | 27,591     |                 | $          | 33,850 |   |
| Deferred  software implementation and license fees |       | 17,654             |       | 23,658               |       |
|                                               |       | 45,245             |       | 57,508               |       |
| Less related  accounts receivable                  |       | (21,264            | )          | (35,327              | )          |
| Net deferred  revenue                              |       | $                  | 23,981     |                 | $          | 22,181 |   |

 

**Research and Development Costs**

 

Research and development costs which are notsubject to capitalization under Statement of Financial Accounting Standards No.86, *“Accounting for the Cost of ComputerSoftware to be Sold, Leased, or Otherwise Marketed”* (“SFAS 86”), areexpensed as incurred and relate mainly to the development of new products, newapplications, new features or enhancements for existing products orapplications.  Sustaining maintenanceactivities are expensed as incurred and charged to cost of revenues — softwaremaintenance fees.

 

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**Other income (expense)**

 

Other income (expense) is comprised of thefollowing (in thousands):

 
| ** **                                              | ** ** | **Three Months Ended April 30,** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                              | ** ** | **2005**                              | ** ** | **2004** | ** ** |
|                                                    |       |                                  |       |   |   |
| Gain on sale  of Cash Services Australia Pty. Limited   |       | $                                     | —     |   | $ | 539 |   |
| Equity in loss  of Cash Services Australia Pty. Limited |       | —                                |       | (17 | ) |
| Minority share of net loss of Carretek LLC              |       | 318                                   |       | 86 |   |
| Foreign exchange losses                                 |       | (17                                   | )          | (129 | ) |
| Other                                                   |       | 5                                     |       | 5 |   |
| Total                                                   |       | $                                     | 306        |   | $ | 484 |   |

 

In April 2004, theCompany sold its 25% interest in Cash Services Australia Pty. Limited.  The carrying value of this investment wasapproximately $383,000 and the Company received $922,000 in proceeds collectedin May 2004.  As a result of thistransaction, the Company recorded a $539,000 gain.

 

The Company owns a 51% interest in CarretekLLC (“Carretek”), which offers financial institutions offshore-centricoutsourcing of their business processes. The minority interest in this loss was recorded in other income(expense) and was $318,000 and $86,000 for the three months ended April 30,2005 and 2004, respectively.

 

**Income Taxes**

 

The Company accounts for income taxes usingthe liability method, whereby deferred tax assets and liabilities aredetermined based on differences between financial reporting and the tax basisof assets and liabilities measured using enacted tax rates and laws that willbe in effect when the differences are expected to reverse.  The measurement of deferred tax assets isadjusted by a valuation allowance, if necessary, to recognize the extent to which,based on available evidence, it is more likely than not that the future taxbenefits will not be realized.

 

**Earnings Per Share**

 

Basic earnings per shareis computed 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 elected to follow AccountingPrinciples Board (“APB”) Opinion No. 25, “*Accountingfor Stock Issued to Employees*,” in accounting for its employee anddirector stock options.  Under APB 25, ifthe exercise price of a stock option equals or exceeds the market price of theunderlying stock on the date of grant, no compensation expense is recognized.  In October 1995, the FinancialAccounting Standards Board (“FASB”) issued Statement of Financial AccountingStandards (“SFAS”) 123, *“Accounting forStock-Based Compensation.”* SFAS 123 allows the Company to continue to follow the present APBOpinion 25 guidelines, but requires pro-forma disclosures of net income andearnings per share as if the Company had adopted the provisions of theStatement.  In December 2002, theFASB issued SFAS 148, *“Accounting forStock-Based Compensation – Transition and Disclosure – an Amendment of FASBStatement No.123,”* which provides alternative methods of transitionfor an entity that voluntarily changes to the fair value based method ofaccounting for stock-based employee compensation.  The Company continues to account for stock-basedcompensation under the provisions of APB Opinion 25 using the intrinsic valuemethod.

 

The stock compensation expense recorded underthe intrinsic value method is primarily the result of restricted common stockissued to employees and officers in fiscal years 2004 and 2003.  The Company is amortizing the compensationexpense on a straight line basis over the period that the restrictions on thecommon stock lapse.

 

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The Company recorded $128,000 and $35,000 ofcompensation expense during the three months periods ended April 30, 2005and 2004, respectively.  419,470 unvestedrestricted common shares remain outstanding at April 30, 2005.

 

Had compensation costfor stock-based compensation plans been determined based on the fair value atthe grant dates for awards under those plans in accordance with the provisionsof SFAS 123, net income (loss) and net income (loss) per share would have beenas follows (in thousands, except per share data):

 
| ** **                                                                 | ** ** | **Three Months Ended  April 30,** | ** ** |
|----------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                 | ** ** | **2005**                               | ** ** | **2004** | ** ** |
|                                                                       |       |                                   |       |   |   |
| Net income  (loss), as reported                                            |       | $                                      | 498        |   | $ | (812 | ) |
| Stock  compensation expense recorded under the intrinsic value method      |       | 128                                    |       | 35 |   |
| Pro forma  stock compensation expense computed under the fair value method |       | (767                                   | )          | (951 | ) |
| Pro forma  net loss                                                        |       | $                                      | (141       | ) | $ | (1,728 | ) |
|                                                                       |       |                                   |       |   |   |
| Basic  earnings (loss) per common share, as reported                       |       | $                                      | 0.02       |   | $ | (0.03 | ) |
| Diluted  earnings (loss) per common share, as reported                     |       | $                                      | 0.02       |   | $ | (0.03 | ) |
| Pro forma  basic loss per common share                                     |       | $                                      | (0.01      | ) | $ | (0.07 | ) |
| Pro forma  diluted loss per common share                                   |       | $                                      | (0.01      | ) | $ | (0.07 | ) |

 

The Company calculatedthe estimated fair value of each stock option using the Black-Scholesoption-pricing model and utilized the following assumptions:

 
| ** **                                      | ** ** | **Three Months Ended  April 30,** | ** ** |
|-------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                      | ** ** | **2005**                               | ** ** | **2004** | ** ** |
|                                            |       |                                   |       |   |   |
| Volatility                                      |       | .905                                   |       | .887 |   |
| Weighted-average  expected lives                |       | 4.00                                   |       | 4.50 |   |
| Expected  dividend yields                       |       | —                                 |       | — |   |
| Weighted-average  risk-free interest rates      |       | 3.83                                   | %          | 2.79 | % |
| Weighted-average  fair value of options granted |       | $                                      | 4.32       |   | $ | 6.20 |   |
|                                                 |            |                                        |            |  |  |  |  |

 

**Risks and Uncertainties**

 

The Company’s future results of operationsand financial condition could be impacted by the following factors, amongothers: dependence on the banking industry, decline in check volumes,fluctuations in operating results, lack of long-term agreements, dependence onkey personnel, rapid technological change and dependence on new products, focuson providing business process outsourcing with 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, our ability to protect ourinformation technology infrastructure, international operations, changinggovernment and tax regulations, stock price fluctuations, impairment ofgoodwill or intangible assets, realization of revenue from contracted sales,potential sales and backlog, changes in the accounting treatment of stockoptions and other share-based compensation and pending class action lawsuits.

 

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**Financial Guarantees**

 

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

 

Under the terms of the majority of theCompany’s software license agreements with its customers, the Company agreesthat in the event the software sold infringes upon any patent, copyright,trademark, or any other proprietary right of a third party, it will indemnifyits customer licensee against any loss, expense, or liability from any damagesthat may be awarded against its customer. The Company includes this infringement indemnification in all of itssoftware license agreements.  In theevent the customer cannot use the software or service due to infringement andthe Company cannot obtain the right to use, replace or modify the license orservice in a commercially feasible manner so that it no longer infringes, thenthe Company may terminate the license and provide the customer a pro-ratarefund of the fees paid by the customer for the infringing license orservice.  The Company has recorded noliability associated with this indemnification, as it is not aware of anypending or threatened infringement actions that are probable losses.  The Company believes the estimated fair valueof these intellectual property indemnification clauses is minimal.

 

The Company has agreed to indemnify membersof the board of directors, officers and certain key employees of the Company ifthey are made a party or are threatened to be made a party to any proceeding byreason of the fact that they are acting in their capacities on behalf of theCompany, or by reason of anything done or not done by them in any suchcapacities.  The indemnity is for any andall expenses and liabilities of any type whatsoever (including but not limitedto, judgments, fines and amounts paid in settlement) actually and reasonablyincurred by the directors or officers in connection with the investigation,defense, settlement or appeal of such proceeding, provided they acted in goodfaith.  The Company maintains insurancecoverage for directors and officers liability (“D&O insurance”).  No maximum liability is stipulated in theseagreements that include indemnifications of members of the board of directors,officers and certain key employees of the Company.  The Company has recorded no liabilityassociated with these indemnifications as it is not aware of any pending orthreatened actions or claims against the members of its board of directors orofficers that are probable losses in excess of amounts covered by its D&Oinsurance.  As a result of the insurancepolicy coverage, the Company believes the estimated fair value of theseindemnification agreements is minimal.

 

**Recently Issued AccountingStandards**

 

On December 16, 2004, the FinancialAccounting Standards Board issued SFAS No. 123 (revised 2004), *“Share-Based Payment,”* which is a revision of SFAS No.123.  SFAS No. 123 (R) supersedes APB No.25, and amends SFAS No. 95, *“Statement of Cash Flows.”*  Generally, the approach in SFAS No. 123 (R)is similar to the approach described in SFAS No. 123.  However, SFAS No. 123 (R) requires allshare-based payments to employees, including grants of employee stock options,to be recognized in the statement of operations based on their fairvalues.  Pro forma disclosure is nolonger an alternative.  The Companyexpects to adopt SFAS No. 123 (R) in the first quarter of fiscal 2006.  SFAS No. 123 (R) permits companies to adoptits requirements using one of two methods:

 

•                  A“modified prospective” method in which compensation cost is recognizedbeginning with the effective date (a) based on the requirements of SFAS No. 123(R) for all share-based payments granted after the effective date and (b) basedon the requirements of SFAS No. 123 for all awards granted to employees priorto the effective date of SFAS No. 123 (R) that remain unvested on the effectivedate.

•                  A“modified retrospective” method which includes the requirements of the modifiedprospective method described above, but also permits entities to restate basedon the amounts previously recognized under SFAS No. 123 for purposes of proforma disclosures either (a) all prior periods presented or (b) prior interimperiods of the year of adoption.

 

The Company is still assessing theappropriate transition method.

 

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As permitted by SFAS No. 123, the Companycurrently accounts for share-based payments to employees using the APB No. 25intrinsic value method and, as such, generally recognizes no compensation costfor employee stock options.  Accordingly,the adoption of SFAS No. 123 (R)’s fair value method will have a significantimpact on our results of operations, although it will have no impact on ouroverall financial position and cash flows. Had we adopted SFAS No. 123 (R) in prior periods, the impact of thatstandard would have approximated the impact of SFAS No. 123 as described in thedisclosure of pro forma net income and earnings per share contained in Note 2above under the caption *Stock Based Compensation*.  Statement No. 123 (R) also requires thebenefits of tax deductions in excess of recognized compensation cost to bereported as a financing cash flow, rather than as an operating cash flow.  This requirement currently does not have aneffect on the Company as all of our deferred tax benefits are fully reserved,with a valuation allowance.

 

In January 2003, the FinancialAccounting Standards Board issued Statement of Financial Accounting StandardsBoard Interpretation No. 46, *“Consolidationof Variable Interest Entities, an Interpretation of ARB No. 41 (“FIN 46”).”*  In December 2003, the FASB modified FIN46 to make certain technical corrections and address certain implementationissues that had arisen (subsequently referred to as “FIN 46R”).  FIN 46 and FIN 46R provide a new frameworkfor identifying variable interest entities (“VIEs”) and determining when acompany should include these assets, liabilities, non-controlling interests andresults of activities of a VIE in its consolidated financial statements.

 

In general, a VIE is a corporation,partnership, limited liability corporation, trust or any other legal structureused to conduct activities or hold assets that either (1) has an insufficientamount of equity to carry out its principal activities without additionalsubordinated financial support, (2) has a group of equity owners that areunable to make significant decisions about its activities, or (3) has a groupof equity owners that do not have the obligation to absorb losses or the rightto receive returns generated by its operations.

 

The Company adopted theprovisions of FIN 46 and FIN 46R as of April 30, 2004.  The effect of adopting the provisions of FIN46 and FIN 46R was not material.

 

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

 

**3.****              Goodwill andIntangible Assets**

 

Goodwill and intangible assets deemed to haveindefinite lives are no longer amortized but are subject to annual impairmenttests.  Other intangible assets, whichinclude acquired developed technology and customer relationships, are amortizedover their estimated useful lives.

 

Customer relationshipswith definite useful lives are amortized on a straight-line basis, whichresulted in amortization expense of $350,000 during the three months ended April 30,2005 and 2004, respectively.

 

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

 
| **Year** | ** ** | **Amount** | ** ** |
|----------|------------|------------|------------|
| 2006     |       | $          | 1,050      |   |
| 2007     |       | 1,400      |       |
| 2008     |       | 467        |       |
|          |            |            |            |  |

 

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

 

The Company is a partyto a revolving credit agreement with a group of banks providing for acommitment amount of $30.0 million and a maturity date of July 31,2006.  The Company did not have anyborrowings outstanding under the revolving credit agreement at April 30,2005.  Borrowings under the creditagreement currently bear interest equal to either the greater of prime orfederal funds rate plus a margin ranging from 1.25% to 2.25% depending on theCompany’s ratio of funded debt to Earnings before Interest, Taxes, Depreciationand Amortization (“EBITDA”), or LIBOR plus a margin equal to 2.75% to 3.75%depending on the Company’s ratio of funded debt to EBITDA.  Interest payments are due quarterly.  The Company is required to pay a commitmentfee equal to 0.50% on the unused amount of the revolving credit agreement.  The revolving credit agreement containscustomary affirmative and negative covenants, including financial covenantsrequiring the maintenance of specified interest coverage, ratio of EBITDA tofunded debt, and ratio of 80% of accounts receivable, cash and short-terminvestments to funded debt. Additionally, the payment of dividends is precluded except upon approvalof the banks.  Substantially all of theCompany’s assets collateralize the revolving credit agreement.  As of April 30, 2005, the Company is incompliance with the covenants of the revolving credit agreement.

 

Interest expense,including the commitment fee and exclusive of the amortization of deferred loancosts on the credit agreement was $37,000 and $39,000 for the three monthsended April 30, 2005 and 2004, respectively.

 

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

 

The Company has established a valuationallowance to reserve its net deferred tax assets at April 30, 2005 becausethe more likely than not criteria for future realization of the Company’s netdeferred tax assets specified in Statement of Financial Accounting StandardsNo. 109, “*Accounting for Income Taxes,”*(“SFAS No. 109”) were not met.

 

The tax provision was $81,000and $0 for the three months ended April 30, 2005 and 2004, respectively,which consists of a provision for foreign taxes.  No U.S. Federal or State tax expense wasrecorded in the three months ended April 30, 2005 due to the availabilityof net operating losses from prior years. No U.S. Federal tax benefit was recorded during the three months ended April 30,2004 due to the uncertainty regarding the Company’s ability to generate taxableincome, and resulting uncertainty relative to the recoverability of deferredtax assets.

 

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

 

**401(k) Plan**

 

The Company has adopteda plan pursuant to Section 401(k) of the Internal Revenue Code (“the Code”)whereby participants may contribute a percentage of compensation not in excessof the maximum allowed under the Code. The plan provides for a matchingcontribution by the Company which was reinstated as of January 31,2004.  Employer matching contributionsamounted to $338,000 and $165,000 for the three months ended April 30,2005 and 2004, respectively. The Company may make additional contributions atthe discretion of the Board of Directors. No discretionary contributions were made during the three months ended April 30,2005 and 2004.

 

**Incentive Compensation Plans**

 

The Carreker Incentive Bonus Plan (“CIBP”)awards employees bonuses based on the Company’s or the applicable business unit’soperating results.  Substantially allemployees are eligible to receive cash awards under the CIBP.  Awards from this plan are paid to employeessubsequent to the end of the fiscal year. In the three months ended April 30, 2005 and 2004, the Companyrecorded expense under this plan of approximately $244,000 and $106,000,respectively.

 

The Company paysdiscretionary bonuses to key employees based primarily on the extent to whichindividuals meet agreed-upon objectives for the year. The Company recordeddiscretionary bonus expense of approximately $265,000 and $101,000 for thethree months ended April 30, 2005 and 2004, respectively.

 

17

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

 

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

 
| ** **                                                                  | ** ** | **Three Months Ended  April 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                  | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| ** **                                                                  | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Basic  earnings (loss) per share:                                           |       |                                   |       |   |   |
| Net income  (loss)                                                          |       | $                                      | 498        |   | $ | (812 | ) |
|                                                                        |       |                                   |       |   |   |
| Weighted  average shares outstanding                                        |       | 24,425                                 |       | 24,376 |   |
|                                                                        |       |                                   |       |   |   |
| Basic  earnings (loss) per share                                            |       | $                                      | 0.02       |   | $ | (0.03 | ) |
|                                                                        |       |                                   |       |   |   |
| Diluted  earnings (loss) per share:                                         |       |                                   |       |   |   |
| Net income  (loss)                                                          |       | $                                      | 498        |   | $ | (812 | ) |
|                                                                        |       |                                   |       |   |   |
| Weighted  average shares outstanding                                        |       | 24,425                                 |       | 24,376 |   |
| Assumed  conversion of employee stock options and unvested restricted stock |       | 442                                    |       | — |   |
| Shares used  in diluted earnings per share calculation                      |       | 24,867                                 |       | 24,376 |   |
|                                                                        |       |                                   |       |   |   |
| Diluted  earnings (loss) per share                                          |       | $                                      | 0.02       |   | $ | (0.03 | ) |

 

Options totaling 2,614,595 and 2,219,882 forthe three months April 30, 2005 and 2004, respectively, have been excludedfrom the diluted earnings per share computation as the options wereanti-dilutive.

 

**8.****              Contingencies**

 

On June 15, 2004, by mutual agreementbetween the parties, Civil Action No. 303CV1211-M was reinstated in the UnitedStates District Court for the Northern District of Texas, Dallas Division. Thisaction was originally filed on May 29, 2003, in the United States DistrictCourt for the Northern District of Texas, Dallas Division as Civil Action no.303CV1211-D. On January 15, 2004, the Court, acting upon the joint motionof the parties, dismissed the action without prejudice. This action was broughtas a shareholders’ derivative action pursuant to Rule 23.1, Fed.R.Civ.P. forthe benefit of Nominal Defendant Carreker Corporation against certain of itscurrent and former officers and directors, i.e., John D. Carreker, Jr., JamesD. Carreker, Richard R. Lee, Jr., James L. Fischer, Donald L. House, David K.Sias, Terry L. Gage, James R. Erwin, Ronald G. Steinhart and Ronald Antinori,seeking to remedy their individual breaches of fiduciary duty, including theirknowing violations of Generally Accepted Accounting Principles (“GAAP”),knowing violations of federal and state securities laws, acts of bad faith andother breaches of fiduciary duty. The plaintiff seeks redress (the form of,among others, unspecified amounts of compensatory damages, interest and costs,including legal fees) for injuries to the Company and its shareholders causedby Defendants’ misfeasance and/or malfeasance during the period from May 20,1998 through December 10, 2002.

 

On June 2, 2003, inthe District Court, Dallas County, Texas, Walter Evans brought a shareholders’derivative action, for the benefit of Nominal Defendant Carreker Corporationagainst James D. Carreker, John D. Carreker, Jr., James R. Erwin, James L.Fischer, Michael D. Hansen, Donald L. House, Richard R. Lee, Jr., David K.Sias, Ronald J. Steinhart, and Ernst & Young, LLP and Carreker Corporation,Nominal Defendant (Cause No. 0305505). The complaint alleges that the directordefendants breached their fiduciary duty to the company. In addition the complaintmakes certain allegations against the Company’s independent registered publicaccounting firm Ernst & Young LLP. The complaint seeks unspecified amountsof compensatory damages, as well as interest and costs, including legal feesfrom the director defendants.

 

18

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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 reCarreker Corporation Securities Litigation*, Civil Action No.303CV0250-M. On October 14, 2003 the plaintiffs filed their Consolidated ClassAction Complaint. The complaint, filed on behalf of purchasers of the Company’scommon stock between May 20, 1998 and December 10, 2002, inclusive, allegedviolations of Section 10(b) of the Securities Exchange Act of 1934 and Rule10b-5 against all defendants (the Company, John D. Carreker Jr., RonaldAntinori, Terry L. Gage and Ernst & Young, the Company’s auditors),violations of Section 20(a) of the Exchange Act against the individualdefendants, and violation of Section 20A of the Securities Exchange Act againstdefendants John D. Carreker, Jr. and Ronald Antinori.  The complaint also alleges, among otherthings, that defendants artificially inflated the value of Carreker stock byknowingly or recklessly misrepresenting the Company’s financial results duringthe purported class period.  On March 22,2005 the Court dismissed the action without prejudice and allowed theplaintiffs 60 days in which to file an amended complaint. Also the Courtdismissed, with prejudice, all claims by shareholders prior to July 31, 1999.

 

On May 31,2005, the plaintiffs filed an Amended Consolidated Class Action Complaint onbehalf of purchasers of the Company’s common stock between July 30, 1999 andDecember 10, 2002, inclusive, which reiterates the allegations in the firstcomplaint, and alleges violations of Section 10(b) of the Securities ExchangeAct of 1934 and Rule 10b-5 against all defendants (the Company, John D.Carreker Jr., Ronald Antinori and Terry L. Gage), violations of Section 20(a)of the Exchange Act against the individual defendants, and violations ofSection 20A of the Securities Exchange Act against defendants John D. Carreker,Jr. and Ronald Antinori.  The plaintiffsare seeking unspecified amounts of compensatory damages, interest and costs,including legal fees.

 

The Companyand individual defendants deny the allegations in these complaints and intendto defend themselves vigorously.  It isnot possible at this time to predict whether the Company will incur anyliability or to estimate the damages, or the range of damages, if any, that theCompany might incur in connection with these lawsuits.  The ultimate resolution of these lawsuitscould have a material adverse effect on the Company’s business, results ofoperations, financial condition and cash flows.

 

The Company isperiodically involved in various other legal actions and claims which arise inthe normal course of business.  In theopinion of management, the final disposition of these matters are not expectedto have a material adverse effect on the Company’s financial position orresults of operations.

 

19

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

 

The tables below showrevenues and income (loss) from operations for the periods indicated for ourthree reportable business segments: Revenue Enhancement, Global PaymentsTechnologies and Global Payments Consulting. Certain prior year amounts have been reclassified to conform with thecurrent year business segment presentation. Our customer projects are sold on a solution basis, so it is necessaryto break them down by segment and allocate accordingly.  Included in “Corporate Unallocated” are costsrelated to selling and marketing, unallocated corporate overhead expense andgeneral software management.  Businesssegment results, which include costs for research and development as well asproduct royalty expense, the amortization and impairment of goodwill andintangible assets, the write-off of capitalized software costs andrestructuring and other charges, were as follows (in thousands):

 
| ** **                                                                                                        | ** ** | **Three Months ended April 30,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                        | ** ** | **Revenue  Enhancement**                    | ** ** | **Global Payments  Technologies** | ** ** | **Global Payments  Consulting** | ** ** | **Corporate  Unallocated** | ** ** | **Total** | ** ** |
| Revenues:                                                                                                         |       |                                        |       |   |   |   |   |   |   |   |   |
| Consulting  fees                                                                                                  |       | $                                           | 7,722      |   | $ | 50 |   | $ | 546 |   | $ | — |   | $ | 8,318 |   |
| Software  license fees                                                                                            |       | 301                                         |       | 3,058 |   | — |   | — |   | 3,359 |   |
| Software  maintenance fees                                                                                        |       | 114                                         |       | 10,970 |   | 228 |   | — |   | 11,312 |   |
| Software  implementation fees                                                                                     |       | 475                                         |       | 3,550 |   | 109 |   | — |   | 4,134 |   |
| Outsourcing  services fees                                                                                        |       | —                                      |       | — |   | — |   | 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 before amortization of customer relationships and  restructuring and other charges |       | $                                           | 3,938      |   | $ | 2,554 |   | $ | (324 | ) | $ | (5,489 | ) | $ | 679 |   |
|                                                                                                              |       |                                        |       |   |   |   |   |   |   |   |   |
| Amortization  of customer relationships                                                                           |       | —                                      |       | 350 |   | — |   | — |   | 350 |   |
| Restructuring  and other charges (credits)                                                                        |       | —                                      |       | 131 |   | (24 | ) | (12 | ) | 95 |   |
| Income  (loss) from operations                                                                                    |       | $                                           | 3,938      |   | $ | 2,073 |   | $ | (300 | ) | $ | (5,477 | ) | $ | 234 |   |

 
| ** **                                                                                                                | ** ** | **Three Months ended April 30,  2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                | ** ** | **Revenue  Enhancement**                    | ** ** | **Global Payments  Technologies** | ** ** | **Global Payments  Consulting** | ** ** | **Corporate  Unallocated** | ** ** | **Total** | ** ** |
| Revenues:                                                                                                                 | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Consulting  fees                                                                                                          |       | $                                           | 8,487      |   | $ | 36 |   | $ | 534 |   | $ | — |   | $ | 9,057 |   |
| Software  license fees                                                                                                    |       | 179                                         |       | 5,644 |   | 33 |   | — |   | 5,856 |   |
| Software  maintenance fees                                                                                                |       | 169                                         |       | 10,688 |   | 227 |   | — |   | 11,084 |   |
| Software  implementation fees                                                                                             |       | 156                                         |       | 2,557 |   | 166 |   | — |   | 2,879 |   |
| Out-of-pocket  expense reimbursements                                                                                     |       | 490                                         |       | 300 |   | 100 |   | — |   | 890 |   |
| Total  revenues                                                                                                           |       | $                                           | 9,481      |   | $ | 19,225 |   | $ | 1,060 |   | $ | — |   | $ | 29,766 |   |
|                                                                                                                      |       |                                        |       |   |   |   |   |   |   |   |   |
| Income  (loss) from operations before amortization of customer relationships and  merger, restructuring and other charges |       | $                                           | 4,615      |   | $ | 4,445 |   | $ | (566 | ) | $ | (6,865 | ) | $ | 1,629 |   |
|                                                                                                                      |       |                                        |       |   |   |   |   |   |   |   |   |
| Amortization  of customer relationships                                                                                   |       | —                                      |       | 350 |   | — |   | — |   | 350 |   |
| Restructuring  and other charges                                                                                          |       | 1,719                                       |       | 212 |   | — |   | 584 |   | 2,515 |   |
| Income  (loss) from operations                                                                                            |       | $                                           | 2,896      |   | $ | 3,883 |   | $ | (566 | ) | $ | (7,449 | ) | $ | (1,236 | ) |

 

20

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During the three months ended July 31,2003, the Company formed Carretek LLC (“Carretek”), in which the Company owns a51% interest, to offer financial institutions offshore-centric outsourcing oftheir business processes and IT services needs. During July 2004, Carretek signed its first contract to performoutsourced services with a customer.  Asthis outsourcing business continues to be in the development phase and itsoperations are immaterial, the financial results for the three months ended April 30,2005 and 2004 are contained in the Corporate-Unallocated business segment in thetables above.

 

For the three months ended April 30,2005, Carretek recorded $257,000 of revenue and recorded expense of$904,000.  For the three months ended April 30,2004, Carretek recorded $0 revenue and recorded expense of $174,000.  Accordingly, the 49% share relating to theminority interest in this loss, which was $318,000 and $86,000 for the threemonths ended April 30, 2005 and 2004, respectively, was recorded in otherincome in the accompanying consolidated statements of operations.  The Company and its partner have fundedCarretek to date in the aggregate amount of $3.2 million, consisting of$100,000 in equity and $3.1 million in the form of additional cash advances.

 

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

 
| ** **          | ** ** | **Three Months Ended  April 30,** | ** ** |
|---------------------|------------|----------------------------------------|------------|
| ** **          | ** ** | **2005**                               | ** ** | **2004** | ** ** |
|                |       |                                   |       |   |   |
| Single  customer    |       | 14                                     | %          | 11 | % |
| Top five  customers |       | 44                                     | %          | 36 | % |

 

Wells Fargo accounted for approximately 14%of total revenues during the three months ended April 30, 2005, AmsouthBank accounted for approximately 11% of total revenues during the three monthsended April 30, 2004.

 

The Companymarkets its solutions in several foreign countries.  Revenues, exclusive of out-of-pocket expensereimbursements, for the periods indicated attributed to countries based on thelocation of the customers, were as follows (in thousands):

 
| ** **      | ** ** | **Three Months Ended**   | ** ** | **Three Months Ended**          | ** ** |
|-----------------|------------|--------------------------|------------|---------------------------------|------------|
| ** **      | ** ** | **April 30,  2005** | ** ** | **April 30,  2004**        | ** ** |
| ** **      | ** ** | **Amount**               | ** ** | **Percent  of total  revenues** | ** ** | **Amount** | ** ** | **Percent  of total  revenues** | ** ** |
| United  States  |       | $                        | 20,043     |                            | 73         | % | $ | 22,194 |   | 77 | % |
| Europe          |       | 2,334                    |       | 9                               |       | 2,375 |   | 8 |   |
| Canada          |       | 1,861                    |       | 7                               |       | 1,525 |   | 5 |   |
| Asia Pacific    |       | 1,062                    |       | 4                               |       | 1,356 |   | 5 |   |
| South Africa    |       | 2,010                    |       | 7                               |       | 1,208 |   | 4 |   |
| Other           |       | 70                       |       | —                          |       | 218 |   | 1 |   |
| Total  revenues |       | $                        | 27,380     |                            | 100        | % | $ | 28,876 |   | 100 | % |

 

21

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

 

**The Company recorded variousrestructuring and other charges and (credits) during the three months ended April 30,2005 and 2004, respectively, as follows (in thousands):**

** **
| ** **                                 | ** ** | **Workforce  Reductions** | ** ** | **EPG  Litigation  Settlement** | ** ** | **Legal and  Professional  Fees** | ** ** | **Other**  | ** ** | **Total**  | ** ** |
|--------------------------------------------|------------|---------------------------|------------|---------------------------------|------------|-----------------------------------|------------|------------|------------|------------|------------|
|                                       |       |                      |       |                            |       |                              |       |       |       |       |       |
| **YTD 2004:**                              | ** ** | ** **                | ** ** | ** **                      | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Quarterly period ended April 30, 2004 |       | 308                       |       | 1,686                           |       | 521                               |       | —     |       | 2.515      |       |
| Total YTD 2004                             |       | $                         | 308        |                            | $          | 1,686                             |       | $          | 521        |       | $          | — |   | $ | 2,515 |   |
|                                       |       |                      |       |                            |       |                              |       |       |       |       |       |
| **YTD 2005:**                              | ** ** | ** **                | ** ** | ** **                      | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Quarterly period ended April 30, 2005 |       | 127                       |       | —                          |       | —                            |       | (32        | )          | 95         |       |
| Total YTD 2005                             |       | $                         | 127        |                            | $          | —                            |       | $          | —     |       | $          | (32 | ) | 95 |   |
|                                            |            |                           |            |                                 |            |                                   |            |            |            |            |            |  |  |  |  |  |

 

**QuarterEnded April 30, 2005**

** **

The Company recorded $127,000 inrestructuring and other charges during the three month period ended April 30,2005, principally associated with the separation of 6 employees.  The Company also lowered its estimate by$32,000 for the costs associated with the discontinuance of one of its softwareofferings originally recorded in January 2004.

 

**QuarterEnded April 30, 2004**

** **

The Company recorded $308,000 inrestructuring and other charges during the three month period ended April 30,2004, principally associated with the separation of 10 employees.  The Company expensed $1.686 million forcompensatory damages to EPG after the jury returned a verdict in favor of EPGon one claim and Carreker on three claims. This litigation ultimately settled in June 2004 for $1.7million.  The Company recorded a chargeof $521,000 relating to legal and professional fees relating to these legalactions.

 

**Theactivity related to the accrued merger and restructuring costs during the threemonths ended April 30, 2005 is as follows (in thousands):**

 
| ** **                        | ** ** | **Workforce  Reductions** | ** ** | **Charges  relating to  CheckFlow  Suite** | ** ** | **Facility  Closures** | ** ** | **Other** | ** ** | **Total** | ** ** |
|-----------------------------------|------------|---------------------------|------------|--------------------------------------------|------------|------------------------|------------|-----------|------------|-----------|------------|
|                              |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Balance at January 31,  2005 |       | $                         | 652        |                                       | $          | 200                    |       | $         | 49         |      | $          | 103 |   | $ | 1,004 |   |
|                              |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Additions to  reserve balance:    |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Severance  charges                |       | 127                       |       | —                                     |       | —                 |       | —    |       | 127       |       |
| Reductions  to reserve balances:  |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Cash paid                         |       | (494                      | )          | —                                     |       | (44                    | )          | —    |       | (538      | )          |
| Change in  estimate               |       | —                    |       | —                                     |       | —                 |       | (32       | )          | (32       | )          |
| Balance at April 30,  2005   |       | $                         | 285        |                                       | $          | 200                    |       | $         | 5          |      | $          | 71 |   | $ | 561 |   |

 

The Company anticipates the remaining reserveaccruals at April 30, 2005 will be paid or remaining customer obligationscompleted within the next 12 months.

 

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

 

All statements other than statements ofhistorical fact contained in this report, including statements in this “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”concerning our financial position and liquidity, results of operations,prospects for future growth, and other matters, are forward-lookingstatements.  Although we believe that theexpectations reflected in such forward-looking statements are reasonable, noassurance can be given that such expectations will prove correct.  Factors that could cause our results todiffer materially from the results discussed in, or contemplated by, suchforward-looking statements include the risks described under “Business –Forward Looking Statements and Risk Factors” contained in our Form 10-K for theyear ended January 31, 2005, as filed with the Securities and ExchangeCommission (SEC).  Such risks include,without limitation: dependence on the banking industry, decline in checkvolumes, fluctuations in operating results, lack of long-term agreements,dependence on key personnel, product liability, rapid technological change anddependence on new products, focus on providing business process outsourcingwith significant offshore components, ability to attract and retain qualifiedpersonnel, customer concentration, competition, proprietary rights,infringement claims, dependence on third parties for technology licenses,liability claims, our ability to protect our information technologyinfrastructure, international operations, changing government and taxregulations, stock price fluctuations, impairment of goodwill or intangibleassets, changes in accounting treatment of share-based compensation and theresolution of pending class action lawsuits. All forward-looking statements in this report are expressly qualified intheir entirety by the cautionary statements in this paragraph, in the “riskfactors” included in our SEC filings and elsewhere in this report.

 

**Overview**

** **

For the last 27 years Carreker Corporationhas designed, developed, sold and delivered payments-related software andconsulting solutions to financial institutions and financial serviceproviders.  Our products and servicesaddress a broad spectrum of payment activities and are designed to help ourclients enhance the performance of their payments businesses; improveoperational efficiency in payments processing; enhance revenue andprofitability from payments-oriented products and services; reduce lossesassociated with fraudulent payment transactions; facilitate compliance withrisk-related laws and regulations; and/or maximize clients’ customer incomestreams by aligning their customer interactions and products with customerneeds.

 

We are organized into three primary operatingdivisions: Global Payments Technologies (“GPT”), Revenue Enhancement (“RevE”)and Global Payments Consulting (“GPC”). These operating divisions are operated in distinct yet synergistic waysto bring value to our clients.  Inaddition we have established a joint venture named Carretek LLC to address thepayments outsourcing arena.

 

*Global PaymentsTechnologies*. This division is responsible for design, development, sales, and supportof our technology solutions.   Revenue isprimarily derived from license fees, implementation fees and maintenance fees.

 

*Revenue Enhancement*.  This highly specialized practice groupprovides consulting and software solutions focused on increasing clients’revenue streams.  Areas of expertiseinclude fee income, market segmentation, management of customer pricestructures, account retention, acquisitions and profitability.  A majority of the revenue generated by thisdivision is through benefit-sharing agreements with our customers, recorded asconsulting revenue along with license fees, maintenance fees and implementationfees from our CVE software offering.

 

*Global PaymentsConsulting*.  Theobjective of this  professional servicesdivision is to provide our clients  with “appliedthought 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.

 

In addition to these three divisions, infiscal 2003 we formed Carretek LLC. Carretek is a transformational business outsourcer for payment andtransaction processing jointly owned by Carreker Corporation and MajescoSoftware, Inc., the U.S. subsidiary of Mastek Limited, a leading Indianoutsourcing company with global operations.

 

23

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*Cost of Revenues andGross Margins.* We strive to control our cost of revenues and thereby maintain orimprove our gross margins.  The majoritems impacting cost of consulting, cost of software maintenance and cost ofsoftware implementation are driven by personnel overhead and relatedexpenses.  The major items impacting costof software licenses are amortization of both capitalized and acquired softwareand also software royalties for software from third parties.  While the amortization expense is relativelyfixed, the third party royalty expense can vary significantly based on therelative product mix.

 

*Operating Expenses.*  Operating expenses, including selling,general and administrative and research and development, are substantially drivenby personnel and overhead expenses. Other significant operating expenses that we monitor includeprofessional fees, use of contractors, travel, insurance and office servicesexpenses.  Additionally in fiscal 2004,the settlement of the EPG legal action along with associated legal fees wasrecorded on the Restructuring and Other Charges financial statement caption onthe Consolidated Statement of Operations.

 

*Liquidity and CashFlows.*  Cash andcash equivalents at April 30, 2005 and 2004 totaled $35.7 million and$31.5 million, respectively.  During Q12005, we generated $2.1 million in cash from operating activities, used $1.1million of cash for investing activities and generated $250,000 from financingactivities.  Our primary utilization ofcash in Q1 2005 was to invest in our corporate and development labinfrastructure along with the development costs associated with buildingseveral new product offerings, especially within our GPT business segment.

 

24

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**Products and Services**

 

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

 

*Global Payments Technologies Solutions.*  Carreker’s technology solutions helpfinancial institutions address the needs of some critical payment services anddelivery functions that impact overall operating revenues and costs and riskmanagement.  These functions include presentmentof checks 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).  GlobalPayments Technologies (“GPT”) solutions address these and other key functionsin the context of improving operational efficiency and a gradual transitionfrom paper to electronic-based payment systems. In addition, we offer technology solutions that optimize the inventorymanagement of a bank’s cash stock levels and logistical service requirements,including managing how much is needed, when it is needed and where it isneeded.  Our solutions reduce the amountof cash banks need to hold in reserve accounts and as cash-on-hand whileensuring a high level of customer service through timely replenishment of ATMcash supplies at minimal logistical services cost.

 

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. The solution automatically alerts appropriate bank personnel  for timely and decisive action and reporting. Scalable solutions are offered  for community banks. |       | FraudLink On-Us, FraudLink Deposit,  FraudLink Deposit – Branch Access Option, Kite, FraudLink Positive Pay,  FraudLink eTracker, FraudLink ACHeCK, FraudLink PC, CORE Workflow Manager,  CORE AML Filter, eFraudLink.com, Fraud Solutions Consulting                        |
|                                                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                                              |
| **Payment Solutions:**                                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                                              |
| ** **                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                                              |
| Back Office Processing                                 |       | Products that bring new efficiencies to  back-office operations through leading-edge image, workflow, and RECO  (character recognition) technologies.                                                                                                                                                                                                                                                                                                             |       | Adjustments/Express, Exceptions/Express,  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.                                                                                                                                                                                                                                                                                                               |       | 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 Corporate and Source Capture  Branch |

 

25

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| **Solution**                                     | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | ** ** | **Products Offered**                                                                                                                  |
|--------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------|
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                  |
| 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         |
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                  |
| Global Tracking                                  |       | A complete bar code tracking system  eliminates manual log sheets, automates data gathering and maximizes workflow  by tracking accountable mail, branch bags, item volumes, currency bags,  incoming domestic and international deposits, outgoing cash letters,  exceptions and much more.                                                                                                                                                                                               |       | Receive Sentry                                                                                                                        |
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                  |
| eMetrics                                         |       | Performance-measurement software suite that  uses historical data to generate key performance indicators, item processing  volume data, productivity statistics and quality control benchmarks.                                                                                                                                                                                                                                                                                            |       | Lumen, ProModel, eiMICR, eiStats,  eiQuality, eiPerform                                                                               |
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                  |
| Electronic Check Presentment 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 & Cash Logistic 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, eiGateway                                                                                                                  |
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                  |
| 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 and optimization  of transportation. Consulting solutions can drive further efficiency and  automation in vault, branch and ATM operations.              |       | iCom, ReserveLink, ReserveLink Plus, Cash  Supply Chain Consulting                                                                    |

 

26

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*Revenue Enhancement.*  The Revenue Enhancement division includes twobusiness units:  RevE and Customer ValueEnhancement (“CVE”), formerly known as EnAct. RevE is a highly specializeddivision that provides consulting services focused on tactical methods ofincreasing banks’ fee income. The scope and depth of this practice has expandedthroughout its 14 year history and now includes retail, small business, andcommercial deposits, treasury management, consumer and commercial lending,credit card lending and trust and investment services. Our solutions involvedeveloping 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 ourRevenue Enhancement offering is our CVE solutions that includes EnAct software,proprietary sales management methodologies and sales training programs. Our CVEsolutions assist financial institutions in leveraging central intelligence withlocal insight. This enables our clients to recognize those customers andprospects representing the greatest value or potential. Our approach is uniqueand complementary to many CRM investments that banks have made in recent yearsand is designed to focus their activities such that they can actually attainincreased returns on these CRM investments.

 

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

 

•                  Enterprisepayment rationalization (strategy through performance optimization)

•                  Paymentresearch services

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

•                  Transactionclearing optimization solutions (transportation, float, clearing form, clearingpartners and funds availability optimization)

•                  Electronic paymentinfrastructure planning (image enablement through converged paymentenvironments)

•                  Consolidationand merger/integration planning

•                  EnterpriseRisk support for payments related functions

 

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 floatthrough float analysis and pricing to improve profitability, reporting,workflow and check clearing operations. These products also provide critical activity summaries, aid in creatingmultiple availability and pricing schedules, and pinpoint thecost/profitability of transactions or relationships.

•                  PaymentsClearing Modeling product – Payments Financial Modeling application that allowsa bank to create an enterprise virtual profit and loss statement for thepayments business as well as model business scenarios around product andservice pricing and transactional volume trends.

 

*Outsourcing*.  Carretek LLC is a transformational businessoutsourcer for payment and transaction processing jointly owned by CarrekerCorporation (51%) and Majesco Software Inc. (49%), the U.S. subsidiary ofMastek Limited, a leading Indian outsourcing company with global operations.  Carretek was formed in fiscal 2003.  While the venture has signed its firstcontract, it is still in the developmental phase and its results are containedin the Corporate-Unallocated business segment.

 

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

 

27

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

 

**Executive Summary**

 

In Q1 2005, we generated revenue of $28.2million and a net income of $498,000. These results compare to revenue of $29.8 million and a net loss of$812,000 in Q1 2004.  All three of ouroperating segments had declines in revenue in Q1 2005, as compared to Q12004.  The most significant decline waswithin our Global Payments Technology (“GPT”) business segment and was theresult of $2.9 million of license revenue recorded in Q1 2004 from a licensesale to a single customer of our Check Image Archive product that was notrepeated in Q1 2005.  We have madesignificant progress in reducing our SG&A costs and in Q1 2005 we have notincurred any significant Restructuring and Other Charges.  We also increased our investment in Researchand Development in Q1 2005, as compared to Q1 2004, and the net result of thesefactors increased our profitability in Q1 2005, as compared to Q1 2004.

 

In Q1 2005, we generated $2.1 million of cashfrom operating activities and increased total cash by $1.2 million, as comparedto $9.7 million of cash generated from operating activities and a $2.9 millionincrease in cash in Q1 2004.  Our cashflow remains positive and is heavily dependent on the timing of the collectionsof our December 31, 2004 maintenance renewals.  Our continued improvements in cash collectionled to more of these renewals being collected in Q4 2004, as compared to theprior year in which more of the December 31, 2003 maintenance renewalinvoices were collected in Q1 2004.

 

Within our Revenue Enhancement (“RevE”)segment, we experienced a $765,000, or 9.0%, decline in revenues within ourtraditional RevE contingent consulting business; however, we experienced anincrease of $383,000, or 67.3%, within our Customer Value Enhancement (“CVE”)software and proprietary sales management business.  RevE consulting revenues were flat in thedomestic market but declined $688,000, or 28.0%, in the internationalmarkets.  The CVE increase was primarilythe result of the reformulation of the CVE business model to reflect termsoftware license arrangements as opposed to traditional perpetual licensearrangements.  This change in strategyappears to be gaining acceptance, and in November 2004 the CVE groupentered into a 6-year term license with a Top 15 U.S. bank that increasedsoftware, services and maintenance revenue beginning in Q1 2005.  Additionally in Q1 2005, we entered into acontract with a large international bank for a similar multi-year engagement.

 

For Q1 2005, total GPT revenues declined $1.3million, or 6.5%, as compared to Q1 2004. This decline was primarily the result of a decline in software revenuediscussed above, partially offset by increases in maintenance and servicesrevenue.

 

Our Global Payments Consulting (“GPC”)segment experienced a slight revenue decline of approximately $86,000, or 8.2%,in Q1 2005, as compared to Q1 2004.  Wecontinue to expand our sales focus in this segment as we reposition thisbusiness to focus on enterprise-wide payment electronification strategies, imageenablement planning and integration and enterprise risk.  New leadership has helped refine ourconsulting offerings with a clear value proposition.

 

Finally, Carretek is our 51% owned businessoutsourcer for payment and transaction processing.  Carretek was formed in fiscal 2003 and signedits first agreement in the second quarter of fiscal 2004.  Fiscal 2004 revenues were minimal, however inlate January 2005 we expanded the scope of our outsourcing engagement withthis single customer to include an additional set of transaction processing functionsand revenue increased to $257,000 in Q1 2005. Even with this expanded scope, we do not expect this business to beprofitable until the scope with this single customer is expanded to its fullcapacity or until additional customers are added.

 

We continue to focus on reducing general andadministrative costs to help fund increasing sales and marketing costs in bothGPT and GPC, along with increasing research and development costs to enhanceour existing product offerings and more importantly, develop new productofferings.  The reductions within generaland administrative were primarily related to cost savings from our new healthcare plan and provider, along with reductions within office services andfacilities.  Additionally in Q1 2005,Restructuring and Other Charges declined significantly as compared to Q12004.  In Q1 2004, we accrued $1.686million estimated settlement amount related to the EPG litigation and expensedapproximately $462,000 of related legal costs. This litigation was ultimately settled in June 2004 for $1.7million.

 

28

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**Results ofOperations**

 

***Comparison of Three MonthsEnded April 30, 2005 (“Q1 2005”) to Three Months Ended April 30, 2004(“Q1 2004”)***

 

***Revenues***

 

*Revenues by Segment ($ inthousands):*

 
| ** **                       | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|----------------------------------|------------|----------------------------------------|------------|--------------|------------|
| ** **                       | ** ** | **2005**                               | ** ** | **2004**     | ** ** | **$** | ** ** | **%** | ** ** |
|                             |       |                                   |       |         |       |   |   |   |   |
| Revenue  Enhancement             |       | $                                      | 8,999      |         | $          | 9,481 |   | $ | (482 | ) | (5.1 | )% |
| Global  Payments Technologies    |       | 17,968                                 |       | 19,225       |       | (1,257 | ) | (6.5 | ) |
| Global  Payments Consulting      |       | 974                                    |       | 1,060        |       | (86 | ) | (8.1 | ) |
| Corporate  (Outsourcing) Revenue |       | 257                                    |       | —       |       | 257 |   | — |   |
|                             |       |                                   |       |         |       |   |   |   |   |
| Total  Revenues                  |       | $                                      | 28,198     |         | $          | 29,766 |   | $ | (1,568 | ) | (5.3 | )% |

 

The decline in revenuefor Q1 2005, as compared to Q1 2004, was driven by declines in all three of ourmajor business segments, offset by increased revenue from Carretek LLC, our 51%owned business which provides payment and transaction processing outsourcingservices.

 

The decline in our GPT business segment, on aquarter-over-quarter basis, has been primarily the result of a decline insoftware revenue of $2.6 million, offset by a $283,000 increase in maintenancerevenue and $1.0 million in services revenue. The decline in GPT software revenue is concentrated within the Paymentsproduct group.  In Q1 2004, the Paymentsproduct group derived $2.9 million from a license sale to a single customer ofour Check Image Archive product which was not repeated in Q1 2005.

 

The decline within our RevE business segment,on a quarter-over-quarter basis, was principally driven by a $765,000, or 9.0%,decline in traditional consulting revenues, offset by a $386,000, or 76.7%,increase in CVE software, maintenance and services revenue.  The decline in RevE consulting revenue wasprimarily with non-U.S. customers, however this decline is a result oftiming.  RevE continues to expand itsmarketing effort internationally.  In Q12005 there was only one non-U.S. revenue producing engagement, as opposed to threein Q1 2004.  The increase in CVEsoftware, maintenance and services revenue in Q1 2005 was primarily attributedto a reformulation of the sales strategy to position the CVE product as anenhancement to customers’ existing CRM solution, as opposed to a replacement ofan existing CRM solution.  Increasedsales capacity also helped fuel this increased activity.

 

The decline in the GPC business segmentrevenue, on a quarter-over-quarter basis, was primarily the result of $57,000of decreased services within our Float group. With recent increases in interest rates, we expect to have futureincreased customer demand for our Float product offerings.  Additionally, with our expanded sales focusand the repositioning of the GPC consulting business to enterprise-wide paymentand risk strategies and image enablement planning and integration, we expect tobe well positioned for revenue growth opportunities.

 

Overall, as we lookacross our three major business segments, we believe that we are wellpositioned and have a competitive advantage to capitalize on the significantchanges brought about by factors affecting our customers including revenuepressures, technology and regulatory change (i.e., Check 21, USA Patriot Actand Basel II), growing costs and reputational risk associated with identity andtransaction fraud.  We anticipate revenue growth in 2005 due to sales ofnew products and increased consulting opportunities.  The Company continues to focus on costmanagement efforts to improve 2005 profitability and increase shareholdervalue. Revenue and operating income for the second quarter of 2005 are expectedto improve over first quarter 2005 levels.

 

29

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*Consulting Fees ($in thousands):*

 
| ** **       | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|------------------|------------|----------------------------------------|------------|--------------|------------|
| ** **       | ** ** | **2005**                               | ** ** | **2004**     | ** ** | **$** | ** ** | **%** | ** ** |
|             |       |                                   |       |         |       |   |   |   |   |
| Consulting  Fees |       | $                                      | 8,318      |         | $          | 9,057 |   | $ | (739 | ) | (8.2 | )% |
|                  |            |                                        |            |              |            |  |  |  |  |  |  |  |

 

The majority of our consulting revenue isderived from our RevE business segment. Consulting revenue in the RevE segment decreased $765,000, or 9.0%, to$7.7 million in Q1 2005 from $8.5 million in Q1 2004.  Domestically, consulting revenue for RevE wasessentially flat at $6.0 million on a quarterly comparison basis, and therewere 12 domestic revenue producing engagements in Q1 2005, as compared to 10 inQ1 2004.  International RevE consultingrevenue decreased $688,000 in Q1 2005, as compared to Q1 2004, and there wasonly 1 non-U.S. revenue producing engagement in Q1 2005 as compared to 3 in Q12004.

 

Consulting revenue in our GPC segment wasessentially flat at $500,000 on a quarterly basis.

 

*Software LicenseFees ($ in thousands):*

 
| ** **             | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|------------------------|------------|----------------------------------------|------------|--------------|------------|
| ** **             | ** ** | **2005**                               | ** ** | **2004**     | ** ** | **$** | ** ** | **%** | ** ** |
|                   |       |                                   |       |         |       |   |   |   |   |
| Software  License Fees |       | $                                      | 3,359      |         | $          | 5,856 |   | $ | (2,497 | ) | (42.6 | )% |
|                        |            |                                        |            |              |            |  |  |  |  |  |  |  |

 

The majority of oursoftware license fees are derived from our GPT business segment.  GPT software license revenue decreased $2.6million, or 45.8%, to $3.0 million in Q1 2005 from $5.6 million in Q12004.  This decline is primarily theresult of a $2.9 million software license in the GPT business segment generatedfrom a single customer in our Check Image Archive product group, which did notrequire implementation services.  Thisdecline is partially offset by $181,000 of Risk product revenue licensed, witha deferral of the related software license revenue, in previous fiscal yearsfor which it was determined in Q1 2005 that no additional implementationservices would be required by the Company.

 

The software revenuederived from our CVE product offering, contained in our RevE business segment,increased to $301,000 in Q1 2005, as compared to $179,000 in Q1 2004.  This increase is the result of reformulatingour sales strategy to position our CVE product as an enhancement to an existingCRM customer installation, as opposed to a replacement for an existing CRM customerinstallation.  The CVE group has alsoadded two additional sales persons in the latter half of fiscal 2004.

 

*Software MaintenanceFees ($ in thousands):*

 
| ** **                 | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|----------------------------|------------|----------------------------------------|------------|--------------|------------|
| ** **                 | ** ** | **2005**                               | ** ** | **2004**     | ** ** | **$** | ** ** | **%** | ** ** |
|                       |       |                                   |       |         |       |   |   |   |   |
| Software  Maintenance Fees |       | $                                      | 11,312     |         | $          | 11,084 |   | $ | 228 |   | 2.1 | % |
|                            |            |                                        |            |              |            |  |  |  |  |  |  |  |

 

The majority of ourmaintenance revenue is derived from our GPT business segment.  Software maintenance fees are invoiced andcollected pursuant to annually renewable product and telephone supportagreements with our software customers. The annual maintenance fee is generally paid by the customer at thebeginning of the maintenance period and revenue is recognized ratably over theterm 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 isreceived, maintenance revenue is recognized for the period that maintenancerevenue was previously deferred. Maintenance contracts usually carry annual maintenance fee escalationclauses generally based on an index, such as the consumer price index.  Because of the revenue recognition policy,maintenance revenue can vary from quarter-to-quarter.

 

30

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*SoftwareImplementation Fees ($ in thousands):*

 
| ** **                    | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|-------------------------------|------------|----------------------------------------|------------|--------------|------------|
| ** **                    | ** ** | **2005**                               | ** ** | **2004**     | ** ** | **$** | ** ** | **%** | ** ** |
|                          |       |                                   |       |         |       |   |   |   |   |
| Software  Implementation Fees |       | $                                      | 4,134      |         | $          | 2,879 |   | $ | 1,255 |   | 43.6 | % |
|                               |            |                                        |            |              |            |  |  |  |  |  |  |  |

 

The majority of oursoftware implementation fees are derived from our GPT business segment.  Within GPT, software implementation fees were$3.6 million in Q1 2005, as compared to $2.6 million in Q1 2004.  The increase in software implementation feesis the result of increasing customization service engagements related toexisting customer software product installations.

 

*Outsourcing ServiceFees ($ in**thousands):*

 
| ** **                | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|---------------------------|------------|----------------------------------------|------------|--------------|------------|
| ** **                | ** ** | **2005**                               | ** ** | **2004**     | ** ** | **$** | ** ** | **%** | ** ** |
|                      |       |                                   |       |         |       |   |   |   |   |
| Outsourcing  Service Fees |       | $                                      | 257        |         | $          | — |   | $ | 257 |   | — | % |
|                           |            |                                        |            |              |            |  |  |  |  |  |  |  |

 

Our outsourcing service revenue is derivedthrough Carretek, our 51% owned business which outsources payment andtransaction processing.  Carretek wasformed in fiscal 2003 and signed its first agreement in the second quarter offiscal 2004.  The fiscal 2004 revenueswere minimal; however in late Q4 2004, we expanded our scope of business withour initial customer to include a second set of transaction processingfunctions, and in Q1 2005 we added a third set of transaction processingfunctions.

 

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

 
| ** **                            | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|---------------------------------------|------------|----------------------------------------|------------|--------------|------------|
| ** **                            | ** ** | **2005**                               | ** ** | **2004**     | ** ** | **$** | ** ** | **%** | ** ** |
|                                  |       |                                   |       |         |       |   |   |   |   |
| Out-of-Pocket  Expense Reimbursements |       | $                                      | 818        |         | $          | 890 |   | $ | (72 | ) | (8.1 | )% |
|                                       |            |                                        |            |              |            |  |  |  |  |  |  |  |

 

The decrease in thesereimbursements occurred within the RevE business segment, and corresponds withthe decline in International RevE consulting revenue noted above.  Most of our software services and consultingengagements require our employees to be at the customer location for extendedperiods of time, which gives rise to out-of-pocket expense reimbursements.

 

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***Cost of Revenues***

 

*Cost ofRevenues by Segment ($ in thousands):*

 
| ** **                        | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|-----------------------------------|------------|----------------------------------------|------------|--------------|------------|
| ** **                        | ** ** | **2005**                               | ** ** | **2004**     | ** ** | **$** | ** ** | **%** | ** ** |
|                              |       |                                   |       |         |       |   |   |   |   |
| Revenue  Enhancement              |       | $                                      | 4,471      |         | $          | 4,376 |   | $ | 95 |   | 2.2 | % |
| % of revenue                      |       | 49.7                                   | %          | 46.2         | %          |   |   |   |   |
|                              |       |                                   |       |         |       |   |   |   |   |
| Global  Payments Technologies     |       | $                                      | 8,143      |         | $          | 8,518 |   | $ | (375 | ) | (4.4 | )% |
| % of revenue                      |       | 45.3                                   | %          | 44.3         | %          |   |   |   |   |
|                              |       |                                   |       |         |       |   |   |   |   |
| Global  Payments Consulting       |       | $                                      | 901        |         | $          | 1,343 |   | $ | (442 | ) | (32.9 | )% |
| % of revenue                      |       | 92.5                                   | %          | 126.7        | %          |   |   |   |   |
|                              |       |                                   |       |         |       |   |   |   |   |
| Corporate  (Outsourcing Services) |       | $                                      | 579        |         | $          | — |   | $ | 579 |   | — | % |
| % of revenue                      |       | 225.3                                  | %          | —       | %          |   |   |   |   |
|                              |       |                                   |       |         |       |   |   |   |   |
| Total Cost  of Revenues           |       | $                                      | 14,094     |         | $          | 14,237 |   | $ | (143 | ) | (1.0 | )% |
| % of revenue                      |       | 50.0                                   | %          | 47.8         | %          |   |   |   |   |

 

Cost of revenues inabsolute dollars declined slightly to $14.1 million in Q1 2005 from $14.2million in Q1 2004.  However, directcosts as a percentage of revenue increased to 50.0% in Q1 2005 from 47.8% in Q12004.  This increase was primarily theresult of lower consulting revenue within our RevE business segment and lowersoftware license revenue within our GPT business segment.

 

Within the RevE businesssegment, the increase in the cost of revenues on a quarter-over-quarter basiswas the result of an approximate $120,000 increase in the cost of consultingdue primarily to $94,000 of royalties accrued for intellectual property to athird party related to one customer engagement in Q1 2005.  Additionally, cost of services increased$69,000 in Q1 2005 due to increased CVE customer installation engagements in Q12005, as compared to Q1 2004.  These twoincreases were partially offset by a $78,000 decline in costs of out-of-pocketexpenses due to less international travel in Q1 2005, as compared to Q12004.  Direct costs as a percentage ofrevenue increased to 49.7% in Q1 2005 from 46.2% due primarily to lower RevEconsulting revenue in Q1 2005, as compared to Q1 2004.

 

Within the GPT businesssegment, the decrease in the cost of revenues on a quarter-over-quarter basiswas primarily the result of a decline in the cost of services achieved throughpersonnel reductions in the last half of fiscal year 2004.  Even with these cost reductions, direct costsas a percentage of GPT revenue increased due to a $2.6 million decline in GPTsoftware license revenue.

 

The direct costreductions within GPC were attributable to personnel reductions performedduring the latter half of fiscal 2004 to bring our costs in line with expectedconsulting revenues.

 

The direct cost increaserelated to Carretek, our 51% owned business which outsources payment andtransaction processing, is related to the direct costs related to our singlecustomer which began in Q2 2004.

 

32

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*Cost of Consulting($ in thousands):*

 
| ** **               | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|--------------------------|------------|----------------------------------------|------------|--------------|------------|
| ** **               | ** ** | **2005**                               | ** ** | **2004**     | ** ** | **$** | ** ** | **%** | ** ** |
|                     |       |                                   |       |         |       |   |   |   |   |
| Cost of  Consulting      |       | $                                      | 4,241      |         | $          | 4,529 |   | $ | (288 | ) | (6.4 | )% |
| % of  consulting revenue |       | 51.0                                   | %          | 50.0         | %          |   |   |   |   |
|                          |            |                                        |            |              |            |  |  |  |  |  |  |  |

 

The cost of consultingconsists primarily of personnel costs related to our consulting engagementswithin our RevE and GPC segments.  Thedecline in cost of consulting on a quarter-over-quarter basis was primarily dueto a $355,000 reduction within our GPC business segment, achieved through personnelreductions made in the latter half of fiscal year 2004 to bring costs in linewith expected GPC consulting revenues. The decreased expenses were partially offset by $117,000 increased costof consulting within our RevE business segment, related primarily to $94,000royalty expense to a third party for intellectual property for one customer.

 

*Cost of SoftwareLicenses ($ in thousands):*

 
| ** **                     | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|--------------------------------|------------|----------------------------------------|------------|--------------|------------|
| ** **                     | ** ** | **2005**                               | ** ** | **2004**     | ** ** | **$** | ** ** | **%** | ** ** |
|                           |       |                                   |       |         |       |   |   |   |   |
| Cost of  Software Licenses     |       | $                                      | 1,536      |         | $          | 1,598 |   | $ | (62 | ) | (3.9 | )% |
| % of  software license revenue |       | 45.7                                   | %          | 27.3         | %          |   |   |   |   |
|                                |            |                                        |            |              |            |  |  |  |  |  |  |  |

 

The cost of softwarelicenses consists primarily of amortization of capitalized and acquiredsoftware costs along with royalties payable to third parties.  The decrease in the cost of software licenserevenue on a quarter-over-quarter basis is primarily the result of lowerroyalty expense in Q1 2005, as compared to Q1 2004, relating to the decline insoftware revenue over the same period. This decline in software revenue also resulted in a sharp increase inthe cost of software license revenue as a percentage of software licenserevenue.

 

In connection with software license andmaintenance agreements entered into with certain banks and purchase agreementsentered into with vendors under which we acquired software technology used inproducts sold to our customers, we are required to pay royalties on sales ofcertain software products.  Under thesearrangements, we accrue royalty expense when the associated revenue isrecognized.  The royalty percentagesgenerally range from 20% to 50% of the associated revenue.  In Q1 2005, we recorded $92,000 of softwareroyalty expense compared to $179,000 of software royalty expense recorded in Q12004.  Depending on our future productmix, our margins from software license fees may be negatively impacted byincreased software royalty expense.

 

33

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*Cost of SoftwareMaintenance ($ in thousands):*

 
| ** **                         | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|------------------------------------|------------|----------------------------------------|------------|--------------|------------|
| ** **                         | ** ** | **2005**                               | ** ** | **2004**     | ** ** | **$** | ** ** | **%** | ** ** |
|                               |       |                                   |       |         |       |   |   |   |   |
| Cost of  Software Maintenance      |       | $                                      | 3,975      |         | $          | 3,798 |   | $ | 177 |   | 4.7 | % |
| % of  software maintenance revenue |       | 35.1                                   | %          | 34.3         | %          |   |   |   |   |
|                                    |            |                                        |            |              |            |  |  |  |  |  |  |  |

 

Cost of software maintenance consistsprimarily of personnel and facility costs to provide telephone support, productdefect support and other enhancements to our existing products, which are notsignificant enough to extend the product’s life cycle or substantially increaseits marketability. The increase in Q1 2005 compared to Q1 2004 occurred as aresult of an increased use of contract labor within our GPT business segmentrelated to and reflecting an increased emphasis on supporting and enhancing ourcurrent product mix.

 

As discussed above, theannual maintenance fee is generally paid by the customer at the beginning ofthe maintenance period and revenue is recognized ratably over the term of therelated contract.  If the annualmaintenance fee is not paid at the beginning of the maintenance period, wedefer the revenue recognition until the time that the maintenance fee is paidby the customer.  When the payment isreceived, maintenance revenue is recognized for the period that maintenancerevenue was previously deferred.  As aresult, our cost of software maintenance as a percentage of related maintenancerevenue may fluctuate.

 

*Cost of SoftwareImplementation ($ in thousands):*

 
| ** **                            | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|---------------------------------------|------------|----------------------------------------|------------|--------------|------------|
| ** **                            | ** ** | **2005**                               | ** ** | **2004**     | ** ** | **$** | ** ** | **%** | ** ** |
|                                  |       |                                   |       |         |       |   |   |   |   |
| Cost of  Software Implementation      |       | $                                      | 2,973      |         | $          | 3,369 |   | $ | (396 | ) | (11.8 | )% |
| % of  software implementation revenue |       | 71.9                                   | %          | 117.0        | %          |   |   |   |   |
|                                       |            |                                        |            |              |            |  |  |  |  |  |  |  |

 

Costs of softwareimplementation consist primarily of personnel and facility costs to providesoftware implementation and project management support to customer softwareimplementations within our GPT business segment and the CVE software productwithin our RevE segment.  The decline incosts of software implementation reflect decreased personnel costs within ourGPT business segment.  These headcount reductionswere performed in the latter half of fiscal 2004 to improve utilization.  The sharp decline in the costs of softwareimplementation, as a percentage of software implementation revenue, was theresult of decreased costs within GPT along with an increased volume of activeservices engagements.

 

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

 
| ** **                         | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|------------------------------------|------------|----------------------------------------|------------|--------------|------------|
| ** **                         | ** ** | **2005**                               | ** ** | **2004**     | ** ** | **$** | ** ** | **%** | ** ** |
|                               |       |                                   |       |         |       |   |   |   |   |
| Cost of  Outsourcing Service Fees  |       | $                                      | 579        |         | $          | — |   | $ | 579 |   | — | % |
| % of  outsourcing services revenue |       | 225.3                                  | %          | —       | %          |   |   |   |   |
|                                    |            |                                        |            |              |            |  |  |  |  |  |  |  |

 

The increase in the cost of outsourcingservice fees is due to the creation of Carretek, our 51% owned businessoutsourcer for payment and transaction processing.  In Q2 2004, this business retained its firstcustomer.  We do not expect our directcosts, as a percentage of outsourcing service revenue, to decline withoutexpanding this single customer to its full capacity or securing additionaloutsourcing customers.

 

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

 
| ** **                                 | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|--------------------------------------------|------------|----------------------------------------|------------|--------------|------------|
| ** **                                 | ** ** | **2005**                               | ** ** | **2004**     | ** ** | **$** | ** ** | **%** | ** ** |
|                                       |       |                                   |       |         |       |   |   |   |   |
| Out-of-Pocket  Expenses                    |       | $                                      | 790        |         | $          | 943 |   | $ | (153 | ) | (16.2 | )% |
| % of  out-of-pocket expense reimbursements |       | 96.6                                   | %          | 106.0        | %          |   |   |   |   |
|                                            |            |                                        |            |              |            |  |  |  |  |  |  |  |

 

These costs representtravel, meals and other sundry expenses incurred by our employees.  These costs are invoiced to the customer,without mark-up, usually on a monthly basis. The absolute costs have declined on a quarterly basis due to fewerinternational RevE consulting engagements. In addition, certain customer contracts contain expense maximums, so incertain cases not all expenses incurred can be passed along to the customerwithout contractual revisions or the customer’s express written approval.

 

***Operating Costs andExpenses:***

 

*Selling, General and Administrative Expenses**($ in thousands):*

 
| ** **                                    | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|-----------------------------------------------|------------|----------------------------------------|------------|--------------|------------|
| ** **                                    | ** ** | **2005**                               | ** ** | **2004**     | ** ** | **$** | ** ** | **%** | ** ** |
|                                          |       |                                   |       |         |       |   |   |   |   |
| Selling,  General and Administrative Expenses |       | $                                      | 10,904     |         | $          | 12,192 |   | $ | (1,288 | ) | (10.6 | )% |
| % of total  revenue                           |       | 38.7                                   | %          | 41.0         | %          |   |   |   |   |
|                                               |            |                                        |            |              |            |  |  |  |  |  |  |  |

 

Selling, general and administrative expensesgenerally consist of personnel costs such as salaries, commissions, incentivecompensation and non-reimbursable travel. Additionally, the provision fordoubtful accounts, insurance, including directors and officers insurance, aswell as professional services such as legal and accounting expense and otherrelated costs are classified within selling, general and administrativeexpense.

 

We continue to focus on decreasing coststhroughout the organization.  Some of theprimary drivers of the decreased SG&A costs in Q1 2005, as compared to Q12004, were as follows:

 

•                  Decreasedcorporate selling and marketing costs of $594,000; however, the individualbusiness segments increased their selling and marketing costs by $301,000.  This transfer of costs was in response to acorporate initiative to shift the selling function from a corporateresponsibility to a business segment responsibility.

•                  Decreasedemployee benefits of approximately $586,000, primarily related to decreasedhealthcare costs as we adopted a new healthcare plan and provider on January 1,2005.

•                  Decreasedoffice services and facility costs of $367,000, primarily related to decreasedrent, telephone and equipment depreciation.

•                  Increasedconsolidation and efficiency within our executive and corporate staff levels.

 

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

 
| ** **                         | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|------------------------------------|------------|----------------------------------------|------------|--------------|------------|
| ** **                         | ** ** | **2005**                               | ** ** | **2004**     | ** ** | **$** | ** ** | **%** | ** ** |
|                               |       |                                   |       |         |       |   |   |   |   |
| Research and  Development Expenses |       | $                                      | 2,521      |         | $          | 1,708 |   | $ | 813 |   | 47.6 | % |
| % of total  revenue                |       | 8.9                                    | %          | 5.7          | %          |   |   |   |   |
|                                    |            |                                        |            |              |            |  |  |  |  |  |  |  |

 

Research and development expenses consist primarily of personnel,contract labor, travel and facilities expenses incurred by our research anddevelopment organization.  Research anddevelopment costs have increased on a quarterly basis as a result of increasednew product development and less software costs capitalized in Q1 2005, ascompared to Q1 2004.  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 accordance with SFAS No. 86, “*Accountingfor Costs of Computer Equipment**tobe Sold, Leased or Otherwise Marketed,”* we capitalized $437,000 inQ1 2005, as compared to $910,000 in Q1 2004. In Q1 2005, we have begun to develop two new Cash solutions and thecosts associated with these two products represented 88% of the amountcapitalized in Q1 2005.  In Q1 2004, 100%of the capitalization was related to the development of Payments products,primarily ExchgLink, our product offering to send and receive check images, andSource Capture, an application which enables bank customers to capture checkimages at corporate sites.

 

Software development costs of a product are capitalized from the timetechnological feasibility is reached until the general release of theproduct.  We establish technologicalfeasibility either through the process of creating a detailed program designand reviewing the detailed program design for any high risk development issuesor the creation of a working model. Capitalization only occurs if we believe costs capitalized arerecoverable through future sales of the software product under development.

 

*Amortization of Intangible Assets:*

 

Amortization of intangible assets was $350,000 for Q1 2005 and Q12004.  The amortization results from theperiodic recognition of amortization expense of intangible customerrelationships acquired in the Check Solutions acquisition in 2001.

 

***Restructuringand Other Charges:***  We recorded various restructuringand other charges and credits, as follows ($ in thousands):

** **
| ** **                                 | ** ** | **Workforce  Reductions** | ** ** | **EPG  Litigation  Settlement** | ** ** | **Legal and  Professional  Fees** | ** ** | **Other**  | ** ** | **Total**  | ** ** |
|--------------------------------------------|------------|---------------------------|------------|---------------------------------|------------|-----------------------------------|------------|------------|------------|------------|------------|
|                                       |       |                      |       |                            |       |                              |       |       |       |       |       |
| **YTD 2004:**                              | ** ** | ** **                | ** ** | ** **                      | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Quarterly period ended April 30, 2004 |       | 308                       |       | 1,686                           |       | 521                               |       | —     |       | 2.515      |       |
| Total YTD 2004                             |       | $                         | 308        |                            | $          | 1,686                             |       | $          | 521        |       | $          | — |   | $ | 2,515 |   |
|                                       |       |                      |       |                            |       |                              |       |       |       |       |       |
| **YTD 2005:**                              | ** ** | ** **                | ** ** | ** **                      | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Quarterly period ended April 30, 2005 |       | 127                       |       | —                          |       | —                            |       | (32        | )          | 95         |       |
| Total YTD 2005                             |       | $                         | 127        |                            | $          | —                            |       | $          | —     |       | $          | (32 | ) | 95 |   |
|                                            |            |                           |            |                                 |            |                                   |            |            |            |            |            |  |  |  |  |  |

 

We recorded $127,000 in restructuring andother charges during the three month period ended April 30, 2005,principally associated with the separation of 6 employees.  We also lowered our estimate by $32,000 forthe costs associated with the discontinuance of one of our software offerings,originally recorded in January 2004.

 

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We recorded $308,000 in restructuring andother charges during the three month period ended April 30, 2004,principally associated with the separation of 10 employees.  We expensed approximately $1.686 million forcompensatory damages to EPG after the jury returned a verdict in favor of EPGon one claim and Carreker on three claims. This litigation was ultimately settled in June 2004 for $1.7million.  We recorded a charge of$521,000 relating to legal and professional fees relating to these legalactions.

 

The activity related to the accrued mergerand restructuring costs during the three months ended April 30, 2005 is asfollows (in thousands):

 
| ** **                        | ** ** | **Workforce  Reductions** | ** ** | **Charges  relating to  CheckFlow  Suite** | ** ** | **Facility  Closures** | ** ** | **Other** | ** ** | **Total** | ** ** |
|-----------------------------------|------------|---------------------------|------------|--------------------------------------------|------------|------------------------|------------|-----------|------------|-----------|------------|
|                              |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Balance at January 31,  2005 |       | $                         | 652        |                                       | $          | 200                    |       | $         | 49         |      | $          | 103 |   | $ | 1,004 |   |
|                              |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Additions to  reserve balance:    |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Severance  charges                |       | 127                       |       | —                                     |       | —                 |       | —    |       | 127       |       |
| Reductions  to reserve balances:  |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Cash paid                         |       | (494                      | )          | —                                     |       | (44                    | )          | —    |       | (538      | )          |
| Change in  estimate               |       | —                    |       | —                                     |       | —                 |       | (32       | )          | (32       | )          |
| Balance at April 30,  2005   |       | $                         | 285        |                                       | $          | 200                    |       | $         | 5          |      | $          | 71 |   | $ | 561 |   |

 

We anticipate the remaining reserve accrualsat April 30, 2005 will be paid or remaining customer obligations completedwithin the next 12 months.

 

***OtherIncome (Expense):***

 

*Interest Income ($in thousands):*

 
| ** **       | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|------------------|------------|----------------------------------------|------------|--------------|------------|
| ** **       | ** ** | **2005**                               | ** ** | **2004**     | ** ** | **$** | ** ** | **%** | ** ** |
|             |       |                                   |       |         |       |   |   |   |   |
| Interest  Income |       | $                                      | 144        |         | $          | 48 |   | $ | 96 |   | 200.0 | % |
|                  |            |                                        |            |              |            |  |  |  |  |  |  |  |

 

Interest income consists of interest earnedon cash and cash equivalents.  Theincrease quarter-over-quarter is primarily the result of higher average cashand cash equivalent balances during Q1 2005, as compared to Q1 2004, andslightly higher yields on these investments.

 

*Interest Expense ($in thousands):*

 
| ** **        | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|-------------------|------------|----------------------------------------|------------|--------------|------------|
| ** **        | ** ** | **2005**                               | ** ** | **2004**     | ** ** | **$** | ** ** | **%** | ** ** |
|              |       |                                   |       |         |       |   |   |   |   |
| Interest  Expense |       | $                                      | (105       | )            | $          | (108 | ) | $ | (3 | ) | (2.8 | )% |
|                   |            |                                        |            |              |            |  |  |  |  |  |  |  |

 

Interest expense is primarily the result ofthe commitment fees associated with the maintenance of our $30.0 millionrevolving credit agreement. Additionally, the amortization of the deferred loan costs are alsoincluded in interest expense.  There wereno borrowings outstanding under this credit agreement in Q1 2005 or Q1 2004.

 

37

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*Other income ($ inthousands):*

 
| ** **                                                  | ** ** | **Three Months Ended  April 30,** | ** ** | **Variance** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------|------------|--------------|------------|
| ** **                                                  | ** ** | **2005**                               | ** ** | **2004**     | ** ** | **$** | ** ** | **%** | ** ** |
|                                                        |       |                                   |       |         |       |   |   |   |   |
| Gain on sale  of Cash Services Australia Pty. Limited       |       | $                                      | —     |         | $          | 539 |   | $ | (539 | ) | (100.0 | )% |
| Equity in  earnings of Cash Services Australia Pty. Limited |       | —                                 |       | (17          | )          | 17 |   | 100.0 |   |
| Minority  share of net loss of Carretek LLC                 |       | 318                                    |       | 86           |       | 232 |   | 269.8 |   |
| Foreign  exchange losses                                    |       | (17                                    | )          | (129         | )          | 112 |   | 86.8 |   |
| Other                                                       |       | 5                                      |       | 5            |       | — |   | — |   |
|                                                        |       |                                   |       |         |       |   |   |   |   |
| Total                                                       |       | $                                      | 306        |         | $          | 484 |   | $ | (178 | ) | (36.8 | )% |

 

In April 2004, we sold our 25% interestin Cash Services Australia Pty. Limited. The carrying value of our investment was approximately $383,000 and wereceived $922,000 in proceeds collected in May 2004.  As a result of this transaction, we recordeda $539,000 gain.

 

We own a 51% interest in Carretek LLC (“Carretek”),through which we offer financial institutions off-shore centric outsourcing oftheir business processes.  Carretek hasgenerated approximately $647,000 and $174,000 in losses for the three monthsended April 30, 2005 and April 30, 2004, respectively.  Accordingly, the 49% share relating to theminority interest in this loss, or $318,000 and $86,000 on a quarterly basis,was recorded in other income (expense).

 

*Provision forIncome Taxes:*

 

The Companyhas established a valuation allowance to reserve its net deferred tax assets atApril 30, 2005 because the more likely than not criteria for futurerealization of the Company’s net deferred tax assets specified in Statement ofFinancial Accounting Standards No. 109, “*Accountingfor Income Taxes,”* (“SFAS No. 109”) were not met.

 

The net tax provision was $81,000 for the three months ended April 30,2005 and consists of a provision for foreign taxes.  No U.S. Federal tax expense was recorded inthe three months ended April 30, 2005, due to the availability of netoperating losses from prior years.  NoU.S. Federal income tax benefit was recorded at April 30, 2004 due to theuncertainty regarding the Company’s ability to generate taxable income, andresulting uncertainty relative to the recoverability of deferred tax assets.

 

In May 2004, the federal tax law changed to allow software licenserevenue to be deferred for tax purposes similar to the percent-complete revenuerecognition model we use for financial statement purposes.  The impact of this change in the tax lawincreased the amount of the net operating loss carryforwards by $8.6 millionand thereby further reduced our effective tax rate at such time as we begin togenerate taxable income.

 

**Liquidity and Capital Resources**

 

Historically, we have funded our operationsand cash expenditures primarily with cash generated from operatingactivities.  At April 30, 2005, wehad working capital of $14.3 million compared to $12.3 million at January 31,2005.  We had $35.7 million in cash andcash equivalents at April 30, 2005, an increase of $1.2 million from $34.5million in cash and cash equivalents at January 31, 2005.  At April 30, 2005 and January 31,2005, we did not have any borrowings outstanding under our revolving line ofcredit.  We expect that existing cash andcash generated from operating activities will be sufficient to meet ourpresently anticipated requirements for the foreseeable future.

 

Cash provided byoperating activities was $2.1 for the three months ended April 30, 2005compared to cash provided by operating activities of $9.8 million in the threemonths ended April 30, 2004.  Thisdecline was primarily the result of the timing of the collection of calendaryear maintenance billings for the calendar renewal of January 1, 2005through December 31, 2005, as compared to the prior year.

 

38

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Average days’ sales outstanding fluctuate fora variety of reasons, including the timing of billings specified by contractualagreement, and receivables for expense reimbursements.  The following table contains the quarterlydays’ sales outstanding (DSO):

 
| **Quarter ended**      | ** ** | **DSO** | ** ** |
|------------------------|------------|---------|------------|
| April 30,  2005   |       | 35      |       |
| January 31,  2005 |       | 35      |       |
| October 31,  2004 |       | 35      |       |
| July 31,  2004    |       | 46      |       |
| April 30,  2004   |       | 46      |       |

 

Cash used in investingactivities remained flat at $1.1 million during the three months ended April 30,2005 and 2004.  Capital expenditures of$698,000 were made in the three months ended April 30, 2005, as comparedto $231,000 for the three months ended April 30, 2004.  These investments were made for routinepurchases of computer hardware and software, along with new computer securitysoftware for our network infrastructure. Additionally, the amount of capitalized software declined to $437,000 inthe three months ended April 30, 2005, as compared to $910,000 for thethree months ended April 30, 2004.

 

Financing activitiesprovided cash of $254,000 in the three months ended April 30, 2005, andused cash of $5.7 million in the three months ended April 30, 2004.  Through April 30, 2005, we purchased$349,000 of our common stock under a program to purchase up to $5.0 millionduring the period April 18, 2005 through October 14, 2005.  These treasury stock purchases were offset by$52,000 of proceeds from the exercise of stock options and a $551,000 minorityshareholder cash advance to Carretek LLC. At April 30, 2004, we made a $6.3 million debt payment, which wasoffset by $375,000 of proceeds related to the exercise of stock options and $147,000minority shareholder cash advance to Carretek LLC.

 

We are a party to arevolving credit agreement with a group of banks providing for a commitmentamount of $30.0 million and a maturity date of July 31, 2006.  At April 30, 2005 and April 30,2004, the Company did not have any borrowings outstanding.  Borrowings under the credit agreementcurrently bear interest equal to either the greater of prime or federal fundsrate plus a margin ranging from 1.25% to 2.25% depending on our ratio of fundeddebt 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 are due quarterly.  We are required to pay a commitment fee equalto 0.50% on the unused amount of the revolving credit agreement.  The revolving credit agreement containscustomary affirmative and negative covenants, some of which have been amended,including financial covenants requiring the maintenance of specified interestcoverage, ratio of EBITDA to funded debt, and ratio of 80% of accountsreceivable, cash and short-term investments to funded debt.  Additionally, the payment of dividends isprecluded subject to the approval of the banks. Substantially all of our assets collateralize this revolving creditagreement.  As of April 30, 2005, weare in compliance with the covenants of the revolving credit agreement, asamended.

 

The following summarizes our contractualobligations at April 30, 2005 and the effect these contractual obligationsare expected 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 |       | $                          | 14,615     |   | $ | 3,571 |   | $ | 5,967 |   | $ | 4,788 |   | $ | 289 |   |
|                   |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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We believe that currentcash balances and expected future cash flows will be sufficient to meet ouranticipated cash needs for working capital, capital expenditures and otheractivities during fiscal 2005.  However,if current sources are not sufficient to meet our needs, we may seek additionalequity or debt financing.  There can beno assurance that additional financing would be available on acceptable terms,if at all.  We are presently involved ina number of lawsuits.  While we do notexpect any negative outcomes, the final resolutions of the lawsuits areunknown, and could include judgments against us, or settlements that couldrequire additional substantial payments by us. See Note 8 in our Notes to Condensed Consolidated Unaudited FinancialStatements.  The timing of the finalresolution of these matters is uncertain. We believe that a material adverse outcome or outcomes with respect tothe lawsuits could have a material adverse effect on our financial results, ourbusiness or our management including but not limited to, significantlyimpacting our liquidity in a negative manner as well as causing covenantviolations under our revolving credit agreement, possibly resulting in adefault thereunder.  Further, we may inthe future pursue acquisitions of businesses, products or technologies thatcould complement or expand our business and product offerings, and could changeour financing needs.  Our forecast of theperiod of time through which our financial resources will be adequate tosupport our operations is a forward looking statement that involves risks anduncertainties, and actual results could vary. The failure to secure additional financing when needed could have amaterial adverse effect on our business, financial condition and results ofoperations.

 

**CriticalAccounting Policies**

** **

In preparing ourconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States, we use certain estimates and assumptionsthat affect the reported amounts and related disclosures and our estimates mayvary from actual results.  We considerthe following seven accounting policies the most important to the portrayal ofour financial condition and those that require the most subjectivejudgment.  Although we believe that ourestimates and assumptions are reasonable, actual results may differ, and suchdifferences could be significant to our financial results.

 

Revenue Recognition

 

Our revenue recognition policies are in accordancewith Statement of Position (“SOP”) 97-2, *“Software RevenueRecognition,”* as amended by SOP 98-9, “*Modificationof SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions,”*and Staff Accounting Bulletin (“SAB”) No. 104, *“Revenue Recognition,”*and Emerging Issues Task Force (“EITF”)No. 00-21,*“Revenue Arrangements with MultipleDeliverables.”* In the case ofsoftware arrangements that require significant production, modification, orcustomization of software, or the license agreement requires us to provideimplementation services that are determined to be essential to other elementsof the arrangement, we follow the guidance in SOP 81-1, *“Accountingfor Performance of Construction – Type and Certain Production – Type Contracts.”*

 

*Consulting Fees.*  We employ three primary pricing methods inconnection with our delivery of consulting services. First, we may price ourdelivery of consulting services on the basis of time and materials, in whichcase the customer is charged agreed-upon daily rates for services performed andout-of-pocket expenses. In this case, we are generally paid fees and relatedamounts usually on a monthly basis, and we recognize revenues as the servicesare performed. Second, we may deliver consulting services on a fixed-pricebasis. In this case, we are generally paid on a monthly basis or pursuant to anagreed upon payment schedule, and we recognize revenues on a proportionateperformance basis. We believe that this method is appropriate because of ourability to determine performance milestones and determine dependable estimatesof our costs applicable to each phase of a contract.  Because financial reporting of thesecontracts depends on estimates, which are assessed continually during the termof the contract, costs are subject to revisions as the contractprogresses.  Anticipated losses onfixed-priced contracts are recognized when estimable.  Third, we may deliver consulting services pursuantto a value-priced contract with the customer. In this case, we are paid, on anagreed upon basis with the customer, either a specified percentage of(1) the projected increased revenues and/or decreased costs that areexpected to be derived by the customer generally over a period of up to twelvemonths following implementation of our solution or (2) the actual increasedrevenues and/or decreased costs experienced by the customer generally over aperiod of up to twelve months following implementation of our solution, subjectin either case to a maximum, if any is agreed to, on the total amount ofpayments to be made to us.  We must firstcommit time and resources to develop projections associated with value-pricingcontracts before a bank will commit to purchase our solutions, and we thereforeassume the risk of making these commitments with no assurance that the customerwill purchase the solution.  Costsassociated with these value-pricing contracts are expensed as incurred**.** These contracts typically include payments to be made to us pursuant toan agreed upon schedule ranging from one to twelve months in length. Werecognize revenues generated from consulting services in connection with value-pricedcontracts based upon projected results only upon completion of all services andagreement upon the actual fee to be paid (even though billings for theseservices may be delayed by mutual agreement for periods not to exceed twelvemonths). In an effort to allow customers to more closely match expectedbenefits from our services with payments to us, we may on occasion, offerpayment terms which

 

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extend beyond 12 months.  When weenter into an agreement that has a significant component of the total amountpayable under the agreement due beyond 12 months or if it is determinedpayments are not fixed and determinable at the date the agreement is enteredinto, revenue under the arrangement will be recognized as payments become dueand payable.  When fees are to be paidbased on a percentage of actual revenues and/or savings to our customers, werecognize revenues only upon completion of all services and as the amounts ofactual revenues or savings are confirmed by the customer with a fixed paymentdate.

 

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

 

We expect that value-pricedcontracts will continue to account for a significant portion of our revenues inthe future. As a consequence of the use of value-priced contracts and due tothe revenue recognition policy associated with those contracts, our results ofoperations will likely fluctuate significantly from period to period.

 

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

 

*Software License Fees.*  A software license is sold either togetherwith implementation services or on a stand-alone basis.  We are usually paid software license fees inone or more installments, as provided in the customer’s contract but not toexceed 12 months.  We recognize softwarelicense revenue upon execution of a contract and delivery of the software,provided that the license fee is fixed and determinable, no significantproduction, modification or customization of the software is required andcollection is considered probable by management.  When the software license arrangementrequires us to provide implementation services that are essential to thefunctionality of the software or significant production, customization ormodification of the software is required, both the product license revenue andimplementation fees are recognized as services are performed.

 

In certain instances, especially withrecently developed software, we defer software license revenue recognitionuntil the earlier of the product being determined to be generally available andsubject to revenue recognition or when the services are completed and theproject is accepted by the customer. This practice is followed for the first two installations of a recentlydeveloped software product.  After twosuccessful implementations, the product is considered generally available (“GA”).

 

Software licenses are often sold as part of amultiple element arrangement that may include maintenance, implementation orconsulting.  We determine whether thereis vendor specific objective evidence of fair value (“VSOEFV”) for each elementidentified in the arrangement to determine whether the total arrangement feescan be allocated to each element.  IfVSOEFV exists for each element, the total arrangement fee is allocated based onthe relative fair value of each element. In cases where there is not VSOEFV for each element, or if it isdetermined services are essential to the functionality of the software beingdelivered, or if significant production, modification or customization of thesoftware is required, we initially defer revenue recognition of the softwarelicense fees until VSOEFV is established or the services are performed.  However, if VSOEFV is determinable for all ofthe undelivered elements, and assuming the undelivered elements are notessential to the delivered elements, we will defer recognition of the full fairvalue related to the undelivered elements and recognize the remaining portionof the arrangement value through application of the residual method.  Where VSOEFV has not been established forcertain undelivered elements, revenue for all elements is deferred until thoseelements have been delivered or their fair values have been determined.  Evidence of VSOEFV is determined for softwareproducts based on actual sales prices for the product sold to a similar classof customer and based on pricing strategies set forth in our price book.  Evidence of VSOEFV for services(installation, implementation and consulting) is based upon standard billingrates and the estimated level of effort for individuals expected to perform therelated services.  We establish VSOEFVfor maintenance agreements using the percentage method such that VSOEFV formaintenance is a percentage of the license fee charged annually for specificsoftware product, which in most instances is 20% of the portion of arrangementfees allocated to the software license element.

 

Although substantiallyall of our current software licenses provide for a fixed-price license fee,some licenses provide for the customer to pay a monthly license fee based onthe actual use of the software product.  Thelevel of license fees earned by us under this arrangement will vary based onthe actual amount of use by the customer. Revenue under these arrangements is recognized on a monthly basis as theusage becomes determinable.

 

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

 

*SoftwareImplementation Fees.* In connection with the sale of a software license, a customer may electto purchase software implementation services, including software enhancementsand other software services.  Most of thecustomers that purchase software licenses from us also purchase softwareimplementation services.  We price ourimplementation services on a time-and-material or on a fixed-price basis, andwe recognize the related revenues as services are performed.  Costs associated with these engagements areexpensed as incurred.

 

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

 

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

 

Royalties

 

In connection withsoftware license and maintenance agreements entered into with certain banks andpurchase agreements with vendors under which we acquired software technologyused in products sold to our customers, we are required to pay royalties onsales of certain software products. Under these arrangements, we accrue royalty expense when the associatedrevenue is recognized.  For currentproduct offerings, the royalty percentages generally range from 20%-50% of theassociated revenues.  Royalty expense isincluded as a component of the cost of software license fees and cost ofsoftware maintenance fees in the accompanying condensed consolidated statementsof operations.

 

Allowance for Doubtful Accounts

 

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

 

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Software Costs Capitalized, AcquiredDeveloped Technology, Goodwill, Other Intangible Assets and Other Long-LivedAssets

 

Software costs capitalized include developedtechnology acquired in acquisitions and costs incurred by us in developing ourproducts that qualify for capitalization. We capitalize our software development costs, other than costs forinternal-use software, in accordance with Statement of Financial AccountingStandards No. 86, “*Accounting for Costs ofComputer Software to be Sold, Leased or Otherwise Marketed”* (“SFAS86”).  Our policy is to capitalizesoftware development costs incurred in developing a product once technologicalfeasibility of the product has been established.  Software development costs capitalized alsoinclude amounts paid for purchased software on products that have reachedtechnological feasibility. Technological feasibility of the product isdetermined after completion of a detailed program design and a determinationhas been made that any uncertainties related to high-risk development issueshave been resolved. If the process of developing the product does not include adetailed program design, technological feasibility is determined only aftercompletion of a working model. All capitalized software development costs areamortized using an amount determined as the greater of: (1) the ratio thatcurrent gross revenues for a capitalized software project bears to the total ofcurrent and future projected gross revenues for that project or (2) thestraight-line method over the estimated remaining economic life of the product(generally three to six years).  We continuallymonitor the net realizable value of the software capitalized and acquireddeveloped technology for factors that would indicate impairment, such as adecline in the demand or loss of a significant customer.  During the quarterly period ended January 31,2005, we performed our annual formal evaluation for impairment and determinedthat the carrying amount of these assets was not impaired and have noted nosubsequent factors that would indicate impairment.

 

Goodwill is assessed on an annual basis for impairmentat the reporting unit level by applying a fair value based test.  We performed the initial impairment test ofgoodwill at February 1, 2002 and a follow up test at November 1, 2002to determine if an impairment charge should be recognized under SFAS 142.  The initial impairment analysis did notresult in any write-down of capitalized costs. We perform an annual impairment assessment on November 1stof each year or when factors indicate that other long-lived assets should beevaluated for possible impairment.  Weuse an estimate of undiscounted future net cash flows over the remaining lifeof the asset to determine if impairment has occurred.  Assets are grouped at the lowest level forwhich there are identifiable cash flows that are largely independent from otherasset groups.  An impairment in thecarrying value of an asset is assessed when the undiscounted, expected futureoperating cash flows derived from the asset are less than its carrying value.  Management believes that assumptions used todetermine cash flows are reasonable, but actual future cash flows may differfrom those estimated.  If we determine anasset has been impaired, the impairment is recorded based on the estimated fairvalue of the impaired asset.  During thequarterly period ended January 31, 2005, we performed our annualevaluation for goodwill impairment and determined that the carrying amount ofgoodwill was not impaired and have not noted any factors subsequent that wouldindicate impairment.  Goodwill at April 30,2005 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.

 

**Restructuring and Other Charges**

** **

During fiscal year 2001,we recorded reserves in connection with our acquisition of Check Solutions andsubsequent operational restructurings. Additional reserves were recorded during each of the succeeding fiscalyears.  These reserves containsignificant estimates pertaining to work force reductions, and the settlementof contractual obligations resulting from our actions.  In the quarterly period ended April 30,2005, we revised our estimate to reflect our remaining costs related to thediscontinuance of one of our software offerings originally recorded in January 2004and reversed $32,000.  Although we do notanticipate any significant changes in the future, the actual costs may differfrom these estimates.

 

**Contingencies**

** **

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

 

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**Income Taxes**

** **

We recognize deferred tax assets orliabilities for the expected future tax consequences of temporary differencesbetween the book and 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 thereversals of existing temporary differences. As a result of our cumulative net losses we have provided a fullvaluation allowance against our net deferred tax assets.  In addition, we expect to provide a fullvaluation allowance of any future tax benefits until we can sustain a level ofprofitability that demonstrates our ability to utilize these assets.

 

**Recently Issued Accounting Standards**

 

See “Recently IssuedAccounting Standards” in Note 2 of the Notes to Consolidated FinancialStatements.

 

**Item 3. ****Quantitative and Qualitative Disclosures about Market Risk**

 

**Interest Rate Risk**

** **

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

 

Investments in bothfixed rate and floating rate interest earning instruments carry a degree ofinterest rate risk.  Fixed ratesecurities may have their fair market value adversely impacted due to a rise ininterest rates, while floating rate securities may produce less income thanexpected if interest rates fall.  Due inpart to these factors, our future investment income may fall short ofexpectations due to changes in interest rates, or we may suffer losses inprincipal if forced to sell securities which have seen a decline in market valuedue to changes in interest rates.  At April 30,2005, we did not hold any fixed-rate investments.

 

We had no outstanding borrowings under ourrevolving credit agreement at April 30, 2005.  As described in Note 4 of our Notes toConsolidated Financial Statements, the interest rate under the revolving creditagreement is variable.

 

**Foreign Currency Risk**

** **

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

 

An insignificant portion of our accounts receivable balance at April 30,2005, was denominated in a foreign currency. Our exposure to adverse movements in foreign exchange rates is typicallynot significant.  Therefore, we do notcurrently hedge our foreign currency exposure; however, we do try to limit ourforeign currency exposure by negotiating these foreign contracts in U.S. Dollars.  However, in the future we may change thispractice.  We will continue to evaluatethe need to adopt a hedge strategy in the future and may implement a formalstrategy if our business transacted in foreign currencies increases.

 

Foreign exchange losses were $17,000 and $129,000 in the three monthsended April 30, 2005 and 2004, respectively.

 

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**Item 4.  Controls andProcedures**

 

*Disclosure Controls and Procedures*

 

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

 

Our management, under the supervision andwith the participation of our Chief Executive and Chief Financial Officers, isresponsible for evaluating the effectiveness of our disclosure controls and procedures(as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act).  As of April 30, 2005, they carried outan evaluation of our disclosure controls and procedures, and the ChiefExecutive 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 recognized that any controls and procedures, nomatter how well designed and operated, can provide only reasonable assurance ofachieving the desired control objectives, and management necessarily wasrequired to apply its judgment in evaluating the cost-benefit relationship ofpossible controls and procedures.

 

*Changes in Internal Control over FinancialReporting*

 

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

 

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**PARTII:   OTHER INFORMATION**

 

**ITEM1.**                             LEGAL PROCEEDINGS

 

Except as noted below,the information contained in Part I, Item 3. Legal Proceedings in our Form 10-Kfor the period ended January 31, 2005 is hereby incorporated by reference.

 

The Company and individual defendants denythe allegations in the complaints referenced in the information incorporatedherein by reference and intend to defend themselves vigorously.  It is not possible at this time to predictwhether we will incur any liability or to estimate the damages, or the range ofdamages, if any, that we might incur in connection with such lawsuits.  The ultimate resolution of such lawsuitscould have a material adverse effect on our business, results of operations,financial condition and cash flows.

 

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 reCarreker Corporation Securities Litigation*, Civil Action No.303CV0250-M. On October 14, 2003 the plaintiffs filed their Consolidated ClassAction Complaint. The complaint, filed on behalf of purchasers of the Company’scommon stock between May 20, 1998 and December 10, 2002, inclusive, allegedviolations of Section 10(b) of the Securities Exchange Act of 1934 and Rule10b-5 against all defendants (the Company, John D. Carreker Jr., RonaldAntinori, Terry L. Gage and Ernst & Young, the Company’s auditors),violations of Section 20(a) of the Exchange Act against the individualdefendants, and violation of Section 20A of the Securities Exchange Act againstdefendants John D. Carreker, Jr. and Ronald Antinori.  The complaint also alleges, among otherthings, that defendants artificially inflated the value of Carreker stock byknowingly or recklessly misrepresenting the Company’s financial results duringthe purported class period.  On March 22,2005 the Court dismissed the action without prejudice and allowed theplaintiffs 60 days in which to file an amended complaint. Also the Courtdismissed, with prejudice, all claims by shareholders prior to July 31, 1999.

 

On May 31,2005, the plaintiffs filed an Amended Consolidated Class Action Complaint onbehalf of purchasers of the Company’s common stock between July 30, 1999 andDecember 10, 2002, inclusive, which reiterates the allegations in the firstcomplaint, and alleges violations of Section 10(b) of the Securities ExchangeAct of 1934 and Rule 10b-5 against all defendants (the Company, John D.Carreker Jr., Ronald Antinori and Terry L. Gage), violations of Section 20(a)of the Exchange Act against the individual defendants, and violations ofSection 20A of the Securities Exchange Act against defendants John D. Carreker,Jr. and Ronald Antinori.  The plaintiffsare seeking unspecified amounts of compensatory damages, interest and costs,including legal fees.

 

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

 

The following tableprovides information about the Company’s purchases of shares of its commonstock in the open market during the three months ended April 30, 2005:

 
| **Period**                | ** ** | **Total  Number of  Shares  Purchased  (1)** | ** ** | **Average  Price Paid  Per Share** | ** ** | **Total Number of  Shares Purchased as  part of Publicly  Announced Plans or  Programs** | ** ** | **Maximum Number  of Shares that may  yet be Purchased  under the Plans or  Programs** | ** ** |
|---------------------------|------------|----------------------------------------------|------------|------------------------------------|------------|------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
|                      |       |                                         |       |                               |       |                                                                                     |       |                                                                                   |       |
| 4/1/2005 – 4/30/2005 |       | 70,000                                       |       | $                                  | 4.98       |                                                                                     | 70,000     |                                                                                   |       | (2) |
|                           |            |                                              |            |                                    |            |                                                                                          |            |                                                                                        |            |  |

 

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(1)  Does not include 88,000 shares settled on May2, 2005 through May 4, 2005 at a cost of approximately $394,000.

 

(2)  Under a share repurchase program approved bythe Board of Directors of Carreker Corporation on April 18, 2005, theCompany is authorized to repurchase up to $5.0 million of its common stockthrough October 14, 2005.  Therepurchase program is designed to comply with Rules 10b5-1 and 10b-18 under theSecurities Exchange Act of 1934 under which an agent appointed by the Companywill determine the time, amount, and price at which purchases of common stockwill be made, subject to certain parameters established in advance by theCompany.

 

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**ITEM 3.**                             DEFAULTSUPON SENIOR SECURITIES

 

None.

 

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

 

None.

 

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

 

None.

 

**ITEM 6.**                             EXHIBITS

 
| **Number** | ** ** | **Exhibit Description**                                                                                                           |
|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                              |
| 10.1       |       | Form of Restricted Stock Agreement between  the Company and its Executives                                                        |
|       |       |                                                                                                                              |
| 31.1       |       | Certification Pursuant to Section 302(a)  of the Sarbanes-Oxley Act of 2002                                                  |
|       |       |                                                                                                                              |
| 31.2       |       | Certification Pursuant to Section 302(a)  of the Sarbanes-Oxley Act of 2002                                                  |
|       |       |                                                                                                                              |
| 32.1       |       | Certification Pursuant to 18 U.S.C. Section 1350,  as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
|       |       |                                                                                                                              |
| 32.2       |       | Certification Pursuant to 18 U.S.C. Section 1350,  as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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**SIGNATURES**

 

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

 

 

CARREKERCORPORATION

 

 
| By:    | /s/ John D. Carreker,  Jr. |   |   | Date: |   June 8,  2005 |   |
|--------|----------------------------|--------|--------|-------|---------------------------|--------|
|   | John D. Carreker, Jr.      |   |   |
|   | Chairman of the  Board and |   |   |
|   | Chief Executive  Officer   |   |   |
|   |                       |   |
|   |                       |   |
| By:    | /s/ Lisa K.  Peterson      |   |   | Date: |   June 8,  2005 |   |
|   | Lisa K. Peterson           |   |   |
|   | Chief Financial Officer    |   |   |
|        |                            |        |        |       |                           |        |  |

 

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