**United States**

**Securities and ExchangeCommission**

**Washington,D.C.  20549**

 

# **FORM10-Q**

 

**ý****                ****Quarterly Report Pursuant to Section 13 or 15(d)of the Securities Exchange Act of 1934 for the Period Ended October 31, 2004.**

** **

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

 

**Period from                            to                            .**

 

**Commissionfile number  0-24201**

 

**Carreker Corporation**

(Exactname of registrant as specified in its charter)

 

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

 

**(972) 458-1981**

(Registrant’stelephone number, including area code)

 

 

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

 

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

 

Indicate by check mark whether the registrantis an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).Yes  ý      No o

 

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

 

Common Stock, $.01 par value — 24,860,198shares as of November 30, 2004.

 

 

 

**CARREKERCORPORATION**

 

**Index**

 
| **PART 1:**    | **FINANCIAL INFORMATION**                                                                                                |       |
|----------------|--------------------------------------------------------------------------------------------------------------------------|------------|
| ** **     | ** **                                                                                                               |       |
| **Item 1.**    | **Financial  Statements (unaudited)**                                                                                    | ** ** |
| ** **     | ** **                                                                                                               | ** ** |
| ** **     | **Condensed Consolidated Balance Sheets at  October 31, 2004 and January 31, 2004**                                      | ** ** |
| ** **     | ** **                                                                                                               | ** ** |
| ** **     | **Condensed Consolidated  Statements of Operations for the three and nine months ended October 31,  2004 and 2003** | ** ** |
| ** **     | ** **                                                                                                               | ** ** |
| ** **     | **Condensed Consolidated Statements  of Stockholders’ Equity for the three and nine months ended October 31, 2004** | ** ** |
| ** **     | ** **                                                                                                               | ** ** |
| ** **     | **Condensed Consolidated  Statements of Cash Flows for the three and nine months ended October 31,  2004 and 2003** | ** ** |
| ** **     | ** **                                                                                                               | ** ** |
| ** **     | **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

----

 

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

 

**    Item 1.  Financial Statements**

 

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

 
| ** **                                                                                                                                       | ** ** | **October 31,** | ** ** | **January 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|-----------------|------------|
| ** **                                                                                                                                       | ** ** | **2004**        | ** ** | **2004**        | ** ** |
| Current assets                                                                                                                                   |       |            |       |            |       |
| Cash and cash equivalents                                                                                                                        |       | $               | 26,787     |            | $          | 28,605 |   |
| Accounts receivable, net of allowance of $667 and $1,512 at October  31, 2004 and January 31, 2004, respectively                                 |       | 11,950          |       | 21,751          |       |
| Prepaid expenses and other current assets                                                                                                        |       | 2,913           |       | 3,331           |       |
| Total current assets                                                                                                                             |       | 41,650          |       | 53,687          |       |
|                                                                                                                                             |       |            |       |            |       |
| Property and equipment, net of accumulated depreciation of $19,480  and $17,140 at October 31, 2004 and January 31, 2004, respectively           |       | 6,918           |       | 6,690           |       |
| Capitalized software costs, net of accumulated amortization of  $12,197 and $11,050 at October 31, 2004 and January 31, 2004, respectively       |       | 3,083           |       | 2,028           |       |
| Acquired developed technology, net of accumulated amortization of  $14,618 and $11,153 at October 31, 2004 and January 31, 2004, respectively    |       | 11,082          |       | 14,547          |       |
| Goodwill, net of accumulated amortization of $3,405 at October 31,  2004 and January 31, 2004                                                    |       | 20,765          |       | 21,193          |       |
| Customer relationships, net of accumulated amortization of $4,783 and  $3,733 at October 31, 2004 and January 31, 2004, respectively             |       | 3,617           |       | 4,667           |       |
| Deferred loan costs, net of accumulated amortization of $1,232 and  $1,028 at October 31, 2004 and January 31, 2004, respectively                |       | 476             |       | 680             |       |
| Other assets                                                                                                                                     |       | 1,036           |       | 1,087           |       |
| Total assets                                                                                                                                     |       | $               | 88,627     |            | $          | 104,579 |   |
|                                                                                                                                             |       |            |       |            |       |
| Current liabilities                                                                                                                              |       |            |       |            |       |
| Accounts payable                                                                                                                                 |       | $               | 1,151      |            | $          | 913 |   |
| Accrued compensation and benefits                                                                                                                |       | 7,159           |       | 9,219           |       |
| Other accrued expenses                                                                                                                           |       | 3,274           |       | 4,520           |       |
| Income tax payable                                                                                                                               |       | 222             |       | 181             |       |
| Deferred revenue                                                                                                                                 |       | 17,566          |       | 25,231          |       |
| Accrued merger and restructuring costs                                                                                                           |       | 594             |       | 1,898           |       |
| Total current liabilities                                                                                                                        |       | 29,966          |       | 41,962          |       |
| Long-term debt                                                                                                                                   |       | —          |       | 6,250           |       |
| Other long-term liabilities                                                                                                                      |       | 481             |       | 49              |       |
| Total liabilities                                                                                                                                |       | 30,447          |       | 48,261          |       |
|                                                                                                                                             |       |            |       |            |       |
| 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; 24,848 and  24,357 shares issued at October 31, 2004 and January 31, 2004, respectively |       | 249             |       | 244             |       |
| Additional paid-in capital                                                                                                                       |       | 110,714         |       | 108,757         |       |
| Accumulated deficit                                                                                                                              |       | (52,780         | )          | (52,680         | )          |
| Less treasury stock, at cost: 1 common share at October 31, 2004 and  January 31, 2004                                                           |       | (3              | )          | (3              | )          |
| Total stockholders’ equity                                                                                                                  |       | 58,180          |       | 56,318          |       |
| Total liabilities and stockholders’ equity                                                                                                  |       | $               | 88,627     |            | $          | 104,579 |   |

 

Seeaccompanying notes.

 

3

----

 

 

**CARREKER CORPORATION**

**Condensed Consolidated Statements ofOperations**

**(Unaudited)**

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

 
| ** **                                                 | ** ** | **Three Months Ended  October 31,** | ** ** | **Nine Months Ended  October 31,** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                                                 | ** ** | **2004**                            | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                       |       |                                |       |                               |       |   |   |   |   |
| **Revenues:**                                              |       |                                |       |                               |       |   |   |   |   |
| Consulting fees                                            |       | $                                   | 7,930      |                               | $          | 6,396 |   | $ | 27,501 |   | $ | 21,349 |   |
| Software license fees                                      |       | 5,701                               |       | 7,026                              |       | 16,134 |   | 21,955 |   |
| Software maintenance fees                                  |       | 11,491                              |       | 11,770                             |       | 32,807 |   | 34,764 |   |
| Software implementation fees                               |       | 4,622                               |       | 4,983                              |       | 11,143 |   | 14,385 |   |
| Outsourcing service fees                                   |       | 50                                  |       | —                             |       | 60 |   | — |   |
| Out-of-pocket expense reimbursements                       |       | 813                                 |       | 1,228                              |       | 2,365 |   | 3,367 |   |
| Total revenues                                             |       | 30,607                              |       | 31,403                             |       | 90,010 |   | 95,820 |   |
|                                                       |       |                                |       |                               |       |   |   |   |   |
| **Cost of revenues:**                                      |       |                                |       |                               |       |   |   |   |   |
| Consulting fees                                            |       | 4,555                               |       | 4,936                              |       | 14,166 |   | 15,193 |   |
| Software license fees                                      |       | 2,503                               |       | 2,037                              |       | 5,771 |   | 5,662 |   |
| Software maintenance fees                                  |       | 3,765                               |       | 3,600                              |       | 10,949 |   | 9,910 |   |
| Software implementation fees                               |       | 4,002                               |       | 4,485                              |       | 11,181 |   | 14,398 |   |
| Outsourcing service fees                                   |       | 222                                 |       | —                             |       | 236 |   | — |   |
| Out-of-pocket expenses                                     |       | 738                                 |       | 1,122                              |       | 2,333 |   | 3,413 |   |
| Total cost of revenues                                     |       | 15,785                              |       | 16,180                             |       | 44,636 |   | 48,576 |   |
| Gross profit                                               |       | 14,822                              |       | 15,223                             |       | 45,374 |   | 47,244 |   |
|                                                       |       |                                |       |                               |       |   |   |   |   |
| **Operating costs and expenses:**                          |       |                                |       |                               |       |   |   |   |   |
| Selling, general and administrative                        |       | 11,320                              |       | 11,797                             |       | 35,483 |   | 36,267 |   |
| Research and development                                   |       | 2,520                               |       | 1,876                              |       | 6,102 |   | 5,522 |   |
| Amortization of customer relationships                     |       | 350                                 |       | 350                                |       | 1,050 |   | 1,050 |   |
| Restructuring and other charges                            |       | 266                                 |       | (229                               | )          | 2,978 |   | 1,233 |   |
| Total operating costs and expenses                         |       | 14,456                              |       | 13,794                             |       | 45,613 |   | 44,072 |   |
| Income (loss) from operations                              |       | 366                                 |       | 1,429                              |       | (239 | ) | 3,172 |   |
|                                                       |       |                                |       |                               |       |   |   |   |   |
| **Other income (expense):**                                |       |                                |       |                               |       |   |   |   |   |
| Interest income                                            |       | 92                                  |       | 69                                 |       | 207 |   | 223 |   |
| Interest expense                                           |       | (106                                | )          | (234                               | )          | (336 | ) | (991 | ) |
| Other income                                               |       | 275                                 |       | 219                                |       | 732 |   | 269 |   |
| Total other income (expense)                               |       | 261                                 |       | 54                                 |       | 603 |   | (499 | ) |
| Income before provision for income taxes                   |       | 627                                 |       | 1,483                              |       | 364 |   | 2,673 |   |
| Provision for income taxes                                 |       | 114                                 |       | 146                                |       | 464 |   | 372 |   |
| Net income (loss)                                          |       | $                                   | 513        |                               | $          | 1,337 |   | $ | (100 | ) | $ | 2,301 |   |
| Basic earnings (loss) per share                            |       | $                                   | 0.02       |                               | $          | 0.06 |   | $ | 0.00 |   | $ | 0.10 |   |
| Diluted earnings (loss) per share                          |       | $                                   | 0.02       |                               | $          | 0.05 |   | $ | 0.00 |   | $ | 0.10 |   |
| Shares used in computing basic earnings (loss) per share   |       | 24,821                              |       | 23,812                             |       | 24,623 |   | 23,635 |   |
| Shares used in computing diluted earnings (loss) per share |       | 25,589                              |       | 24,645                             |       | 24,623 |   | 23,820 |   |

 

Seeaccompanying notes.

 

4

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**CARREKERCORPORATION**

**Condensed Consolidated Statements of Stockholders’Equity**

**(Unaudited)**

**(Inthousands, 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, 2004                                       |       | 24,357           |       | $                      | 244        |            | $          | 108,757            |       | $                            | (52,680    | ) | 1 |   | $ | (3 | ) | $ | 56,318 |   |
|                                                              |       |             |       |                   |       |            |       |               |       |                         |       |   |   |   |   |
| Cancellation of restricted stock                                  |       | (20              | )          | —                 |       | —          |       | —             |       | —                       |       | — |   | — |   |
| Compensation expense related to issuance of restricted stock      |       | —           |       | —                 |       | 35              |       | —             |       | —                       |       | — |   | 35 |   |
| Issuance of shares of common stock upon exercise of stock options |       | 74               |       | —                 |       | 375             |       | —             |       | —                       |       | — |   | 375 |   |
| Net loss                                                          |       | —           |       | —                 |       | —          |       | (812               | )          | —                       |       | — |   | (812 | ) |
| Balance at April 30, 2004                                         |       | 24,411           |       | 244                    |       | 109,167         |       | (53,492            | )          | 1                            |       | (3 | ) | 55,916 |   |
|                                                              |       |             |       |                   |       |            |       |               |       |                         |       |   |   |   |   |
| Cancellation of restricted stock                                  |       | (7               | )          | —                 |       | —          |       | —             |       | —                       |       | — |   | — |   |
| Compensation expense related to issuance of restricted stock      |       | 251              |       | 2                      |       | 139             |       | —             |       | —                       |       | — |   | 141 |   |
| Issuance of shares of common stock upon exercise of stock options |       | 147              |       | 2                      |       | 947             |       | —             |       | —                       |       | — |   | 949 |   |
| Net income                                                        |       | —           |       | —                 |       | —          |       | 199                |       | —                       |       | — |   | 199 |   |
| Balance at July 31, 2004                                          |       | 24,802           |       | 248                    |       | 110,253         |       | (53,293            | )          | 1                            |       | (3 | ) | 57,205 |   |
|                                                              |       |             |       |                   |       |            |       |               |       |                         |       |   |   |   |   |
| Cancellation of restricted stock                                  |       | (4               | )          | —                 |       | —          |       | —             |       | —                       |       | — |   | — |   |
| Compensation expense related to issuance of restricted stock      |       | 2                |       | —                 |       | 148             |       | —             |       | —                       |       | — |   | 148 |   |
| Issuance of shares of common stock upon exercise of stock options |       | 48               |       | 1                      |       | 313             |       | —             |       | —                       |       | — |   | 314 |   |
| Net income                                                        |       | —           |       | —                 |       | —          |       | 513                |       | —                       |       | — |   | 513 |   |
| Balance at October 31, 2004                                       |       | 24,848           |       | $                      | 249        |            | $          | 110,714            |       | $                            | (52,780    | ) | 1 |   | $ | (3 | ) | $ | 58,180 |   |

 

Seeaccompanying notes.

 

 

5

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**CARREKERCORPORATION**

**Condensed Consolidated Statements of Cash Flows**

**(Unaudited)**

**(Inthousands)**

 
| ** **                                                                                          | ** ** | **Three Months Ended  October 31,** | ** ** | **Nine Months Ended  October 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                          | ** ** | **2004**                            | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Operating Activities:**                                                                           |       |                                |       |                               |       |   |   |   |   |
| Net income (loss)                                                                                   |       | $                                   | 513        |                               | $          | 1,337 |   | $ | (100 | ) | $ | 2,301 |   |
| Adjustments to reconcile net income (loss) to net cash provided by  (used in) operating activities: |       |                                |       |                               |       |   |   |   |   |
| Depreciation and amortization of property and equipment                                             |       | 826                                 |       | 882                                |       | 2,483 |   | 2,588 |   |
| Amortization of capitalized software costs and acquired developed  technology                       |       | 1,823                               |       | 1,311                              |       | 4,611 |   | 3,917 |   |
| Amortization of customer relationships                                                              |       | 350                                 |       | 350                                |       | 1,050 |   | 1,050 |   |
| Compensation expense related to issuance of restricted stock                                        |       | 148                                 |       | 52                                 |       | 324 |   | 87 |   |
| Minority share of loss in Carretek LLC                                                              |       | (234                                | )          | —                             |       | (454 | ) | — |   |
| Gain on sale of Cash Services Australia Pty. Limited                                                |       | —                              |       | —                             |       | (539 | ) | — |   |
| Reduction in allowance for doubtful accounts                                                        |       | (275                                | )          | (91                                | )          | (667 | ) | (118 | ) |
| Amortization of deferred loan costs                                                                 |       | 67                                  |       | 68                                 |       | 204 |   | 284 |   |
| Non cash reduction in merger cost accrual                                                           |       | —                              |       | (540                               | )          | (1,215 | ) | (540 | ) |
| Changes in operating assets and liabilities:                                                        |       |                                |       |                               |       |   |   |   |   |
| Accounts receivable                                                                                 |       | 3,571                               |       | (2,332                             | )          | 10,468 |   | 3,389 |   |
| Prepaid expenses and other current assets                                                           |       | 525                                 |       | (1,574                             | )          | 1,462 |   | (710 | ) |
| Accounts payable and accrued expenses                                                               |       | (451                                | )          | 164                                |       | (2,729 | ) | (2,918 | ) |
| Income taxes payable/receivable                                                                     |       | 87                                  |       | 11                                 |       | 41 |   | 111 |   |
| Deferred revenue                                                                                    |       | (7,159                              | )          | (4,437                             | )          | (7,665 | ) | (240 | ) |
| Net cash provided by (used in) operating activities                                                 |       | (209                                | )          | (4,799                             | )          | 7,274 |   | 9,201 |   |
| **Investing Activities:**                                                                           |       |                                |       |                               |       |   |   |   |   |
| Purchases of property and equipment                                                                 |       | (1,346                              | )          | (279                               | )          | (2,711 | ) | (849 | ) |
| Computer software costs capitalized                                                                 |       | (593                                | )          | (204                               | )          | (2,201 | ) | (204 | ) |
| Purchase of acquired developed software                                                             |       | —                              |       | (1,500                             | )          | — |   | (1,500 | ) |
| Net cash used in investing activities                                                               |       | (1,939                              | )          | (1,983                             | )          | (4,912 | ) | (2,553 | ) |
| **Financing Activities:**                                                                           |       |                                |       |                               |       |   |   |   |   |
| Payments on long-term debt                                                                          |       | —                              |       | —                             |       | (6,250 | ) | (12,500 | ) |
| Payments of deferred loan costs                                                                     |       | —                              |       | —                             |       | — |   | (456 | ) |
| Proceeds from exercises of stock options                                                            |       | 314                                 |       | 384                                |       | 1,638 |   | 384 |   |
| Minority interest and minority shareholder loan to Carretek LLC                                     |       | 172                                 |       | 98                                 |       | 432 |   | 98 |   |
| Net cash provided by (used in) financing activities                                                 |       | 486                                 |       | 482                                |       | (4,180 | ) | (12,474 | ) |
| Net decrease in cash and cash equivalents                                                           |       | (1,662                              | )          | (6,300                             | )          | (1,818 | ) | (5,826 | ) |
| Cash and cash equivalents at beginning of period                                                    |       | 28,449                              |       | 27,460                             |       | 28,605 |   | 26,986 |   |
| Cash and cash equivalents at end of period                                                          |       | $                                   | 26,787     |                               | $          | 21,160 |   | $ | 26,787 |   | $ | 21,160 |   |
|                                                                                                |       |                                |       |                               |       |   |   |   |   |
| Supplemental disclosures of cash flow information:                                                  |       |                                |       |                               |       |   |   |   |   |
| Cash paid for interest                                                                              |       | $                                   | 38         |                               | $          | 79 |   | $ | 147 |   | $ | 748 |   |
| Cash paid for income taxes, net                                                                     |       | $                                   | 11         |                               | $          | 118 |   | $ | 393 |   | $ | 248 |   |

 

Seeaccompanying notes.

 

6

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**CarrekerCorporation**

**Notes to Condensed ConsolidatedUnaudited Financial Statements****For the Three and Nine Months Ended October 31, 2004 and 2003**

 

 

 

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

 

       Carreker Corporation (“theCompany,” “Carreker,” “our,” “we”) provides payments-related software andconsulting 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.****          ****Summaryof Significant Accounting Procedures**

 

**       Principles of Consolidationand Presentation**

 

       The condensed consolidated unaudited financial statementsinclude the accounts of the Company and its wholly owned subsidiaries. Allsignificant intercompany balances and transactions have been eliminated inconsolidation.

 

       In the three and nine months ended October 31, 2004, the consolidatedfinancial statements also contain Carretek LLC which is a 51% ownedsubsidiary.  The minority interest andminority interest in income (loss) of Carretek LLC represents the 49% minoritystockholders’ investment and share of the loss of this consolidated subsidiary.

 

       The accompanying condensed consolidated unaudited financialstatements and notes have been prepared in accordance with the rules andregulations of the Securities and Exchange Commission for Form 10-Q and includeall of the information and disclosures required by generally acceptedaccounting principles for interim financial reporting.  The accompanying financial statements reflectall adjustments, (consisting of normal recurring entries) which in the opinionof management are necessary for a fair presentation of the results for theinterim periods presented.  The resultsof operations, for the three and nine months ended October 31, 2004, are notnecessarily indicative of full-year results.

 

       Certain prior year amounts have been reclassifiedto conform to the current year presentation. For the three months ended October 31, 2003, selling, general andadministrative expenses have been reduced by $356,000, while cost ofsales-software maintenance fees, cost of sales-software implementation fees andresearch and development expenses increased $142,000, $72,000 and $142,000,respectively.  Additionally, for the ninemonths ended October 31, 2003, selling, general and administrative expenseshave been reduced by $666,000, while cost of sales-software maintenance fees,cost of sales-software implementation fees and research and developmentexpenses increased $266,000, $134,000 and $266,000, respectively.  These reclassifications were made to conformto the presentation of certain information technology costs in the three andnine months ended October 31, 2004.

 

       The preparation of financial statements in conformity withaccounting principles generally accepted in the United States requires the useof estimates and assumptions that affect the amounts reported in the financialstatements and accompanying notes.  Asdiscussed below, the Company makes significant estimates and assumptions in theareas of accounts receivable, impairment of intangibles and revenuerecognition.  Although the Companybelieves that the estimates and assumptions are reasonable, actual results maydiffer, and such differences could be significant to the Company’s financialresults.

 

**       Cash and Cash Equivalents**

 

       The Company considers all highly liquid investments with maturitiesof three months or less when purchased to be cash equivalents. Cash and cashequivalents consist primarily of demand deposit accounts and shares in a demandmoney market account comprised of domestic and foreign commercial paper,certificates of deposit and U.S. government obligations which are maintainedwith nationally recognized financial institutions.

 

 

7

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**       Foreign CurrencyTranslation**

 

       The Company considers the U.S. Dollar to be the functional currencyfor its international subsidiaries.  Allremeasurement adjustments are recorded in the consolidated statement ofoperations.

 

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

 

       Financial instruments, which potentially subject the Companyto concentration of credit risk consist principally of temporary cashinvestments and accounts receivable.  TheCompany places temporary cash investments with major banks and limits itsexposure with any one financial institution.

 

       A significant portion of the Company’s business consists ofproviding consulting services and licensing software to major domestic andinternational banks, which gives rise to a concentration of credit risk inreceivables.  Because the Company’saccounts receivable are typically unsecured, the Company periodically evaluatesthe collectibility of its accounts based on a combination of factors, includinga particular customer’s ability to pay as well as the age of receivables.  In cases where the evidence suggests acustomer may not be able to satisfy its obligation to the Company or if thecollection of the receivable becomes doubtful due to a dispute that arisessubsequent to the delivery of the Company’s products and services, the Companysets up a reserve in an amount determined appropriate for the perceivedrisk.  Most of the Company’s contractsinclude multiple payment milestones, some of which occur in advance of revenuerecognition, which mitigates the risk both in terms of collectibility andadjustments to recorded revenue. Write-offs of receivables during the threemonths ended October 31, 2004 and 2003 were $45,000 and $76,000,respectively.  Write-offs of receivablesduring the nine months ended October 31, 2004 and 2003 were $179,000 and $181,000,respectively.

 

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

 

       Accounts receivable, net of related deferred revenue andallowances, consist of the following (in thousands):

 

| ** **                           | ** ** | **October 31,** | ** ** | **January 31,** | ** ** |
|--------------------------------------|------------|-----------------|------------|-----------------|------------|
| ** **                           | ** ** | **2004**        | ** ** | **2004**        | ** ** |
| Gross accounts receivable            |       | $               | 38,207     |            | $          | 65,109 |   |
| Less related deferred revenue        |       | (25,590         | )          | (41,846         | )          |
| Less allowance for doubtful accounts |       | (667            | )          | (1,512          | )          |
| Net accounts receivable              |       | $               | 11,950     |            | $          | 21,751 |   |

 

**       Property and Equipment**

 

       Property and equipment are stated at cost. Depreciation iscalculated using the straight-line method over the estimated useful lives ofthe respective assets, generally from three 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):

 

| ** **                                     | ** ** | **October 31,** | ** ** | **January 31,** | ** ** |
|------------------------------------------------|------------|-----------------|------------|-----------------|------------|
| ** **                                     | ** ** | **2004**        | ** ** | **2004**        | ** ** |
| Furniture                                      |       | $               | 5,098      |            | $          | 5,070 |   |
| Equipment and software                         |       | 20,032          |       | 17,686          |       |
| Leasehold improvements                         |       | 1,268           |       | 1,074           |       |
| Total cost                                     |       | 26,398          |       | 23,830          |       |
|                                           |       |            |       |            |       |
| Less accumulated depreciation and amortization |       | (19,480         | )          | (17,140         | )          |
| Net property and equipment                     |       | $               | 6,918      |            | $          | 6,690 |   |

 

       The Company accounts for the costs of computer softwaredeveloped or obtained for internal use in accordance with Statement of Position98-1, *“Accounting for the Costs of ComputerSoftware 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 other intangible assetsin accordance with Statement of Financial Accounting Standards No. 142, *“Goodwill and Other Intangible Assets,”*(SFAS 142).  Under the provisions of SFAS142, an annual assessment of goodwill impairment is performed.  This assessment involves the use of estimatesrelated to fair market values of the Company’s reporting units with which thegoodwill is associated.  The assessmentof goodwill impairment in the future will be impacted if future operating cashflows of the Company’s reporting units decline, which would result in decreasesin the related 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.  Intangible assets not subject toamortization are tested annually for impairment, and are tested for impairmentmore frequently if events and circumstances indicate that an asset might beimpaired.  An impairment loss isrecognized to the extent that the carrying amount exceeds the asset’s fairvalue.

 

       The Company accounts for long lived assets in accordance withStatement of Financial Accounting Standards No. 144, *“Accounting for the Impairment or Disposal of Long-Lived Assets,”*(SFAS 144).  Under the provisions of SFAS144, long-lived assets, such as property, plant and equipment and purchasedintangibles subject to amortization, are tested for recoverability wheneverevents or changes in circumstances indicate that the carrying amount of anasset may not be recoverable. Recoverability of assets to be held and used is measured by a comparisonof the carrying amount of an asset to estimated undiscounted future cash flowsexpected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cashflows, an impairment charge is recognized by the amount by which the carryingamount of the assets exceeds the fair value of the asset.

 

 

**       Deferred LoanCosts**

 

       Deferred loan costs consist of loanclosing costs and other administrative expenses associated with the RevolvingCredit Agreement.  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 Costsand Acquired Developed Technology**

 

       The Company capitalizes the development costs of software,other than internal-use software, in accordance with Statement of FinancialAccounting Standards No. 86, *“Accounting forCosts 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 bear to the total of current and estimated future grossrevenues for that project or (2) the straight-line method over the remainingeconomic life of the product (generally three to six years). The Companycapitalized $593,000 and $204,000 of software development costs in the threemonths ended October 31, 2004 and 2003, respectively.  The Company capitalized $2.2 million and$204,000 of software development costs in the nine months ended October 31,2004 and 2003, 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 the anti-money laundering software discussedbelow.  The products reachedtechnological feasibility in the latter half of fiscal 2003 and accordinglycertain costs subsequently incurred were capitalized under SFAS 86.

 

       The Company recorded amortization relating to softwaredevelopment costs capitalized of $668,000 and $239,000 in the three monthsended October 31, 2004 and 2003, respectively. The Company recorded amortization relating to software development costscapitalized of $1.1 million and $786,000 in the nine months ended October 31,2004 and 2003, respectively.  Theincrease in the amortization is the result of approximately $380,000 ofamortization related to the ExchgLink product which was made generallyavailable in the three months ended October 31, 2004.  Amortization expense is recorded as a componentof cost of software license fees in the accompanying consolidated statements ofoperations.

 

 

9

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       In October 2003, the Company purchased ananti-money laundering software solution designed to help banks protect boththeir customers and their corporate reputations from the growing risk offinancial fraud and to comply with a growing number of laws andregulations.  The $1.5 million purchaseprice was recorded in acquired developed technology in the accompanyingcondensed consolidated balance sheets and is being amortized over a 3-yearperiod.

 

       Acquired developed technology includes purchased technologyintangible assets associated with acquisitions. These purchased technology intangibles are initially recorded based onthe fair value ascribed at the time of acquisition.

 

       Acquired developed technology with a useful life of 3-6 yearsis amortized on a straight-line basis, resulting in amortization expense of$1.2 million and $1.1 million for the three months ended October 31, 2004 and2003, respectively, and $3.5 million and $3.1 million for the nine months endedOctober 31, 2004 and 2003.  Amortizationexpense is recorded as a component of cost of software license fees in theaccompanying consolidated statements of operations.

 

       The following table sets forth the estimated amortizationexpense of capitalized software costs and acquired developed technology for thethree months remaining in fiscal year ending January 31, 2005 and for theremaining future fiscal years ending January 31 (in thousands):

 

| **Period**                               | ** ** | **Capitalized  Software Costs** | ** ** | **Acquired  Developed  Technology** | ** ** |
|------------------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|
| November 1, 2004 – January 31, 2005 |       | $                               | 198        |                                | $          | 1,155 |   |
| Fiscal year ending January 31, 2006      |       | 464                             |       | 4,620                               |       |
| Fiscal year ending January 31, 2007      |       | 355                             |       | 4,107                               |       |
| Fiscal year ending January 31, 2008      |       | 236                             |       | 1,200                               |       |
|                                          |            |                                 |            |                                     |            |  |  |

 

       The table does not include the estimated amortization expensefor $1.8 million of capitalized software products that are currently beingdeveloped, and for which amortization has not commenced.

 

 

10

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**       Revenue Recognition**

 

       The Company’s 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 RevenueRecognition with Respect to Certain Transactions,”* Staff AccountingBulletin (“SAB”) No. 104,**RevenueRecognition and Emerging Issues Task Force (“EITF”) No. 00-21,*“Revenue Arrangements with Multiple Deliverables.”* In the case of software arrangements thatrequire significant production, modification, or customization of software, orthe license agreement requires the Company to provide implementation servicesthat are determined to be essential to other elements of the arrangement, theCompany follows the guidance in SOP 81-1, *“Accounting forPerformance of Construction — Type and Certain Production — Type Contracts.”*

 

*       ConsultingFees.*  The Company employs three primary pricing methods inconnection with its delivery of consulting services. First, the Company may price its delivery of consulting services onthe basis of time and materials, in which case the customer is chargedagreed-upon daily rates for services performed and out-of-pocketexpenses. In this case, the Company isgenerally paid fees and related amounts usually on a monthly basis, and theCompany recognizes revenues as the servicesare performed. Second, the Company maydeliver consulting services on a fixed-price basis. In this case, theCompany is paid on a monthly basis orpursuant to an agreed upon payment schedule, and the Company recognizes revenues on a percentage-of-completionbasis.  The Company believes that this method is appropriate becauseof its ability to determine performance milestones and determine dependableestimates of its costs applicable to each phase of a contract.  Because financial reporting of thesecontracts depends on estimates, which are assessed continually during the termof the contract, costs are subject to revisions as the contractprogresses.  Anticipated losses onfixed-price contracts are recognized when estimatable.  Third, the Company may deliver consulting services pursuant to avalue-priced contract with the customer. In this case, the Company ispaid, on an agreed upon basis with the customer, either a specified percentageof (1) the projected increased revenues and/or decreased costs that areexpected to be derived by the customer generally over a period of up to twelvemonths following implementation of its solution or (2) the actual increasedrevenues and/or decreased costs experienced by the customer generally over aperiod of up to twelve months following implementation of its solution, subjectin either case to a maximum, if any is agreed to, on the total amount of paymentsto be made to the Company.  The Companymust first commit time and resources to develop projections associated withvalue-pricing contracts before a customer will commit to purchase itssolutions, and the Company therefore assumes the risk of making thesecommitments with no assurance that the customer will purchase thesolution.  Costs associated with thesevalue-pricing contracts are expensed as incurred.  These contracts typically include payments tobe made to the Company pursuant to an agreed upon schedule ranging from one totwelve months in length.  TheCompany recognizes revenues generated fromconsulting services in connection with value-priced contracts based uponprojected results only upon completion of all services and agreement upon theactual fee to be paid (even though billings for these services may be delayedby mutual agreement for periods not to exceed twelve months). In an effort toallow customers to more closely match expected benefits from services withpayments to the Company, theCompany on occasion, may offer payment termswhich extend beyond 12 months.  When theCompany enters into an agreement which has a significant component of the totalamount payable under the agreement due beyond 12 months or if it is determinedpayments are not fixed and determinable at the date the agreement was enteredinto, revenue under the arrangement will be recognized as payments become dueand payable.  When fees are to be paidbased on a percentage of actual revenues and/or savings to customers, theCompany recognizes revenues only uponcompletion of all services and as the amounts of actual revenues or savings areconfirmed by the customer with a fixed payment date.

 

**      **Costsassociated with time and materials, fixed-priced and value-priced consultingfee arrangements are expensed as incurred and are included as a component ofthe cost of consulting fees.

 

       The Company expects that value-pricing contracts willcontinue to account for a significant portion of its revenues in the future. Asa consequence of the use of value-pricing contracts and due to therevenue recognition policy associated with those contracts, theCompany’s results of operations will likelyfluctuate significantly from period to period.

 

       Regardless ofthe pricing method employed by the Company in a given contract, the Company is typically reimbursed on a monthly basis for out-of-pocketexpenses incurred on behalf of its customers.

 

*       SoftwareLicense Fees.*  A software license is sold either togetherwith implementation services or on a stand-alone basis.  The Company is usually paid software license fees in one ormore installments, as provided in the customer’s contract but not to exceedtwelve months.  The Company recognizessoftware license revenue upon execution of a contract and delivery of thesoftware, 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.

 

 

11

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       In certain instances, especially withrecently developed software, the Company defers software license revenuerecognition until the services are completed and the project is accepted by thecustomer.  This practice is followed forthe first two installations of a recently developed software product.  After two successful implementations, theproduct is considered generally available (“GA”).

 

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

 

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

 

 

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

 

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

 

The Company’s contractstypically do not include right of return clauses, and as a result, the Companydoes not record a provision for returns.

 

 

**       Royalties**

 

       In connection with software license and maintenance agreementsentered into with certain banks and purchase agreements with vendors underwhich the Company acquired software technology used in products sold to itscustomers, the Company is required to pay royalties on sales of certainsoftware products.  Under thesearrangements, the Company accrues royalty expense when the associated revenueis recognized.  For current productofferings, the royalty percentages generally range from 20% to 50% of theassociated revenues.  Approximately$685,000 and $718,000 of royalty expense was recorded under these agreements inthe three months ended October 31, 2004 and 2003, respectively, and $1.4million and $1.7 million in the nine months ended October 31, 2004 and2003.  Royalty expense is included as acomponent of the cost of software license fees and cost of software maintenancefees in the accompanying condensed consolidated statements of operations.

 

 

12

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       **Deferred Revenue**

 

       Deferred revenue represents amounts paid by customers underterms specified in consulting, software licensing, and maintenance contractsfor which completion of contractual terms or delivery of the software has notoccurred.

 

       Deferred revenue and advance paymentsfrom customers consist of the following (in thousands):

 

| ** **                                        | ** ** | **October 31,** | ** ** | **January 31,** | ** ** |
|---------------------------------------------------|------------|-----------------|------------|-----------------|------------|
| ** **                                        | ** ** | **2004**        | ** ** | **2004**        | ** ** |
| Deferred software maintenance fees                |       | $               | 24,059     |            | $          | 44,117 |   |
| Deferred software implementation and license fees |       | 19,097          |       | 22,960          |       |
|                                              |       | 43,156          |       | 67,077          |       |
| Less related accounts receivable                  |       | (25,590         | )          | (41,846         | )          |
|                                              |       | $               | 17,566     |            | $          | 25,231 |   |

 

**       Research and DevelopmentCosts**

 

       Research and development costs, which are not subject to capitalizationunder Statement of Financial Accounting Standards (SFAS) 86, *“Accounting for the Cost of Computer Software to beSold, Leased, or Otherwise Marketed,”* are expensed as incurred andrelate mainly to the development of new products (prior to achievingtechnological feasibility), new features or enhancements for existing productsor applications.  Sustaining maintenanceactivities are expensed as incurred and charged to cost of revenues-softwaremaintenance fees.

 

 

**       Other income**

 

       Other income is comprised of the following (in thousands):

 
| ** **                                                        | ** ** | **Three Months  Ended October 31,** | ** ** | **Nine Months  Ended October 31,** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                                                        | ** ** | **2004**                            | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| Gain on sale of Cash Services Australia Pty. Limited              |       | $                                   | —     |                               | $          | — |   | $ | 539 |   | $ | — |   |
| Equity in earnings (loss) of Cash Services Australia Pty. Limited |       | —                              |       | 68                                 |       | (17 | ) | 142 |   |
| Minority share of net loss  of Carretek LLC                       |       | 234                                 |       | —                             |       | 454 |   | — |   |
| Foreign exchange gains  (losses)                                  |       | 43                                  |       | 161                                |       | (245 | ) | 114 |   |
| Other                                                             |       | (2                                  | )          | (10                                | )          | 1 |   | 13 |   |
| Total                                                             |       | $                                   | 275        |                               | $          | 219 |   | $ | 732 |   | $ | 269 |   |

 

       In April 2004, the Company 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.

 

       During fiscal 2003, the Company formed Carretek LLC(“Carretek”), in which the Company owns a 51% interest, to offer financialinstitutions offshore centric outsourcing of their business processes.  The minority interest in this loss wasrecorded in other income (expense) and was $234,000 and $0 for the three monthsended October 31, 2004 and 2003, and $454,000 and $0 for the nine months endedOctober 31, 2004 and 2003, respectively.

 

 

13

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       **Income Taxes**

 

       The Company accounts for income taxes using the liabilitymethod, whereby deferred tax assets and liabilities are determined based ondifferences between financial reporting and tax basis of assets and liabilitiesmeasured using enacted tax rates and laws that will be in effect when thedifferences are expected to reverse.  Themeasurement of deferred tax assets is adjusted by a valuation allowance, ifnecessary, to recognize the extent to which, based on available evidence, it ismore likely than not that the future tax benefits will not be realized.

 

 

**       Earnings Per Share**

 

       Basic earnings per share is computedusing the weighted average number of shares of common stock outstanding duringeach period. Diluted earnings per share is computed using the weighted averagenumber of shares of common stock outstanding during each period and commonequivalent shares consisting of stock options (using the treasury stockmethod), if such stock options have a dilutive effect in the aggregate.

 

 

**       Stock-Based Compensation**

 

       The Company has elected to follow Accounting Principles Board(“APB”) Opinion No. 25, “*Accounting forStock 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 isrecognized.  In October 1995, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) 123, *“Accountingfor Stock-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, the FASBissued SFAS 148, *“Accounting for Stock-BasedCompensation — Transition and Disclosure — an Amendment of FASB StatementNo.123,”* which provides alternative methods of transition for anentity that voluntarily changes to the fair value based method of accountingfor stock-based employee compensation. The Company continues to account for stock-based compensation under theprovisions of APB Opinion 25 using the intrinsic value method.

 

 

       Had compensation cost for stock-basedcompensation plans been determined based on the fair value at the grant datesfor awards under those plans in accordance with the provisions of SFAS 123, netincome (loss) and net income (loss) per share would have been as follows (inthousands, except per share data):

 

 
| ** **                                                                 | ** ** | **Three Months Ended  October 31,** | ** ** | **Nine Months Ended  October 31,** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                                                                 | ** ** | **2004**                            | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income (loss), as reported                                             |       | $                                   | 513        |                               | $          | 1,337 |   | $ | (100 | ) | $ | 2,301 |   |
| Stock compensation expense recorded under the intrinsic value method       |       | 148                                 |       | 52                                 |       | 324 |   | 87 |   |
| Pro forma stock compensation expense computed under the fair value  method |       | (1,493                              | )          | (1,113                             | )          | (3,914 | ) | (3,390 | ) |
| Pro forma net income (loss)                                                |       | $                                   | (832       | )                                  | $          | 276 |   | $ | (3,690 | ) | $ | (1,002 | ) |
|                                                                       |       |                                |       |                               |       |   |   |   |   |
| Basic earnings (loss) per common share, as reported                        |       | $                                   | 0.02       |                               | $          | 0.06 |   | $ | 0.00 |   | $ | 0.10 |   |
| Diluted earnings (loss) per common share, as reported                      |       | $                                   | 0.02       |                               | $          | 0.05 |   | $ | 0.00 |   | $ | 0.10 |   |
| Pro forma basic earnings (loss) per common share                           |       | $                                   | (0.03      | )                                  | $          | 0.01 |   | $ | (0.15 | ) | $ | (0.04 | ) |
| Pro forma diluted earnings (loss) per common share                         |       | $                                   | (0.03      | )                                  | $          | 0.01 |   | $ | (0.15 | ) | $ | (0.04 | ) |

 

 

14

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       The Company calculated the estimated fairvalue of each stock option using the Black-Scholes option-pricing model andutilized the following assumptions:

 
| ** **                                     | ** ** | **Three Months Ended  October 31,** | ** ** | **Nine Months Ended  October 31,** | ** ** |
|------------------------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                                     | ** ** | **2004**                            | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| Volatility                                     |       | 0.746                               |       | 0.954                              |       | 0.794 |   | 0.955 |   |
| Weighted-average expected lives                |       | 4.500                               |       | 4.500                              |       | 4.500 |   | 4.500 |   |
| Expected dividend yields                       |       | —                              |       | —                             |       | — |   | — |   |
| Weighted-average risk-free interest rates      |       | 4.25                                | %          | 3.21                               | %          | 3.93 | % | 2.55 | % |
| Weighted-average fair value of options granted |       | $                                   | 5.62       |                               | $          | 3.90 |   | $ | 5.93 |   | $ | 3.09 |   |
|                                                |            |                                     |            |                                    |            |  |  |  |  |  |  |  |  |

 

       **Risks and Uncertainties**

 

**      **The Company’s future resultsof operations and financial condition could be impacted by the followingfactors, among others: 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 component, ability to attract and retain qualifiedpersonnel, customer concentration, competition, potential strategic alliancesand acquisitions, proprietary rights, infringement claims, dependence on thirdparties for technology licenses, liability claims, pending lawsuits, stockprice fluctuations, international operations, use of independent contractors,changing government and tax regulations, anti-takeover provisions in ourcharter, impairment of goodwill or intangible assets and realization of revenuefrom contracted sales, potential sales and backlog.

 

**       FinancialGuarantees**

 

       The following is a summary of the applicable guarantees andindemnifications:

 

Underthe terms of the majority of the Company’s software license agreements with itscustomers, the Company agrees that in the event the software sold infringesupon any patent, copyright, trademark, or any other proprietary right of athird party, it will indemnify its customer licensee, against any loss,expense, or liability from any damages that may be awarded against itscustomer.  The Company includes thisinfringement indemnification in all of its software license agreements.  In the event the customer cannot use thesoftware or service due to infringement and the Company cannot obtain the rightto use, replace or modify the license or service in a commercially feasiblemanner so that it no longer infringes, then the Company may terminate thelicense and provide the customer a pro-rata refund of the fees paid by thecustomer for the infringing license or service. The Company has recorded no liability associated with this indemnification,as it is not aware of any pending or threatened infringement actions that areprobable losses.  The Company believesthe estimated fair value of these intellectual property indemnification clausesis minimal.

 

TheCompany has agreed to indemnify members of the board of directors, officers andcertain key employees of the Company, if they are made a party or arethreatened to be made a party to any proceeding (other than an action by or inthe right of the Company) by reason of the fact that they are acting in theircapacities on behalf of the Company, or by reason of anything done or not doneby them in any such capacities.  Theindemnity is for any and all expenses and liabilities of any type whatsoever(including but not limited to, judgments, fines and amounts paid in settlement)actually and reasonably incurred by the directors or officers in connectionwith the investigation, defense, settlement or appeal of such proceeding,provided they acted in good faith.  TheCompany maintains insurance coverage for directors and officers liability(“D&O insurance”).  No maximumliability is stipulated in these agreements that include indemnifications ofmembers of the board of directors, officers and certain key employees of theCompany.  The Company has recorded noliability associated with these indemnifications as it is not aware of anypending or threatened actions or claims against its members of board ofdirectors or officers that are probable losses in excess of amounts covered byits D&O insurance.  As a result ofthe insurance policy coverage, the Company believes the estimated fair value ofthese indemnification agreements is minimal.

 

 

15

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**       RecentlyIssued Accounting Standards**

 

       In January 2003, the Financial Accounting Standards Board issuedStatement of Financial Accounting Standards Board Interpretation No. 46, *“Consolidation of Variable Interest Entities, anInterpretation of ARB No. 41 (FIN 46).”*  In December 2003, the FASB modified FIN 46 tomake certain technical corrections and address certain implementation issuesthat had arisen subsequently referred to as “FIN 46R”.  FIN 46 and FIN 46R provides 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, limitedliability corporation, trust or any other legal structure used to conductactivities or hold assets that either (1) has an insufficient amount of equityto carry out its principal activities without additional subordinated financialsupport, (2) has a group of equity owners that are unable to make significantdecisions about its activities, or (3) has a group of equity owners that do nothave the obligation to absorb losses or the right to receive returns generatedby its operations.

 

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

 

**3.****          ****Goodwilland Intangible Assets**

 

       The Company adopted SFAS No. 142, *“Goodwill and Other Intangible Assets,”* effective February1, 2002.  Under SFAS 142, goodwill andintangible assets deemed to have indefinite lives are no longer amortized butare subject to annual impairment tests in accordance with this statement.  Other intangible assets, which includeacquired developed technology and customer relationships, will continue to beamortized over their useful lives.

 

       Customer relationships with definiteuseful lives are amortized on a straight-line basis, which resulted inamortization expense of $350,000 for the three months ended October 31, 2004and 2003, respectively, and $1.1 million for the nine months ended October 31,2004 and 2003.

 

       The following table sets forth the estimated amortizationexpense of customer relationships for the indicated fiscal years ending January31 (in thousands):

 

| **Period**                               | ** ** | **Amount** | ** ** |
|------------------------------------------|------------|------------|------------|
| November 1, 2004 — January 31, 2005 |       | $          | 350        |   |
| Fiscal year ending January 31, 2006      |       | 1,400      |       |
| Fiscal year ending January 31, 2007      |       | 1,400      |       |
| Fiscal year ending January 31, 2008      |       | 467        |       |
|                                          |            |            |            |  |

 

        Certain accrued liabilities were recorded during theacquisition of Check Solutions Company in June 2001.  During the nine months ended October 31,2004, these estimates were revised and $428,000 of these accrued liabilitieswere reversed and recorded as an adjustment to Goodwill.

 

 

16

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**4.****          ****RevolvingCredit Agreement**

 

       The Company is a party to a revolvingcredit agreement with a group of banks providing for a commitment amount of$30.0 million and a maturity date of July 31, 2006.  Borrowings under the credit agreement, asamended, currently bear interest equal to either the greater of prime orfederal funds rate plus a margin ranging from 1.25% to 2.25% depending on theCompany’s ratio of funded debt to Earnings before Interest, Taxes, Depreciationand Amortization (“EBITDA”), or LIBOR plus a margin equal to 2.75% to 3.75% dependingon 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 contains customaryaffirmative and negative covenants, including financial covenants requiring themaintenance of specified interest coverage, ratio of EBITDA to funded debt, andratio of 80% of accounts receivable, cash and short-term investments to fundeddebt.  Additionally, the payment ofdividends is precluded except upon approval of the banks.  Substantially all of the Company’s assetscollateralize the revolving credit agreement. As of October 31, 2004, the Company is in compliance with the covenantsof the revolving credit agreement, as amended.

 

       The Company did not have any borrowingsoutstanding under the revolving credit agreement at October 31, 2004.  Interest expense, including the commitmentfee and exclusive of the amortization of deferred loan costs, on the creditagreement was $38,000 and $166,000 for the three months ended October 31, 2004and 2003, respectively, and $132,000 and $707,000 for the nine months endedOctober 31, 2004 and 2003.

 

**5.****          ****Provisionfor Income Taxes**

 

       The Company has established a valuation allowance to reserveits net deferred tax assets at October 31, 2004 because the more likely thannot criteria for future realization of the Company’s net deferred tax assetsspecified in Statement of Financial Accounting Standards No. 109, “*Accounting for Income Taxes,”* (“SFAS No.109”) were not met.

 

       Thenet tax provision was $114,000 and $464,000 for the three and nine months endedOctober 31, 2004, which consists of a provision for state and foreigntaxes.  The net tax provision of $146,000and $372,000 for the three and nine months ended October 31, 2003 consists of aprovision for state and foreign taxes. No U.S. Federal tax benefit was recorded due to the uncertaintyregarding the Company’s ability to generate taxable income, and resultinguncertainty relative to the recoverability of deferred tax assets.

 

 

17

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**6.****          ****IncentiveCompensation Plans**

 

       **Profit Sharing Plan**

 

       The Company has adopted a profit sharingplan 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.  Employermatching contributions amounted to $102,000 and $0 for the three months endedOctober 31, 2004 and 2003, respectively, and $431,000 and $0 for the ninemonths ended October 31, 2004 and 2003. The Company may make additionalcontributions at the discretion of the Board of Directors.  No discretionary contributions were madeduring the three and nine months ended October 31, 2004 and 2003.

 

       **Incentive Compensation Plans**

 

       Effective May 3, 2004, the variablecompensation plan was terminated.  TheCompany did not record expense under this plan for the three or nine monthsended October 31, 2004 and 2003.

 

       The Carreker Incentive Bonus Plan (“CIBP”) awards employeesbased on the Company’s and the applicable business unit’s operatingresults.  Substantially all employees areeligible to receive cash awards under the CIBP. Awards from this plan are paid to employees subsequent to the end of thefiscal year.  In the three months endedOctober 31, 2004 and 2003, the Company recorded expense under this plan ofapproximately $484,000 and $509,000, respectively.  In the nine months ended October 31, 2004 and2003, the Company recorded expense under this plan of approximately $1.0million and $1.6 million, respectively.

 

       The Company pays discretionary bonusesfrom time to time to key employees.The Company recorded discretionary bonus expense of approximately $703,000 and$421,000 for the three months ended October 31, 2004 and 2003, respectively,and $1.1 million and $639,000 for the nine months ended October 31, 2004 and2003.

 

 

18

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

 

       The following table sets forth the computation of basic anddiluted earnings (loss) per share (in thousands, except per share amounts):

 
| ** **                                            | ** ** | **Three Months Ended  October 31,** | ** ** | **Nine Months Ended  October 31,** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                                            | ** ** | **2004**                            | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| Basic earnings (loss) per share:                      |       |                                |       |                               |       |   |   |   |   |
| Net income                                            |       | $                                   | 513        |                               | $          | 1,337 |   | $ | (100 | ) | $ | 2,301 |   |
|                                                  |       |                                |       |                               |       |   |   |   |   |
| Weighted average shares outstanding                   |       | 24,821                              |       | 23,812                             |       | 24,623 |   | 23,635 |   |
|                                                  |       |                                |       |                               |       |   |   |   |   |
| Basic earnings (loss) per share                       |       | $                                   | 0.02       |                               | $          | 0.06 |   | $ | 0.00 |   | $ | 0.10 |   |
|                                                  |       |                                |       |                               |       |   |   |   |   |
| Diluted earnings (loss) per share:                    |       |                                |       |                               |       |   |   |   |   |
| Net earnings (loss)                                   |       | $                                   | 513        |                               | $          | 1,337 |   | $ | (100 | ) | $ | 2,301 |   |
|                                                  |       |                                |       |                               |       |   |   |   |   |
| Weighted average shares outstanding                   |       | 24,821                              |       | 23,812                             |       | 24,623 |   | 23,635 |   |
| Assumed conversion of employee stock options          |       | 768                                 |       | 833                                |       | — |   | 185 |   |
| Shares used in diluted earnings per share calculation |       | 25,589                              |       | 24,645                             |       | 24,623 |   | 23,820 |   |
|                                                  |       |                                |       |                               |       |   |   |   |   |
| Diluted earnings (loss) per share                     |       | $                                   | 0.02       |                               | $          | 0.05 |   | $ | 0.00 |   | $ | 0.10 |   |

 

       Options totaling 1,955,533 and 2,516,118, for the three monthsended October 31, 2004 and 2003, respectively, and 1,480,522 and 4,218,207, forthe nine months ended October 31, 2004 and 2003 have been excluded from thediluted earnings per share computation as the options were anti-dilutive.

 

 

19

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**8.****          ****Contingencies**

 

       On June 15, 2004, by mutual agreement between the parties,Civil Action No. 303CV1211-M was reinstated in the United States District Courtfor the Northern District of Texas, Dallas Division. This action was originallyfiled on May 29, 2003, in the United States District Court for the NorthernDistrict of Texas, Dallas Division as Civil Action no. 303CV1211-D. On January15, 2004, the Court, acting upon the joint motion of the parties, dismissed theaction without prejudice. This action was brought as a shareholders’ derivativeaction pursuant to Rule 23.1, Fed.R.Civ.P. for the benefit of Nominal DefendantCarreker Corporation against certain of its current and former officers anddirectors, i.e., John D. Carreker, Jr., James D. Carreker, Richard R.Lee, Jr., James L. Fischer, Donald L. House, David K. Sias, Terry L. Gage,James R. Erwin, Ronald G. Steinhart and Ronald Antinori, seeking to remedytheir individual breaches of fiduciary duty, including their knowing violationsof Generally Accepted Accounting Principles (“GAAP”), knowing violations offederal and state securities laws, acts of bad faith and other breaches offiduciary duty. The plaintiff seeks redress (the form of, among others,unspecified amounts of compensatory damages, interest and costs, includinglegal fees) for injuries to the Company and its shareholders caused byDefendants’ misfeasance and/or malfeasance during the period from May 20, 1998through December 10, 2002.

 

       On June 2, 2003, in the District Court,Dallas County, Texas, Walter Evans brought a shareholders’ derivative action,for the benefit of Nominal Defendant Carreker Corporation against James D.Carreker, John D. Carreker, Jr., James R. Erwin, James L. Fischer, Michael D.Hansen, Donald L. House, Richard R. Lee, Jr., David K. Sias, Ronald J.Steinhart, and Ernst & Young, LLP and Carreker Corporation, NominalDefendant (Cause No. 0305505). The complaint alleges that the directordefendants breached their fiduciary duty to the company. In addition thecomplaint makes certain allegations against the company’s independent auditorsErnst & Young LLP. The complaint seeks unspecified amounts of compensatorydamages, as well as interest and costs, including legal fees from the directordefendants.

 

       On April 16, 2003 the United States District Court for theNorthern District of Texas, Dallas Division, issued an order consolidating anumber of purported class action lawsuits against the Company, John D. CarrekerJr. and Terry L. Gage into a Consolidated Action styled In re CarrekerCorporation Securities Litigation, Civil Action No. 303CV0250-M.  Also, on March 3, 2003, Claude Alton Coulterfiled a purported class action lawsuit (Civil Action No. 503-CV-5-Q) againstthe Company, John D. Carreker Jr. and Terry L. Gage in the United StatesDistrict Court for the Eastern District of Texas, Texarkana Division.  These complaints, filed on behalf of purchasersof the Company’s common stock between May 20, 1998 and December 10, 2002,inclusive, allege violations of Section 10(b) of the Securities Exchange Act of1934 and Rule 10b-5 against all defendants and violations of Section 20(a) ofthe Exchange Act against the individual defendants.  These complaints also allege, among otherthings, that defendants artificially inflated the value of the Company’s stockby knowingly or recklessly misrepresenting the Company’s financial resultsduring the purported class period.  Theplaintiffs are seeking unspecified amounts of compensatory damages, interestand costs, including legal fees.

 

       The Company and individual defendants deny the allegations inthese complaints and intend to defend themselves vigorously.  It is not possible at this time to predictwhether the Company will incur any liability or to estimate the damages, or therange of damages, if any, that the Company might incur in connection with theselawsuits.  The ultimate resolution of theselawsuits could have a material adverse effect on the Company's business,results of operations, financial condition and cash flows.

 

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

 

 

20

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**9.****          ****BusinessSegments and Revenue Concentration**

 

       The tables below show revenues and income(loss) from operations for the periods indicated for our three reportablebusiness segments: Revenue Enhancement, Global Payments Technologies and GlobalPayments Consulting.  Certain prior yearamounts have been reclassified to conform with the current year businesssegment presentation.  Our customerprojects are sold on a solution basis, so it is necessary to break them down bysegment and allocate accordingly. Included in “Corporate Unallocated” are costs related to selling andmarketing, unallocated corporate overhead expense and general softwaremanagement.  Business segment resultsinclude costs such as research and development expense as well as productroyalty expense, the amortization of intangible assets and restructuring andother charges, were as follows (in thousands):

 

 
| ** **                                                                                                       | ** ** | **Three Months ended October 31, 2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                                       | ** ** | **Revenue Enhancement**                 | ** ** | **Global Payments Technologies** | ** ** | **Global Payments Consulting** | ** ** | **Corporate Unallocated** | ** ** | **Total** | ** ** |
| Revenues:                                                                                                        |       |                                    |       |   |   |   |   |   |   |   |   |
| Consulting fees                                                                                                  |       | $                                       | 7,141      |   | $ | — |   | $ | 789 |   | $ | — |   | $ | 7,930 |   |
| Software license fees                                                                                            |       | 25                                      |       | 5,676 |   | — |   | — |   | 5,701 |   |
| Software maintenance fees                                                                                        |       | 371                                     |       | 10,956 |   | 164 |   | — |   | 11,491 |   |
| Software implementation fees                                                                                     |       | 161                                     |       | 4,393 |   | 68 |   | — |   | 4,622 |   |
| Outsourcing services fees                                                                                        |       | —                                  |       | — |   | — |   | 50 |   | 50 |   |
| Out-of-pocket expense reimbursements                                                                             |       | 289                                     |       | 369 |   | 155 |   | — |   | 813 |   |
| Total revenues                                                                                                   |       | $                                       | 7,987      |   | $ | 21,394 |   | $ | 1,176 |   | $ | 50 |   | $ | 30,607 |   |
|                                                                                                             |       |                                    |       |   |   |   |   |   |   |   |   |
| Income (loss) from operations before amortization of customer  relationships and restructuring and other charges |       | $                                       | 3,350      |   | $ | 4,754 |   | $ | (588 | ) | $ | (6,534 | ) | $ | 982 |   |
|                                                                                                             |       |                                    |       |   |   |   |   |   |   |   |   |
| Amortization of customer relationships                                                                           |       | —                                  |       | 350 |   | — |   | — |   | 350 |   |
| Restructuring and other charges                                                                                  |       | —                                  |       | — |   | 199 |   | 67 |   | 266 |   |
| Income (loss) from operations                                                                                    |       | $                                       | 3,350      |   | $ | 4,404 |   | $ | (787 | ) | $ | (6,601 | ) | $ | 366 |   |

 
| ** **                                                                                                       | ** ** | **Three Months ended October 31, 2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                                       | ** ** | **Revenue Enhancement**                 | ** ** | **Global Payments Technologies** | ** ** | **Global Payments Consulting** | ** ** | **Corporate Unallocated** | ** ** | **Total** | ** ** |
| Revenues:                                                                                                        |       |                                    |       |   |   |   |   |   |   |   |   |
| Consulting fees                                                                                                  |       | $                                       | 6,151      |   | $ | 35 |   | $ | 210 |   | $ | — |   | $ | 6,396 |   |
| Software license fees                                                                                            |       | 646                                     |       | 6,350 |   | 30 |   | — |   | 7,026 |   |
| Software maintenance fees                                                                                        |       | 410                                     |       | 11,158 |   | 202 |   | — |   | 11,770 |   |
| Software implementation fees                                                                                     |       | 301                                     |       | 4,401 |   | 281 |   | — |   | 4,983 |   |
| Out-of-pocket expense reimbursements                                                                             |       | 378                                     |       | 759 |   | 91 |   | — |   | 1,228 |   |
| Intercompany revenue                                                                                             |       | —                                  |       | (126 | ) | 126 |   | — |   | — |   |
| Total revenues                                                                                                   |       | $                                       | 7,886      |   | $ | 22,577 |   | $ | 940 |   | $ | — |   | $ | 31,403 |   |
|                                                                                                             |       |                                    |       |   |   |   |   |   |   |   |   |
| Income (loss) from operations before amortization of customer  relationships and restructuring and other charges |       | $                                       | 2,985      |   | $ | 5,935 |   | $ | (762 | ) | $ | (6,608 | ) | $ | 1,550 |   |
|                                                                                                             |       |                                    |       |   |   |   |   |   |   |   |   |
| Amortization of customer relationships                                                                           |       | —                                  |       | 350 |   | — |   | — |   | 350 |   |
| Restructuring and other charges                                                                                  |       | —                                  |       | (540 | ) | — |   | 311 |   | (229 | ) |
| Income (loss) from operations                                                                                    |       | $                                       | 2,985      |   | $ | 6,125 |   | $ | (762 | ) | $ | (6,919 | ) | $ | 1,429 |   |

 

 

21

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| ** **                                                                                                       | ** ** | **Nine Months ended October 31, 2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                       | ** ** | **Revenue Enhancement**                | ** ** | **Global Payments Technologies** | ** ** | **Global Payments Consulting** | ** ** | **Corporate Unallocated** | ** ** | **Total** | ** ** |
| Revenues:                                                                                                        |       |                                   |       |   |   |   |   |   |   |   |   |
| Consulting fees                                                                                                  |       | $                                      | 24,979     |   | $ | 350 |   | $ | 2,172 |   | $ | — |   | $ | 27,501 |   |
| Software license fees                                                                                            |       | 217                                    |       | 15,884 |   | 33 |   | — |   | 16,134 |   |
| Software maintenance fees                                                                                        |       | 755                                    |       | 31,426 |   | 626 |   | — |   | 32,807 |   |
| Software implementation fees                                                                                     |       | 476                                    |       | 10,234 |   | 433 |   | — |   | 11,143 |   |
| Outsourcing services fees                                                                                        |       | —                                 |       | — |   | — |   | 60 |   | 60 |   |
| Out-of-pocket expense reimbursements                                                                             |       | 1,083                                  |       | 936 |   | 346 |   | — |   | 2,365 |   |
| Total revenues                                                                                                   |       | $                                      | 27,510     |   | $ | 58,830 |   | $ | 3,610 |   | $ | 60 |   | $ | 90,010 |   |
|                                                                                                             |       |                                   |       |   |   |   |   |   |   |   |   |
| Income (loss) from operations before amortization of customer relationships  and restructuring and other charges |       | $                                      | 12,959     |   | $ | 12,302 |   | $ | (1,417 | ) | $ | (20,055 | ) | $ | 3,789 |   |
|                                                                                                             |       |                                   |       |   |   |   |   |   |   |   |   |
| Amortization of customer relationships                                                                           |       | —                                 |       | 1,050 |   | — |   | — |   | 1,050 |   |
| Restructuring and other charges                                                                                  |       | 1,747                                  |       | (639 | ) | 199 |   | 1,671 |   | 2,978 |   |
| Income (loss) from operations                                                                                    |       | $                                      | 11,212     |   | $ | 11,891 |   | $ | (1,616 | ) | $ | (21,726 | ) | $ | (239 | ) |

 
| ** **                                                                                                       | ** ** | **Nine Months ended October 31, 2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                       | ** ** | **Revenue Enhancement**                | ** ** | **Global Payments Technologies** | ** ** | **Global Payments Consulting** | ** ** | **Corporate Unallocated** | ** ** | **Total** | ** ** |
| Revenues:                                                                                                        |       |                                   |       |   |   |   |   |   |   |   |   |
| Consulting fees                                                                                                  |       | $                                      | 20,032     |   | $ | 164 |   | $ | 1,153 |   | $ | — |   | $ | 21,349 |   |
| Software license fees                                                                                            |       | 2,368                                  |       | 19,557 |   | 30 |   | — |   | 21,955 |   |
| Software maintenance fees                                                                                        |       | 879                                    |       | 33,229 |   | 656 |   | — |   | 34,764 |   |
| Software implementation fees                                                                                     |       | 722                                    |       | 13,023 |   | 640 |   | — |   | 14,385 |   |
| Out-of-pocket expense reimbursements                                                                             |       | 1,242                                  |       | 1,739 |   | 386 |   | — |   | 3,367 |   |
| Intercompany revenue                                                                                             |       | —                                 |       | (165 | ) | 165 |   | — |   | — |   |
| Total revenues                                                                                                   |       | $                                      | 25,243     |   | $ | 67,547 |   | $ | 3,030 |   | $ | — |   | $ | 95,820 |   |
|                                                                                                             |       |                                   |       |   |   |   |   |   |   |   |   |
| Income (loss) from operations before amortization of customer  relationships and restructuring and other charges |       | $                                      | 10,413     |   | $ | 19,950 |   | $ | (2,869 | ) | $ | (22,039 | ) | $ | 5,455 |   |
|                                                                                                             |       |                                   |       |   |   |   |   |   |   |   |   |
| Amortization of customer relationships                                                                           |       | —                                 |       | 1,050 |   | — |   | — |   | 1,050 |   |
| Restructuring and other charges                                                                                  |       | —                                 |       | (529 | ) | 346 |   | 1,416 |   | 1,233 |   |
| Income (loss) from operations                                                                                    |       | $                                      | 10,413     |   | $ | 19,429 |   | $ | (3,215 | ) | $ | (23,455 | ) | $ | 3,172 |   |

 

During the three months ended July 31, 2003,the Company formed Carretek LLC (“Carretek”), in which the Company owns a 51%interest, to offer financial institutions offshore-centric outsourcing of theirbusiness processes.  During July 2004,Carretek signed its first contract to perform outsourced services with acustomer.  As this outsourcing businessis in the development phase and its operations immaterial, the financialresults for the three months and nine months ended October 31, 2004 and 2003,respectively, are contained in the Corporate-Unallocated business segment inthe tables above.

 

SinceCarretek’s inception, the Company and its partner funded Carretek with anaggregate amount of approximately $1.1 million from both partners.  $100,000 was in equity and another $980,000in the form of a note payable.  The$481,000 minority interest in the note payable is reflected as a long-termliability in the accompanying condensed consolidated balance sheets.

 

 

22

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

 

| ** **         | ** ** | **Three Months Ended  October 31,** | ** ** | **Nine Months Ended  October 31,** | ** ** |
|--------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **         | ** ** | **2004**                            | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| Single customer    |       | 19.3                                | %          | 10.5                               | %          | 13.1 | % | 9.6 | % |
| Top five customers |       | 40.7                                | %          | 33.5                               | %          | 32.6 | % | 31.7 | % |

 

        The Company markets its solutions inseveral foreign countries.  Revenues,exclusive of out-of-pocket expense reimbursements, for the three and ninemonths ended attributed to countries based on the location of the customerswere as follows ($ in thousands):

 

| ** **     | ** ** | **Three Months Ended** | ** ** | **Three Months Ended**        | ** ** |
|----------------|------------|------------------------|------------|-------------------------------|------------|
| ** **     | ** ** | **October 31, 2004**   | ** ** | **October 31, 2003**          | ** ** |
| ** **     | ** ** | **Amount**             | ** ** | **Percent of total revenues** | ** ** | **Amount** | ** ** | **Percent of total revenues** | ** ** |
| United States  |       | $                      | 24,712     |                          | 83         | % | $ | 24,293 |   | 81 | % |
| Europe         |       | 1,966                  |       | 7                             |       | 2,143 |   | 7 |   |
| Canada         |       | 1,348                  |       | 4                             |       | 1,565 |   | 5 |   |
| Asia Pacific   |       | 946                    |       | 3                             |       | 1,244 |   | 4 |   |
| South Africa   |       | 631                    |       | 2                             |       | 679 |   | 2 |   |
| Other          |       | 191                    |       | 1                             |       | 251 |   | 1 |   |
| Total revenues |       | $                      | 29,794     |                          | 100        | % | $ | 30,175 |   | 100 | % |

 

| ** **     | ** ** | **Nine Months Ended** | ** ** | **Nine Months Ended**         | ** ** |
|----------------|------------|-----------------------|------------|-------------------------------|------------|
| ** **     | ** ** | **October 31, 2004**  | ** ** | **October 31, 2003**          | ** ** |
| ** **     | ** ** | **Amount**            | ** ** | **Percent of total revenues** | ** ** | **Amount** | ** ** | **Percent of total revenues** | ** ** |
| United States  |       | $                     | 67,916     |                          | 78         | % | $ | 74,828 |   | 81 | % |
| Europe         |       | 6,511                 |       | 7                             |       | 6,400 |   | 7 |   |
| Canada         |       | 4,690                 |       | 5                             |       | 5,004 |   | 5 |   |
| Asia Pacific   |       | 3,261                 |       | 4                             |       | 3,498 |   | 4 |   |
| South Africa   |       | 4,628                 |       | 5                             |       | 2,218 |   | 2 |   |
| Other          |       | 639                   |       | 1                             |       | 505 |   | 1 |   |
| Total revenues |       | $                     | 87,645     |                          | 100        | % | $ | 92,453 |   | 100 | % |

 

 

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**10.****   ****Restructuringand Other Charges**

 

**The Company recorded various merger, restructuringand other charges and credits, as follows (in thousands):**

** **
| ** **                              | ** ** | **Workforce Reductions** | ** ** | **Credit relating to CheckFlow Suite** | ** ** | **Facility Closures** | ** ** | **EPG Litigation Settlement** | ** ** | **Legal and Professional Fees** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|--------------------------|------------|----------------------------------------|------------|-----------------------|------------|-------------------------------|------------|---------------------------------|------------|-----------|------------|
| **YTD 2003:**                           |       |                     |       |                                   |       |                  |       |                          |       |                            |       |      |       |
| Quarterly period ended April 30, 2003   |       | $                        | 545        |                                   | $          | —                |       | $                             | —     |                            | $          | —    |       | $ | 139 |   | $ | 684 |   |
| Quarterly period ended July 31, 2003    |       | 648                      |       | —                                 |       | —                |       | —                        |       | 130                             |       | 778       |       |
| Quarterly period ended October 31, 2003 |       | (251                     | )          | —                                 |       | (119                  | )          | —                        |       | 141                             |       | (229      | )          |
| Total YTD 2003                          |       | $                        | 942        |                                   | $          | —                |       | $                             | (119       | )                               | $          | —    |       | $ | 410 |   | $ | 1,233 |   |
|                                    |       |                     |       |                                   |       |                  |       |                          |       |                            |       |      |       |
| **YTD 2004:**                           |       |                     |       |                                   |       |                  |       |                          |       |                            |       |      |       |
| Quarterly period ended April 30, 2004   |       | 308                      |       | —                                 |       | —                |       | 1,686                         |       | 521                             |       | 2,515     |       |
| Quarterly period ended July 31, 2004    |       | 192                      |       | (1,215                                 | )          | —                |       | 14                            |       | 1,206                           |       | 197       |       |
| Quarterly period ended October 31, 2004 |       | 246                      |       | —                                 |       | —                |       | —                        |       | 20                              |       | 266       |       |
| Total YTD 2004                          |       | $                        | 746        |                                   | $          | (1,215                | )          | $                             | —     |                            | $          | 1,700     |       | $ | 1,747 |   | $ | 2,978 |   |

** **

**QuarterEnded April 30, 2003**

** **

       The Company recorded $545,000 in restructuring and othercharges during the three month period ended April 30, 2003, principallyassociated with the separation of 17 employees, within both the Corporate andGlobal Payments Consulting (“GPC”) business segments.  During the quarterly period ended April 30,2003, the Company recorded a charge of $139,000 relating to legal andprofessional fees relating to the Company’s restatement efforts and the legalactions described in Note 8.

 

**QuarterEnded July 31, 2003**

 

       The Company recorded $648,000 in restructuring and othercharges during the three month period ended July 31, 2003, principallyassociated with the separation of 9 employees, within both the Corporate andGPC business segments.  During thequarterly period ended July 31, 2003, the Company recorded a charge of $130,000relating to legal fees relating to the legal actions described in Note 8.

 

**QuarterEnded October 31, 2003**

 

       The Company recorded $170,000 in restructuring and othercharges during the three month period ended October 31, 2003, principallyassociated with the separation of 3 employees, within the Corporate businesssegment.  During the quarterly periodended October 31, 2003, the Company recorded a charge of $141,000 relating tolegal fees relating to the legal actions described in Note 8.

 

       Additionally, during the three months ended October 31, 2003,the Company reversed $421,000 primarily related to the true-up of terminationbenefits as actual costs were lower than estimated amounts.  Additionally, $119,000 was reversed whenestimated costs to close certain facilities were lower than our originalestimates.

 

 

24

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**QuarterEnded April 30, 2004**

 

       The Company recorded $308,000 in restructuring and othercharges during the three month period ended April 30, 2004, principallyassociated with the separation of 10 employees. During the quarterly period ended April 30, 2004, the Company recorded acharge of $521,000 relating to legal and professional fees relating to theCompany’s legal actions described in Note 8. Approximately $462,000 of the $521,000 of legal and professional feeswere recorded as selling, general and administrative costs during the quarterended April 30, 2004 and reclassified to restructuring and other charges in thequarter ended July 31, 2004.

 

       The Company 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.

 

**QuarterEnded July 31, 2004**

 

       The Company recorded $192,000 in restructuring and othercharges during the three month period ended July 31, 2004, principallyassociated with the separation of 8 employees. During the quarter ended July 31, 2004, the Company recorded a charge of$36,000 relating to legal and professional fees relating to the Company’sshareholder legal actions described in Note 8.

 

       An additional $14,000 was expensed and the entire $1.7 millionEPG settlement was paid to the plaintiff. Additionally, the Company recorded a charge for the litigation costsrelated to this legal action totaling $1.2 million.

 

       The Company received a final payment of $455,000 from acustomer in the settlement with one of its original CheckFlow Suitecustomers.  This payment was recordeddirectly to this reserve.  Concurrently,based on revised cost estimates, the Company lowered its estimate of the costto develop and install any additional software, or software modifications, withthese customers and reversed approximately $1.2 million of this reserve.

 

**QuarterEnded October 31, 2004**

 

       The Company recorded $247,000 in restructuring and othercharges during the three month period ended October 31, 2004, principallyassociated with the separation of 6 employees. During the quarter ended October 31, 2004, the Company recorded a chargeof $20,000 relating to legal and professional fees relating to the Company’sshareholder and other legal actions described in Note 8.

 

25

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       The activity related to the accruedmerger and restructuring costs during the three and nine months ended October31, 2004 is as follows (in thousands):

 
| ** **                      | ** ** | **Workforce Reductions** | ** ** | **Charges/ Credits relating to CheckFlow Suite** | ** ** | **Facility Closures** | ** ** | **Other** | ** ** | **Total** | ** ** |
|---------------------------------|------------|--------------------------|------------|--------------------------------------------------|------------|-----------------------|------------|-----------|------------|-----------|------------|
| Balance at January 31, 2004     |       | $                        | 500        |                                             | $          | 1,296                 |       | $         | 5          |      | $          | 97 |   | $ | 1,898 |   |
|                            |       |                     |       |                                             |       |                  |       |      |       |      |       |
| Additions to reserve balance:   |       |                     |       |                                             |       |                  |       |      |       |      |       |
| Severance charges               |       | 308                      |       | —                                           |       | —                |       | —    |       | 308       |       |
| Reductions to reserve balances: |       |                     |       |                                             |       |                  |       |      |       |      |       |
| Cash paid                       |       | (412                     | )          | (29                                              | )          | —                |       | (5        | )          | (446      | )          |
| Balance at April 30, 2004       |       | 396                      |       | 1,267                                            |       | 5                     |       | 92        |       | 1,760     |       |
|                            |       |                     |       |                                             |       |                  |       |      |       |      |       |
| Additions to reserve balance:   |       |                     |       |                                             |       |                  |       |      |       |      |       |
| Severance charges               |       | 192                      |       | —                                           |       | —                |       | —    |       | 192       |       |
| Cash received from customer     |       | —                   |       | 455                                              |       | —                |       | —    |       | 455       |       |
| Reductions to reserve balances: |       |                     |       |                                             |       |                  |       |      |       |      |       |
| Cash paid                       |       | (495                     | )          | (149                                             | )          | —                |       | (12       | )          | (656      | )          |
| Change in estimate              |       | —                   |       | (1,215                                           | )          | —                |       | —    |       | (1,215    | )          |
| Balance at July 31, 2004        |       | 93                       |       | 358                                              |       | 5                     |       | 80        |       | 536       |       |
|                            |       |                     |       |                                             |       |                  |       |      |       |      |       |
| Additions to reserve balance:   |       |                     |       |                                             |       |                  |       |      |       |      |       |
| Severance charges               |       | 247                      |       | —                                           |       | —                |       | —    |       | 247       |       |
| Cash received from customer     |       | —                   |       | —                                           |       | —                |       | 46        |       | 46        |       |
| Reductions to reserve balances: |       |                     |       |                                             |       |                  |       |      |       |      |       |
| Cash paid                       |       | (121                     | )          | (91                                              | )          | —                |       | (23       | )          | (235      | )          |
| Change in estimate              |       | —                   |       | —                                           |       | —                |       | —    |       | —    |       |
| Balance at October 31, 2004     |       | $                        | 219        |                                             | $          | 267                   |       | $         | 5          |      | $          | 103 |   | $ | 594 |   |

 

 

26

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

 

       All statements other than statements of historical factcontained in this report, including statements in this “Management’s Discussionand Analysis of Financial Condition and Results of Operations” concerning ourfinancial position and liquidity, results of operations, prospects for futuregrowth, and other matters, are forward-looking statements.  Although we believe that the expectationsreflected in such forward-looking statements are reasonable, no assurance canbe 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, 2004, 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 qualified personnel,customer concentration, competition, potential strategic alliances andacquisitions, proprietary rights, infringement claims, dependence on thirdparties for technology licenses, liability claims, pending lawsuits, stockprice fluctuations, international operations, use of independent contractors,changing government and tax regulations, anti-takeover provisions in ourcharter and impairment of goodwill or intangible assets.  In addition, from time to time we provideinformation regarding our contract sales, potential sales opportunities andbacklog and our expectations with regard to the related realization ofrevenues. Our expectations with regard to the realization of revenues fromthese contract sales, potential sales and backlog are forward-lookingstatements and are subject to the foregoing risks and those set forth under“Item 5. Other Information” in this report. 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**

 

       We provide payments-relatedsoftware and consulting solutions to financial institutions and financialservice providers.  We serve all of thetop 20 and 75 of the next largest 100 commercial banks in the UnitedStates.  We also consider othergeographic regions to be important elements of our market opportunity.  Our products and services traverse a broadspectrum of payment activities and are designed to improve operationalefficiency in how payments are processed; enhance revenue and profitabilityfrom payments-oriented products and services; reduce losses associated withfraudulent payment transactions; and/or improve the alignment of productofferings with our customer needs, hence maximizing their customer incomestreams.

 

       We areorganized into three primary operating divisions: Global Payments Technologies(“GPT”), Revenue Enhancement (“RevE”) and Global Payments Consulting(“GPC”).  These three divisions bringtogether the capabilities essential to providing the innovation and deliveryengines for our products and services.

 

 

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*       Global PaymentsTechnologies Solutions.*  Carreker’s technologysolutions help financial institutions address the needs of some criticalpayment services and delivery functions that impact overall operating costs andrisk management.  These functions includepresentment of checks in paper and electronic form, identification and mitigationof fraudulent 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 key functions in thecontext of improving operational efficiency and a gradual transition from paperto electronic-based payment systems.  Inaddition, we offer technology solutions that optimize the inventory managementof a bank’s cash stock levels, including managing how much is needed, when itis needed and where it is needed.  Oursolutions reduce the amount of cash banks need to hold in reserve accounts andas cash-on-hand, while ensuring a high level of customer service through timelyreplenishment of ATM cash supplies.

 

       Specific solutions in the GPT groupinclude:

 
| **Solution**                                           | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                   | ** ** | **Products  Offered**                                                                                                                                                                                                                                                             |
|--------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 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                        |
|                                                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                                              |
| 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 |
|                                                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                                              |
| Check Image  Archive Management                        |       | Comprehensive  array of check image archive management products that may be tailored to a  bank’s unique requirements based on their operational environments and  volumes. Carreker offers archive technology for both in-house solutions and  shared outsource providers.                                                                                                                                                                                  |       | Check Image  Archive-AIX, Check Image Archive-MVS, Check Image Archive Load                                                                                                                                                                                                       |
|                                                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                                              |
| Other Check Image  Applications                        |       | An array of solutions that  address revenue enhancement, risk reduction, and expense reduction issues  through the application of image, workflow and RECO technologies.                                                                                                                                                                                                                                                                                          |       | Image Statements, CDRom  Delivery, Input/Express, Express Capture, Payee Name Verification, and Amount  Encoding Verification                                                                                                                                                     |

 

 

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|                                             |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |   |                                                                                                     |
|--------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------|
| 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”) as well as improving a bank’s yield from float management. 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,  CheckLink, CheckLink PC, Deposit Manager, Branch Truncation Manager and  Cnotes |
|                                             |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |   |                                                                                                     |
| 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  automate and standardize the cash ordering process. Consulting solutions can  drive further efficiency and automation in vault, branch and ATM operations.                                                                                        |   | iCom, ReserveLink,  ReserveLink Plus, Cash Supply Chain Consulting                                       |

 

 

 

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*       RevenueEnhancement Solutions.*  The Revenue Enhancementdivision includes two business units: RevE and Customer Value Enhancement (“CVE”), formerly known as EnAct.RevE is a highly specialized division that provides consulting services focusedon tactical methods of increasing banks’ fee income. The scope and depth ofthis practice has expanded throughout its 14 year history and now includesretail, small business, and commercial deposits, treasury management, consumerand commercial lending, credit card lending and trust and investment services.Our solutions involve developing strategies that enable our clients to takeadvantage of electronification trends, often gaining first mover advantages forour clients. In addition to developing strategies, our business model ensuresthat we continue to translate those strategies into tactical implementationswith measurable revenue streams. Our client base has continued to expand withvery high penetration rates in the markets in which we operate. Thus, we haveexperienced a trend of becoming longer term strategic partners with ourclients.

 

       Another component of our Revenue Enhancementdivision is our business providing CVE software and proprietary salesmanagement methodology. Our CVE solutions assist financial institutions inleveraging central intelligence with local insight. This enables our clients torecognize those customers and prospects representing the greatest value orpotential. Our approach is unique and complimentary to many CRM investmentsthat banks have made in recent years and is designed to focus their activitiessuch that they can actually attain increased returns on these CRM investments.

 

       *Global Payments Consulting.* Carreker helps financial institutions pro-actively plan,prepare and optimize for the regulatory, competitive and technological impactsaffecting the financial payments environment. Our Global Payments Consulting (GPC) division provides strategicplanning and implementation advisory services for financial institutions andother clients.  These planning andimplementation services include:

 

•                  Enterprisepayment strategy

•                  Paymentresearch services

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

•                  Image-enabledpayment infrastructure planning

•                  Transportation,float and funds availability optimization

•                  Organizationaldesign

•                  Consolidationand merger/integration planning

•                  ProgramManagement

•                  Check 21readiness

 

       Each service’s objective is to assist ourclients in preparing and positioning their organization for the rapidlychanging payment landscape.

 

       The GPC division also contains the license, maintenance andservices revenue of our Float Management software products.  These Float Management products providesolutions that manage a bank’s float through float analysis and pricing toimprove profitability, reporting, workflow and check clearing operations.  These products also provide critical activitysummaries, aid in creating multiple availability and pricing schedules, andpinpoint the cost/profitability of transactions or relationships.  The products offered consist of FloatAnalysis System and Float Pricing System.

 

       *Outsourcing*.  Carretek LLC is a transformational businessoutsourcer for payment and transaction processing jointly owned by CarrekerCorporation and Majesco Software Inc., the US subsidiary of Mastek Limited, aleading 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 institutions andtheir processors to realize the benefits of transformational offshore-centricoutsourcing (“offshoring”) of their business processes.  The benefits to clients could includereduction in operating costs, improvements in productivity, and enhancement ofquality.

 

       Initially, Carretek is focused on offshoring payments-relatedbusiness processes.  Through Carretek,financial institutions can leverage the global work force at this criticalperiod when Check 21 and other payment electronification trends are pressuringfinancial institutions to reduce their payment per item costs beyond the powerof traditional cost management practices.  Carretek has designed and built specificproduct offerings targeted at payment and transaction processing functions forthis express purpose.  Within thisarea of expertise, the Carretek offering includes a flexible array of offshoreoutsourcing services to financial institutions.

 

 

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**Executive Summary**

 

       In Q3 2004, we generatednet income of $513,000 and on a year-to-date basis we generated a net loss of$100,000.  The banking market in which weoperate is healthy and the buying climate continues to be favorable with theCheck 21 law that took effect on October 28, 2004 and the need for banks tomake investments in electronifying their check payment system.  However, these conditions have also attractedcompetition for our GPT business segment, including point solution providersand large hardware and solution providers like IBM, Unisys and NCR who viewCheck 21 as an opportunity for incremental software and advisory servicesrevenue.

 

       Our Q2 2004 sales activityreflected this strong market demand with our GPT business segment having one ofthe strongest contract sales quarters to date for software and services;however, in Q3 2004 that trend did notcontinue as delays in decision making by customers and competitive lossescontributed to the softness in contracted sales in Q3 2004.  The outlook for Q4 2004 continues to remainvery sensitive to the volume and timing of sales, product delivery, customerimplementation schedules and customer-dependent timing on a small number ofengagements in our RevE business segment. We expect total revenues for Q4 2004 to be flat to slightly down, andoperating profit to be approximately break-even or slightly negative.  During Q3 2003, we qualified an increasednumber of Check 21 and other potential sales opportunities, and anticipate thatcontract sales will improve in Q4 2004 and beyond as an expanded array of newproducts become available.  Accordingly,we believe that this will result in revenue growth in 2005.

 

       Although GPT had lower sales volume in Q3 2004, GPT segmentrevenue increased 17.5% to $21.4 million in Q3 2004, as compared to $18.2million in Q2 2004; however, GPT segment revenue declined 5.2%, or $1.2million, as compared to Q3 2003.  Theincrease in GPT segment revenue in Q3 2004, as compared to Q2 2004, wasprimarily the result of the acceptance of our new image exchange product,ExchgLink, by our bank development partner. This product acceptance was directly related to the recognition ofapproximately $1.9 million of license revenue and $921,000 of services revenuesin Q3 2004.

 

       On a year-to-date basis,GPT segment revenue declined $8.7 million, or 12.9%, to $58.8 million from$67.5 million, primarily as a result of weak license and related servicescontract sales in Q4 2003 and Q1 2004, primarily related to delays intechnology investments by our customers.  We believe some of these delays are due to thefact that we bundle our products to provide a better value for ourcustomers.  This bundling tends to extendthe buying cycle; however, we believe it is in the best long-term interest ofour customers and the Company.

 

       In Q3 2004, our RevE segment revenue grew 1.3% on aquarter-over-quarter basis and 9.0% on a YTD basis.  We continue to experience good demand in theRevE consulting business because banks continue to be challenged to grow,and/or maintain existing revenue streams, primarily by two major shifts in thebanking industry: (1) the shift from end-of-day paper payment services toelectronic intra-day services and (2) the value proposition shift from paperhandling to risk mitigation/information services.  Both of these shifts are intensified by thefact that Check 21, a momentum builder for both shifts, went into effect inOctober 2004.  Within the RevE market, wedo experience moderate competition. There are a number of smaller competitors that have put downwardpressure on our pricing; however, customers value our larger size and thequality of our consultants, which provide better assurance of a successfulengagement.

 

       In Q3 2004, our GPC segmentrevenue grew 25.1% on a quarter-over-quarter basis and 19.1% on a YTDbasis.  Over the last eighteen months, wehave been repositioning this business from a staff supplement focus to one ofthought leadership where margins and growth potential are superior.  While the path to profitability andsignificant growth has taken longer than originally anticipated, we considerthis business to be an important part of our overall integrated solutionoffering.  The two drivers that webelieve will fuel this growth are: (1) Check 21 with all of the changes itrequires and (2) our own technology, designed to facilitate our customers’transition from paper to electronics. The customer decision making process with regard to adopting imagetechnology can be costly and complex, which provides a good opportunity for ourconsulting business.  The competition weface in GPC resembles that of GPT.  Wehave both very large providers on one side and small single-service consultancieson the other.  We believe we maintain astrong competitive position because of our long-time and hard-earned reputationof advising these banks on similar operations and technology changes.

 

       In Q2 2004, we announced our first contract for Carretek, our51% owned offshore business process outsourcing initiative.  Presently, the revenue impact is minimal,however there are two drivers for growth: (1) Check 21 has accelerated thepressure on banks to reduce the cost of processing paper payments and (2) theavailability of image technology that makes it possible to separate the informationto be processed from the paper itself. As for competition, there are many offshoring vendors; however, webelieve our model is unique as we bring payment knowledge and bank expertise,along with an experienced offshore partner and facilities.

 

 

 

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       Beginning in Q3 2003, we began to increase our research anddevelopment (“R&D”) spending to address new product offerings and existingproduct enhancements that will be required by our customers to address all ofthe significant changes brought about by Check 21 legislation, USA Patriot Actand Basel II.  Through October 31, 2004,total R&D spending (including amounts capitalized) has increased to $8.3million in 2004, as compared to $5.7 million for the same period in 2003.  We expect this trend to continue for thebalance of 2004 as we continue to develop new products.

 

       To help fund these investments in our products, we arecontinually trying to improve performance, quality and efficiency within ourorganization.  We have focused onreducing selling, general and administrative expenses and improving theutilization of our technical staff and consultants.  While we have managed to lower theseexpenses, the reductions have been partially offset by increases in Directorsand Officers’ Insurance, professional fees for Sarbanes-Oxley compliance,employee benefits, and increased GPT business segment selling expenses.

 

       Finally, 2004 operatingresults have been negatively affected by several non-recurring items.  The EPG litigation settlement of $1.7million, along with $462,000 in litigation costs, were recorded in Q12004.  In Q2 2004, an additional $1.2million in litigation costs were incurred. These Q2 2004 litigation costs were offset by a $1.2 million change inestimated reserves related to a discontinued product.  See *Restructuringand Other Charges* withinManagement’s Discussion and Analysis of Financial Condition and Results ofOperations.

 

 

**Results of Operations**

 

***Comparison of Three Months EndedOctober 31, 2004 (“Q3 2004”) to Three Months Ended October 31, 2003 (“Q3 2003”)and Nine Months Ended October 31, 2004 (“YTD 2004”) to Nine Months EndedOctober 31, 2003 (“YTD 2003”)***

 

***Revenues***

* *

*       Revenuesby Segment ($ in thousands):*

 
| ** **                      | ** ** | **Three Months Ended October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended October 31,** | ** ** | **Variance** | ** ** |
|---------------------------------|------------|------------------------------------|------------|--------------|------------|-----------------------------------|------------|--------------|------------|
| ** **                      | ** ** | **2004**                           | ** ** | **2003**     | ** ** | **$**                             | ** ** | **%**        | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Revenue Enhancement             |       | $                                  | 7,987      |         | $          | 7,886                             |       | $            | 101        |   | 1.3 | % | $ | 27,510 |   | $ | 25,243 |   | $ | 2,267 |   | 9.0 | % |
| Global Payments Technologies    |       | 21,394                             |       | 22,577       |       | (1,183                            | )          | (5.2         | )          | 58,830 |   | 67,547 |   | (8,717 | ) | (12.9 | ) |
| Global Payments Consulting      |       | 1,176                              |       | 940          |       | 236                               |       | 25.1         |       | 3,610 |   | 3,030 |   | 580 |   | 19.1 |   |
| Corporate (Outsourcing) Revenue |       | 50                                 |       | —       |       | 50                                |       | —       |       | 60 |   | — |   | 60 |   | — |   |
|                            |       |                               |       |         |       |                              |       |         |       |   |   |   |   |   |   |   |   |
| Total Revenues                  |       | $                                  | 30,607     |         | $          | 31,403                            |       | $            | (796       | ) | (2.5 | )% | $ | 90,010 |   | $ | 95,820 |   | $ | (5,810 | ) | (6.1 | )% |

 

*      *The declinein revenue for Q3 2004, as compared to Q3 2003, was driven by a 5.2% decline inrevenue within the GPT business segment, offset by a 1.3% increase in RevErevenue and a 25.1% increase in revenue within our GPC business segment.  The decline in revenue on a YTD basis wasdriven by a 12.9% decline within the GPT business segment, offset by 9.0%growth within the RevE business segment and a 19.1% increase in our GPCbusiness segment.

 

       The decline in our GPT business segment,on both a quarter-over-quarter basis and a YTD basis, was primarily the resultof weak software and related services contract sales in Q4 2003 and Q1 2004, primarilyrelated to delays in technology investments by our customers.  We believe some of these delays are due to thefact that we bundle our products to provide a better value for ourcustomers.  This bundling tends to extendthe buying cycle, however we believe it is in the best long-term interest ofour customers and the Company.

 

       The increase within our RevE business segment, on both aquarter-over-quarter and YTD basis, was principally driven by a 16.1% increasein consulting revenues on a quarterly basis and a 24.7% increase on a YTDbasis.  The increase in consultingrevenues on a quarterly basis was derived principally from a larger number ofdomestic engagements and the increase on a YTD basis was the result ofincreased international consulting revenue. These increases in consulting revenue were offset by a 80.3% decline inCVE software and services revenue on a quarterly basis and a 77.6% decline on aYTD basis.  The steep declines within CVEwere the result of a lack of sales leadership and capacity.  Two new sales persons were hired in Q3 2004.

 

       The increases in revenues in 2004 withinour GPC business segment, on both a quarter-over-quarter and YTD basis, reflectthe results of expanded sales focus in this segment as we repositioned thisbusiness to focus on Check 21 enterprise-wide payment strategies and imageenablement planning and integration.

 

 

32

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       Overall, as we look across our threemajor business segments, we believe that we are well positioned and have acompetitive advantage to capitalize on the significant changes brought about bythe Check 21 legislation, USA Patriot Act and Basel II due to our subjectmatter expertise in the impacted areas. We anticipate that contract sales will improve in Q4 2004, and beyond,as an expanded array of new products become available.  Accordingly, we believe this will result inrevenue growth in 2005.

 

       *Consulting Fees ($ inthousands):*

 
| ** **      | ** ** | **Three Months Ended October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended October 31,** | ** ** | **Variance** | ** ** |
|-----------------|------------|------------------------------------|------------|--------------|------------|-----------------------------------|------------|--------------|------------|
| ** **      | ** ** | **2004**                           | ** ** | **2003**     | ** ** | **$**                             | ** ** | **%**        | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Consulting Fees |       | $                                  | 7,930      |         | $          | 6,396                             |       | $            | 1,534      |   | 24.0 | % | $ | 27,501 |   | $ | 21,349 |   | $ | 6,152 |   | 28.8 | % |
|                 |            |                                    |            |              |            |                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

       The majority of our consulting revenue is derived from ourRevE business segment.  Consultingrevenue in the RevE segment increased $1.0 million, or 16.1%, to $7.1 millionin Q3 2004 from $6.1 million in Q3 2003. Domestically, consulting revenue for RevE increased approximately$759,000 on a quarterly basis, and there were 14 revenue producing engagementsin Q3 2004, as compared to 9 in Q3 2003. International RevE consulting revenue increased $357,000 in Q3 2004, ascompared to Q3 2003.  Consulting revenue in the RevE segment increased$5.0 million, or 24.7%, to $25.0 million on a YTD basis from $20.0 million forthe same period in 2003.  Domestically,consulting revenue for RevE was flat on a YTD basis and there were 20 revenueproducing engagements on a YTD basis in 2004 and 17 in 2003.  International RevE consulting revenueincreased $5.1 million in YTD 2004, as compared to YTD 2003.  Additionally, there were 4 internationalrevenue producing engagements in YTD 2004, as compared to 1 in YTD 2003.

 

       Consulting revenue in our GPC segment increased 276.7%, to$789,000 in Q3 2004 from $210,000 in Q3 2003, and increased 88.4% to $2.2million in YTD 2004 from $1.2 million in YTD 2003.  We have seen increased momentum from ourredefined GPC segment, and we continue to be cautiously optimistic about thefuture growth prospects of the GPC segment.

 

       *Software License Fees ($ inthousands):*

 
| ** **            | ** ** | **Three Months Ended October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended October 31,** | ** ** | **Variance** | ** ** |
|-----------------------|------------|------------------------------------|------------|--------------|------------|-----------------------------------|------------|--------------|------------|
| ** **            | ** ** | **2004**                           | ** ** | **2003**     | ** ** | **$**                             | ** ** | **%**        | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Software License Fees |       | $                                  | 5,701      |         | $          | 7,026                             |       | $            | (1,325     | ) | (18.9 | )% | $ | 16,134 |   | $ | 21,955 |   | $ | 5,821 |   | (26.5 | )% |
|                       |            |                                    |            |              |            |                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

       The majority of our software license feesare derived from our GPT business segment. GPT software license revenue decreased $674,000, or 10.6%, to $5.7million in Q3 2004 from $6.4 million in Q3 2003.  GPT software license revenue declined $3.7million, or 18.8%, to $15.9 million in YTD 2004 from $19.6 million in YTD2003.  The acceptance of our new imageexchange product, ExchgLink, by our development partner was directly related tothe recognition of approximately $1.9 million, or 32.8%, of the GPT softwarelicense fees in Q3 2004, and 11.7% on a YTD basis.  Additionally, $3.4 million, or 21.3%, on aYTD 2004 basis of software license revenue in the GPT business segment was theresult of a license sale to a single customer in our Check Image Archive area,which did not require implementation services. In 2003, the software license revenue was more evenly distributed overour customer base.

 

 

33

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       Several new product initiatives were launched during thelatter half of fiscal 2003 and continuing into fiscal 2004.  These initiatives include:

 

•                  ExchgLink:  an application designed to send and receivecheck images.  This product has beeninstalled at our development partner site, along with an additional beta site.  The majority of the license revenues wererecognized in Q3 2004.

•                  Source Capture:  an application that enables customers tocapture check images at corporate sites. License revenues are deferred since the product is not generallyavailable.

•                  CORE Fraud Manager:  our next generation fraud application whichintegrates multiple fraud detection and regulatory compliance functions into asingle unified framework.  Licenserevenues are deferred since the product is not generally available.

•                  CORE Filter:  an anti-money laundering application.

•                  Express Research:  an image-enabled back office application.

 

       The requirements for our softwaresolution to support Check 21 were defined in 2003.  Expanded requirements became visible in thefirst half of fiscal 2004.  Likewise, thetiming of the investment decisions by our bank customers became increasinglyvisible over the same time period.

 

       The software revenue derived from our CVEproduct offering, contained in our RevE business segment, declined to $25,000in Q3 2004, as compared to $646,000 in Q3 2003 and declined to $217,000 in YTD2004, as compared to $2.4 million in YTD 2003. This decline resulted from a lack of sales leadership and capacity.  Two new sales persons were hired in Q32004.  In November 2004, the CVE groupsigned a multi-year contract to provide software, services and maintenance witha customer.  While the impact on fiscal2004 is expected to be minimal, this contract will positively impact fiscal2005 and beyond.

 

       *Software Maintenance Fees($ in thousands):*

 
| ** **                | ** ** | **Three Months Ended October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended October 31,** | ** ** | **Variance** | ** ** |
|---------------------------|------------|------------------------------------|------------|--------------|------------|-----------------------------------|------------|--------------|------------|
| ** **                | ** ** | **2004**                           | ** ** | **2003**     | ** ** | **$**                             | ** ** | **%**        | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Software Maintenance Fees |       | $                                  | 11,491     |         | $          | 11,770                            |       | $            | (279       | ) | (2.4 | )% | $ | 32,807 |   | $ | 34,764 |   | $ | (1,957 | ) | (5.6 | )% |
|                           |            |                                    |            |              |            |                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

       The majority of our maintenance revenueis derived from our GPT business segment. Software maintenance fees are invoiced and collected pursuant toannually renewable product and telephone support agreements with our softwarecustomers.  The annual maintenance fee isgenerally paid by the customer at the beginning of the maintenance period andrevenue is recognized ratably over the term of the related contract.  If the annual maintenance fee is not paid atthe beginning of the maintenance period, we defer revenue recognition until thetime that the maintenance fee is paid by the customer.  When the payment is received, maintenancerevenue is recognized for the period that maintenance revenue was previouslydeferred.  Maintenance contracts usuallycarry annual maintenance fee escalation clauses generally based on an index,such as the consumer price index. Increases for maintenance revenue in 2004 due to this escalation wereoffset by the fact that one major customer gave notice of their intent to notrenew their $2.5 million maintenance contract for fiscal 2004.

 

 

34

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       *Software ImplementationFees ($ in thousands):*

 
| ** **                   | ** ** | **Three Months Ended October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended October 31,** | ** ** | **Variance** | ** ** |
|------------------------------|------------|------------------------------------|------------|--------------|------------|-----------------------------------|------------|--------------|------------|
| ** **                   | ** ** | **2004**                           | ** ** | **2003**     | ** ** | **$**                             | ** ** | **%**        | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Software Implementation Fees |       | $                                  | 4,622      |         | $          | 4,983                             |       | $            | (361       | ) | (7.2 | )% | $ | 11,143 |   | $ | 14,385 |   | $ | (3,242 | ) | (22.5 | )% |
|                              |            |                                    |            |              |            |                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

       The majority of our softwareimplementation fees are derived from our GPT business segment.  Within GPT, software implementation fees were$4.4 million in both Q3 2004 and Q3 2003. YTD 2004, software implementation revenue within GPT declined $2.8million, or 21.4%, to $10.2 million from $13.0 million in YTD 2003.  This decline reflects the lower volume ofboth software license and software implementation sales contracts signed in thelatter half of 2003 and fiscal 2004.  InQ3 2004, approximately $921,000, or 21.0%, of the GPT software implementationfees were directly related to the acceptance of our new image exchange product,ExchgLink, by our bank development partner. In the majority of our customer arrangements, installation services areprovided to the customer when a license is purchased.

 

       *Out-of-Pocket ExpenseReimbursements ($ in thousands)*:

 
| ** **                           | ** ** | **Three Months Ended October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended October 31,** | ** ** | **Variance** | ** ** |
|--------------------------------------|------------|------------------------------------|------------|--------------|------------|-----------------------------------|------------|--------------|------------|
| ** **                           | ** ** | **2004**                           | ** ** | **2003**     | ** ** | **$**                             | ** ** | **%**        | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Out-of-Pocket Expense Reimbursements |       | $                                  | 813        |         | $          | 1,228                             |       | $            | (415       | ) | (33.8 | )% | $ | 2,365 |   | $ | 3,367 |   | $ | (1,002 | ) | (29.8 | )% |
|                                      |            |                                    |            |              |            |                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

       The decrease in these reimbursements, onboth a quarter-over-quarter and YTD basis, occurred within the GPT businesssegment, and corresponds with the decline in software implementation revenuenoted above.  Most of the softwareservices and consulting engagements require our employees to be at the customerlocation for extended periods of time, which gives rise to out-of-pocketexpense reimbursements.

 

 

35

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***Cost of Revenues***

*** ***

*Cost of Revenues by Segment ($ inthousands):*

 
| ** **                       | ** ** | **Three Months Ended October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended October 31,** | ** ** | **Variance** | ** ** |
|----------------------------------|------------|------------------------------------|------------|--------------|------------|-----------------------------------|------------|--------------|------------|
| ** **                       | ** ** | **2004**                           | ** ** | **2003**     | ** ** | **$**                             | ** ** | **%**        | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Revenue Enhancement              |       | $                                  | 4,139      |         | $          | 4,625                             |       | $            | (486       | ) | (10.5 | )% | $ | 13,114 |   | $ | 14,136 |   | $ | (1,022 | ) | (7.2 | )% |
| % of revenue                     |       | 51.8                               | %          | 58.6         | %          |                              |       |         |       | 47.7 | % | 56.0 | % |   |   |   |   |
|                             |       |                               |       |         |       |                              |       |         |       |   |   |   |   |   |   |   |   |
| Global Payments Technologies     |       | $                                  | 10,138     |         | $          | 9,995                             |       | $            | 143        |   | 1.4 | % | $ | 27,315 |   | $ | 29,400 |   | $ | (2,085 | ) | (7.1 | )% |
| % of revenue                     |       | 47.4                               | %          | 44.3         | %          |                              |       |         |       | 46.4 | % | 43.5 | % |   |   |   |   |
|                             |       |                               |       |         |       |                              |       |         |       |   |   |   |   |   |   |   |   |
| Global Payments Consulting       |       | $                                  | 1,285      |         | $          | 1,560                             |       | $            | (275       | ) | (17.6 | )% | $ | 3,971 |   | $ | 5,040 |   | $ | (1,069 | ) | (21.2 | )% |
| % of revenue                     |       | 109.3                              | %          | 166.0        | %          |                              |       |         |       | 110.0 | % | 166.3 | % |   |   |   |   |
|                             |       |                               |       |         |       |                              |       |         |       |   |   |   |   |   |   |   |   |
| Corporate (Outsourcing) Services |       | $                                  | 223        |         | $          | —                            |       | $            | 223        |   | — | % | $ | 236 |   | $ | — |   | $ | 236 |   | — | % |
| % of revenue                     |       | 446.0                              | %          | —       | %          |                              |       |         |       | 393.3 | % | — | % |   |   |   |   |
|                             |       |                               |       |         |       |                              |       |         |       |   |   |   |   |   |   |   |   |
| Total Cost of Revenues           |       | $                                  | 15,785     |         | $          | 16,180                            |       | $            | (395       | ) | (2.4 | )% | $ | 44,636 |   | $ | 48,576 |   | $ | (3,940 | ) | (8.1 | )% |
| % of revenue                     |       | 51.6                               | %          | 51.5         | %          |                              |       |         |       | 49.6 | % | 50.7 | % |   |   |   |   |

 

       Costs of revenues in absolute dollars declined in both theRevE and GPC segments and increased in both the GPT and Corporate segments inQ3 2004, as compared to Q3 2003.  Cost ofrevenues in absolute dollars declined in all three of our major businesssegments on a YTD basis.  However, directcosts as a percentage of revenues increased within the GPT business segment as declines in software license, software maintenanceand software implementation revenue were greater than the cost reductions.

 

       Within GPT,cost of revenues increased slightly on a quarter-over-quarter basis.  This increase was the result of increasedsoftware amortization on the ExchgLink product. Approximately $380,000 of capitalized software was amortized and matchedwith the related license revenue.  On aYTD basis, the decline in cost of revenues is mainly attributable to thereduction in direct costs related to services. These declines represent some personnel reductions, as well as theredeployment of the services staff to Research and Development projects,software maintenance projects and sales support.

 

       Similarly, withinthe RevE business segment, the decline in cost of revenues was related to thedeclines in the direct costs within the CVE software business; however, thesedeclines were partially offset by smaller increases in the cost of consultingrevenue.  As with GPT, there have beenpersonnel reductions within the CVE software business, as well as aredeployment of staff to sales support.

 

       The directcost reductions within GPC were attributable to personnel reductions withintheir consulting practices to bring costs in line with expected consultingrevenues.

 

 

36

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       *Cost of Consulting ($ inthousands):*

 
| ** **              | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|-------------------------|------------|-------------------------------------|------------|--------------|------------|------------------------------------|------------|--------------|------------|
| ** **              | ** ** | **2004**                            | ** ** | **2003**     | ** ** | **$**                              | ** ** | **%**        | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Cost of Consulting      |       | $                                   | 4,555      |         | $          | 4,936                              |       | $            | (381       | ) | (7.7 | )% | $ | 14,166 |   | $ | 15,193 |   | $ | (1,027 | ) | (6.8 | )% |
| % of consulting revenue |       | 57.4                                | %          | 77.2         | %          |                               |       |         |       | 51.5 | % | 71.2 | % |   |   |   |   |
|                         |            |                                     |            |              |            |                                    |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

       The cost of consulting consists primarilyof personnel costs related to our consulting engagements within our RevE andGPC segments.  The majority of thedecline in the 2004 periods, as compared to the 2003 periods, is attributed toa $241,000 decrease on a quarterly basis and a $998,000 decrease on a YTD basiswithin our GPC segment.  Personnel costs,along with contractor costs and travel, have been reduced to bring them in linewith expected near-term consulting revenues.

 

       *Cost of Software Licenses($ in thousands):*

 
| ** **                    | ** ** | **Three Months Ended October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended October 31,** | ** ** | **Variance** | ** ** |
|-------------------------------|------------|------------------------------------|------------|--------------|------------|-----------------------------------|------------|--------------|------------|
| ** **                    | ** ** | **2004**                           | ** ** | **2003**     | ** ** | **$**                             | ** ** | **%**        | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Cost of Software Licenses     |       | $                                  | 2,503      |         | $          | 2,037                             |       | $            | 466        |   | 22.9 | % | $ | 5,771 |   | $ | 5,662 |   | $ | 109 |   | 1.9 | % |
| % of software license revenue |       | 43.9                               | %          | 29.0         | %          |                              |       |         |       | 35.8 | % | 25.8 | % |   |   |   |   |
|                               |            |                                    |            |              |            |                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Thecost of software licenses consists primarily of amortization of capitalized andacquired software costs along with royalties payable to third parties.  The increase in cost of software license feeson a quarter-over-quarter basis is primarily the result of increasedcapitalized software amortization related to our ExchgLink product.  Approximately $380,000 of additional softwareamortization was matched with the related revenues in Q3 2004.  On a YTD basis, the increase in capitalizedsoftware amortization is partially offset by lower software royalty costs.

 

In connection with softwarelicense and maintenance agreements entered into with certain banks and purchaseagreements 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 Q3 2004, we recorded $685,000 of royaltyexpense compared to $718,000 of royalty expense recorded in Q3 2003.  In YTD 2004, we recorded $1.4 million ofroyalty expense compared to $1.7 million for the YTD 2003.  Depending on our future product mix, ourmargins from software license fees may be negatively impacted by increasedsoftware royalty expense.

 

 

37

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       *Cost of SoftwareMaintenance ($ in thousands):*

 
| ** **                        | ** ** | **Three Months Ended October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended October 31,** | ** ** | **Variance** | ** ** |
|-----------------------------------|------------|------------------------------------|------------|--------------|------------|-----------------------------------|------------|--------------|------------|
| ** **                        | ** ** | **2004**                           | ** ** | **2003**     | ** ** | **$**                             | ** ** | **%**        | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Cost of Software Maintenance      |       | $                                  | 3,765      |         | $          | 3,600                             |       | $            | 165        |   | 4.6 | % | $ | 10,949 |   | $ | 9,910 |   | $ | 1,039 |   | 10.5 | % |
| % of software maintenance revenue |       | 32.8                               | %          | 30.6         | %          |                              |       |         |       | 33.4 | % | 28.5 | % |   |   |   |   |
|                                   |            |                                    |            |              |            |                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

       Cost of software maintenance consists primarily of personneland facility costs to provide telephone support, products defect support andother enhancements to our existing products, which are not significant enoughto extend the product’s life cycle or substantially increase its marketability.The increase in Q3 2004, compared to Q3 2003, and YTD 2004, as compared to YTD2003, occurred as a result of increases in both our GPT and RevE businesssegments.  This increase is personnel relatedand reflects increased emphasis in supporting and enhancing our current productmix.  This increase was not attributableto additional overall headcount; rather, this cost increase represents apartial redeployment of our technical staff from the software services area tothe maintenance area.

 

       As discussed above, the annualmaintenance fee is generally paid by the customer at the beginning of themaintenance period and revenue is recognized ratably over the term of therelated contract.  If the annual maintenancefee is not paid at the beginning of the maintenance period, we defer therevenue recognition until the time that the maintenance fee is paid by thecustomer.  When the payment is received,maintenance revenue is recognized for the period that maintenance revenue waspreviously deferred.  As a result, ourcost of software maintenance as a percentage of related maintenance revenue mayfluctuate.

 

       *Cost of SoftwareImplementation ($ in thousands):*

 
| ** **                           | ** ** | **Three Months Ended October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended October 31,** | ** ** | **Variance** | ** ** |
|--------------------------------------|------------|------------------------------------|------------|--------------|------------|-----------------------------------|------------|--------------|------------|
| ** **                           | ** ** | **2004**                           | ** ** | **2003**     | ** ** | **$**                             | ** ** | **%**        | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Cost of Software Implementation      |       | $                                  | 4,002      |         | $          | 4,485                             |       | $            | (483       | ) | (10.8 | )% | $ | 11,181 |   | $ | 14,398 |   | $ | 3,217 |   | 22.3 | % |
| % of software implementation revenue |       | 86.6                               | %          | 90.0         | %          |                              |       |         |       | 100.3 | % | 100.1 | % |   |   |   |   |
|                                      |            |                                    |            |              |            |                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

       Costs of software implementation consistprimarily of personnel and facility costs to provide software implementationand project management support to customer software implementations within ourGPT business segment and our RevE segment. The decline in costs of software implementation, for both the quarterlyand YTD periods, is due to a decline in new software license and implementationprojects, in both the GPT segment and the RevE segment.  On a quarterly basis, the cost of serviceimplementations declined $263,000 and $321,000 in the GPT and RevE segments,respectively.  On a YTD basis, the costof service implementations declined $2.3 million and $1.0 million in the GPTand RevE segments, respectively.  Theselower costs correspond to the lower volume of active software implementationengagements in 2004, as compared to 2003.

 

 

38

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       *Out-of-Pocket Expenses ($in thousands):*

 
| ** **                                | ** ** | **Three Months Ended October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended October 31,** | ** ** | **Variance** | ** ** |
|-------------------------------------------|------------|------------------------------------|------------|--------------|------------|-----------------------------------|------------|--------------|------------|
| ** **                                | ** ** | **2004**                           | ** ** | **2003**     | ** ** | **$**                             | ** ** | **%**        | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Cost of Out-of-Pocket Expenses            |       | $                                  | 738        |         | $          | 1,122                             |       | $            | (384       | ) | (34.2 | )% | $ | 2,333 |   | $ | 3,413 |   | $ | (1,080 | ) | (31.6 | )% |
| % of out-of-pocket expense reimbursements |       | 90.8                               | %          | 91.4         | %          |                              |       |         |       | 98.6 | % | 101.4 | % |   |   |   |   |
|                                           |            |                                    |            |              |            |                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

       These costs represent travel, meals andother 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 both a quarterly and YTD basis in2004, due to fewer software implementation engagements as discussed above.  In addition, certain customer contractscontain expense maximums, so in certain cases not all expenses incurred can bepassed along to the customer.

 

***Operating Costs and Expenses:***

 

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

 
| ** **                                   | ** ** | **Three Months Ended October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended October 31,** | ** ** | **Variance** | ** ** |
|----------------------------------------------|------------|------------------------------------|------------|--------------|------------|-----------------------------------|------------|--------------|------------|
| ** **                                   | ** ** | **2004**                           | ** ** | **2003**     | ** ** | **$**                             | ** ** | **%**        | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Selling, General and Administrative Expenses |       | $                                  | 11,320     |         | $          | 11,797                            |       | $            | (477       | ) | (4.0 | )% | $ | 35,483 |   | $ | 36,267 |   | $ | (784 | ) | (2.2 | )% |
| % of total revenue                           |       | 37.0                               | %          | 37.6         | %          |                              |       |         |       | 39.4 | % | 37.8 | % |   |   |   |   |
|                                              |            |                                    |            |              |            |                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

       Selling, general and administrative expenses generally consistof personnel costs such as salaries, commissions, incentive compensation andnon-reimbursable travel. Additionally, the provision for doubtful accounts,insurance, including directors and officers insurance, as well as professionalservices such as legal and accounting expense and other related costs areclassified within selling, general and administrative expense.

 

       We have experienced a decrease in thesecosts on both a quarterly and YTD basis. While we have made progress in reducing costs in this area by reducingpersonnel costs within our general and administrative areas, these reductionshave been partially offset by increases in personnel expenses related toselling activities, especially within our GPT segment.  Additionally, we have incurred increasednon-personnel related expenses such as insurance costs for our directors and officers,increased employee benefit costs, increased costs related to Carretek LLC, andprofessional fees associated with our Sarbanes-Oxley compliance.

 

       Additionally, because of the decline in delinquent accountsreceivable balance, we have reduced our allowance for doubtful accounts by$275,000 in Q3 2004 and $667,000 on a YTD basis.

 

 

39

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*       Researchand Development**($ in thousands):*

 
| ** **                        | ** ** | **Three Months Ended October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended October 31,** | ** ** | **Variance** | ** ** |
|-----------------------------------|------------|------------------------------------|------------|--------------|------------|-----------------------------------|------------|--------------|------------|
| ** **                        | ** ** | **2004**                           | ** ** | **2003**     | ** ** | **$**                             | ** ** | **%**        | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Research and Development Expenses |       | $                                  | 2,520      |         | $          | 1,876                             |       | $            | 644        |   | 34.3 | % | $ | 6,102 |   | $ | 5,522 |   | $ | 580 |   | 10.5 | % |
| % of total revenue                |       | 8.2                                | %          | 6.0          | %          |                              |       |         |       | 6.8 | % | 5.8 | % |   |   |   |   |
|                                   |            |                                    |            |              |            |                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

       Researchand development expenses consist primarily of personnel, contract labor, traveland facilities expenses incurred by our research and developmentorganization.  As anticipated in Q3 2004,research and development costs have increased on both a quarterly and YTD basisas a result of increased new product development.  Research and development costs are typicallylimited to development of new software products, or enhancements to existingsoftware products, which extend the product’s life cycle and/or substantiallyincrease its marketability.

 

       Inaccordance with SFAS No. 86, “*Accounting forCosts of Computer Equipment**to beSold, Leased or Otherwise Marketed,”* we capitalized $593,000 in Q32004, as compared to $204,000 in Q3 2003. On a YTD basis, we have capitalized $2.2 million in 2004, as compared to$204,000 in 2003.  In 2004, $540,000 ofour capitalization is related to our first version of ExchgLink, our productoffering to send and receive check images. This product became generally available in Q3 2004.  We have several other development initiativesunderway in fiscal 2004 such as the second version of ExchgLink; ExpressResearch, an image-enabled back office application; Source Capture, anapplication which enables customers to capture check images at corporate sites;our next generation fraud application; an anti-money laundering application;and wire fraud.  Considering theseinitiatives, we expect the total amount of research and development expense toincrease slightly in Q4 2004.

 

       Softwaredevelopment costs of a product are capitalized from the time technological feasibilityis reached until the general release of the product.  We establish technological feasibility eitherthrough the process of creating a detailed program design and reviewing thedetailed program design for any high risk development issues or the creation ofa working model.  Capitalization onlyoccurs if we believe costs capitalized are recoverable through future sales ofthe software product under development.

 

 

*       Amortizationof Intangible Assets:*

 

       Amortizationof intangible assets was $350,000 for Q3 2004 and Q3 2003, and $1.1 million forYTD 2004 and YTD 2003.  The amortizationresults from the periodic recognition of amortization expense of intangiblecustomer relationships acquired in the Check Solutions acquisition in 2001.

 

 

40

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

** **

** **
| ** **                              | ** ** | **Workforce Reductions** | ** ** | **Credit relating to CheckFlow Suite** | ** ** | **Facility Closures** | ** ** | **EPG Litigation Settlement** | ** ** | **Legal and Professional Fees** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|--------------------------|------------|----------------------------------------|------------|-----------------------|------------|-------------------------------|------------|---------------------------------|------------|-----------|------------|
| **YTD 2003:**                           |       |                     |       |                                   |       |                  |       |                          |       |                            |       |      |       |
| Quarterly period ended April 30, 2003   |       | $                        | 545        |                                   | $          | —                |       | $                             | —     |                            | $          | —    |       | $ | 139 |   | $ | 684 |   |
| Quarterly period ended July 31, 2003    |       | 648                      |       | —                                 |       | —                |       | —                        |       | 130                             |       | 778       |       |
| Quarterly period ended October 31, 2003 |       | (251                     | )          | —                                 |       | (119                  | )          | —                        |       | 141                             |       | (229      | )          |
| Total YTD 2003                          |       | $                        | 942        |                                   | $          | —                |       | $                             | (119       | )                               | $          | —    |       | $ | 410 |   | $ | 1,233 |   |
|                                    |       |                     |       |                                   |       |                  |       |                          |       |                            |       |      |       |
| **YTD 2004:**                           |       |                     |       |                                   |       |                  |       |                          |       |                            |       |      |       |
| Quarterly period ended April 30, 2004   |       | 308                      |       | —                                 |       | —                |       | 1,686                         |       | 521                             |       | 2,515     |       |
| Quarterly period ended July 31, 2004    |       | 192                      |       | (1,215                                 | )          | —                |       | 14                            |       | 1,206                           |       | 197       |       |
| Quarterly period ended October 31, 2004 |       | 246                      |       | —                                 |       | —                |       | —                        |       | 20                              |       | 266       |       |
| Total YTD 2004                          |       | $                        | 746        |                                   | $          | (1,215                | )          | $                             | —     |                            | $          | 1,700     |       | $ | 1,747 |   | $ | 2,978 |   |

** **

**QuarterEnded April 30, 2003**

** **

       We recorded $545,000 in restructuring andother charges during the three month period ended April 30, 2003, principallyassociated with the separation of 17 employees, within both the Corporate andGlobal Payments Consulting (“GPC”) business segments.  During the quarterly period ended April 30,2003, we recorded a charge of $139,000 relating to legal and professional feesrelating to our restatement efforts and the legal actions described in Note 8.

 

**QuarterEnded July 31, 2003**

 

       We recorded $648,000 in restructuring and other charges duringthe three month period ended July 31, 2003, principally associated with theseparation of 9 employees, within both the Corporate and GPC businesssegments.  During the quarterly periodended July 31, 2003, we recorded a charge of $130,000 relating to legal feesrelating to the legal actions described in Note 8.

 

**QuarterEnded October 31, 2003**

 

       We recorded $170,000 in restructuring and other charges duringthe three month period ended October 31, 2003, principally associated with theseparation of 3 employees, within the Corporate business segment.  During the quarterly period ended October 31,2003, we recorded a charge of $141,000 relating to legal fees relating to thelegal actions described in Note 8.

 

       Additionally, during the three months ended October 31, 2003,we reversed $421,000 primarily related to the true-up of termination benefitsas actual costs were lower than estimated amounts.  Additionally, $119,000 was reversed whenestimated costs to close certain facilities were lower than our originalestimates.

 

 

41

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**QuarterEnded April 30, 2004**

 

       We recorded $308,000 in restructuring and other charges duringthe three month period ended April 30, 2004, principally associated with theseparation of 10 employees.  During thequarterly period ended April 30, 2004, the Company recorded a charge of$521,000 relating to legal and professional fees relating to our legal actionsdescribed in Note 8.  Approximately$462,000 of the $521,000 of legal and professional fees were recorded asselling, general and administrative costs during the quarter ended April 30,2004 and reclassified to restructuring and other charges in the quarter endedJuly 31, 2004.

 

       The Company 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.

 

**QuarterEnded July 31, 2004**

 

       We recorded $192,000 in restructuring and other charges duringthe three month period ended July 31, 2004, principally associated with theseparation of 8 employees.  During thequarter ended July 31, 2004, we recorded a charge of $36,000 relating to legaland professional fees relating to our shareholder legal actions described inNote 8.

 

       An additional $14,000 was expensed and the entire $1.7 millionEPG settlement was paid to the plaintiff. Additionally, we recorded a charge for the litigation costs related tothis legal action totaling $1.2 million.

 

       We received a final payment of $455,000 from a customer in thesettlement with one of our original CheckFlow Suite customers.  This payment was recorded directly to thisreserve.  Concurrently, based on revisedcost estimates, we lowered our estimate of the cost to develop and install anyadditional software, or software modifications, with these customers andreversed approximately $1.2 million of this reserve.

 

**QuarterEnded October 31, 2004**

 

       We recorded $247,000 in restructuring and other charges duringthe three month period ended October 31, 2004, principally associated with theseparation of 6 employees.  During thequarter ended October 31, 2004, we recorded a charge of $20,000 relating tolegal and professional fees relating to the Company’s shareholder legal actionsdescribed in Note 8.

 

 

42

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       The activity related to the accruedmerger and restructuring costs during the three and nine months ended October31, 2004 is as follows (in thousands):

 
| ** **                      | ** ** | **Workforce Reductions** | ** ** | **Charges / Credits relating to CheckFlow Suite** | ** ** | **Facility Closures** | ** ** | **Other** | ** ** | **Total** | ** ** |
|---------------------------------|------------|--------------------------|------------|---------------------------------------------------|------------|-----------------------|------------|-----------|------------|-----------|------------|
| Balance at January 31, 2004     |       | $                        | 500        |                                              | $          | 1,296                 |       | $         | 5          |      | $          | 97 |   | $ | 1,898 |   |
|                            |       |                     |       |                                              |       |                  |       |      |       |      |       |
| Additions to reserve balance:   |       |                     |       |                                              |       |                  |       |      |       |      |       |
| Severance charges               |       | 308                      |       | —                                            |       | —                |       | —    |       | 308       |       |
| Reductions to reserve balances: |       |                     |       |                                              |       |                  |       |      |       |      |       |
| Cash paid                       |       | (412                     | )          | (29                                               | )          | —                |       | (5        | )          | (446      | )          |
| Balance at April 30, 2004       |       | 396                      |       | 1,267                                             |       | 5                     |       | 92        |       | 1,760     |       |
|                            |       |                     |       |                                              |       |                  |       |      |       |      |       |
| Additions to reserve balance:   |       |                     |       |                                              |       |                  |       |      |       |      |       |
| Severance charges               |       | 192                      |       | —                                            |       | —                |       | —    |       | 192       |       |
| Cash received from customer     |       | —                   |       | 455                                               |       | —                |       | —    |       | 455       |       |
| Reductions to reserve balances: |       |                     |       |                                              |       |                  |       |      |       |      |       |
| Cash paid                       |       | (495                     | )          | (149                                              | )          | —                |       | (12       | )          | (656      | )          |
| Change in estimate              |       | —                   |       | (1,215                                            | )          | —                |       | —    |       | (1,215    | )          |
| Balance at July 31, 2004        |       | 93                       |       | 358                                               |       | 5                     |       | 80        |       | 536       |       |
|                            |       |                     |       |                                              |       |                  |       |      |       |      |       |
| Additions to reserve balance:   |       |                     |       |                                              |       |                  |       |      |       |      |       |
| Severance charges               |       | 247                      |       | —                                            |       | —                |       | —    |       | 247       |       |
| Cash received from customer     |       | —                   |       | —                                            |       | —                |       | 46        |       | 46        |       |
| Reductions to reserve balances: |       |                     |       |                                              |       |                  |       |      |       |      |       |
| Cash paid                       |       | (121                     | )          | (91                                               | )          | —                |       | (23       | )          | (235      | )          |
| Change in estimate              |       | —                   |       | —                                            |       | —                |       | —    |       | —    |       |
| Balance at October 31, 2004     |       | $                        | 219        |                                              | $          | 267                   |       | $         | 5          |      | $          | 103 |   | $ | 594 |   |
|                                 |            |                          |            |                                                   |            |                       |            |           |            |           |            |  |  |  |  |  |  |

 

 

43

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

 

*       Interest Income($ in thousands):*

 
| ** **      | ** ** | **Three Months Ended October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended October 31,** | ** ** | **Variance** | ** ** |
|-----------------|------------|------------------------------------|------------|--------------|------------|-----------------------------------|------------|--------------|------------|
| ** **      | ** ** | **2004**                           | ** ** | **2003**     | ** ** | **$**                             | ** ** | **%**        | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Interest Income |       | $                                  | 92         |         | $          | 69                                |       | $            | 23         |   | 33.3 | % | $ | 207 |   | $ | 223 |   | $ | (16 | ) | (7.2 | )% |
|                 |            |                                    |            |              |            |                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

       Interest income consists of interest earned on cash and cashequivalents.  The increasequarter-over-quarter is primarily the result of higher cash and cash equivalentbalances in Q3 2004, and slightly higher yields on these investments.

 

*       Interest Expense($ in thousands):*

 
| ** **       | ** ** | **Three Months Ended October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended October 31,** | ** ** | **Variance** | ** ** |
|------------------|------------|------------------------------------|------------|--------------|------------|-----------------------------------|------------|--------------|------------|
| ** **       | ** ** | **2004**                           | ** ** | **2003**     | ** ** | **$**                             | ** ** | **%**        | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Interest Expense |       | $                                  | 106        |         | $          | 234                               |       | $            | (128       | ) | (54.7 | )% | $ | 336 |   | $ | 991 |   | $ | (655 | ) | (66.1 | )% |
|                  |            |                                    |            |              |            |                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

       Interest expense is primarily the result of borrowings underour $30.0 million revolving credit agreement. Additionally, the amortization of the deferred loan costs are alsoincluded in interest expense.  Thedecline is attributable to less outstanding borrowings under the revolvingcredit agreement on both a quarterly and YTD basis in 2004, as compared to2003.

 

*       Other income ($in thousands):*

 
| ** **                                                 | ** ** | **Three Months Ended October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended October 31,** | ** ** | **Variance** | ** ** |
|------------------------------------------------------------|------------|------------------------------------|------------|--------------|------------|-----------------------------------|------------|--------------|------------|
| ** **                                                 | ** ** | **2004**                           | ** ** | **2003**     | ** ** | **$**                             | ** ** | **%**        | ** ** | **2004** | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Gain on sale of Cash Services Australia Pty. Limited       |       | $                                  | —     |         | $          | —                            |       | $            | —     |   | — |   | $ | 539 |   | $ | — |   | 539 |   | — | % |
| Equity in earnings of Cash Services Australia Pty. Limited |       | —                             |       | 68           |       | (68                               | )          | —       |       | (17 | ) | 142 |   | (159 | ) | (112.0 | )% |
| Minority share of net loss of Carretek LLC                 |       | 234                                |       | —       |       | 234                               |       | —       |       | 454 |   | — |   | 454 |   | — | % |
| Foreign exchange gains (losses)                            |       | 43                                 |       | 161          |       | (118                              | )          | (73.3%       | )          | (245 | ) | 114 |   | (359 | ) | (314.9 | )% |
| Other                                                      |       | (2                                 | )          | (10          | )          | 8                                 |       | 80.0         | %          | 1 |   | 13 |   | (12 | ) | (92.3 | )% |
|                                                       |       |                               |       |         |       |                              |       |         |       |   |   |   |   |   |   |   |   |
| Total                                                      |       | $                                  | 275        |         | $          | 219                               |       | $            | 56         |   | 25.6 | % | $ | 732 |   | $ | 269 |   | $ | 463 |   | 172.1 | % |
|                                                            |            |                                    |            |              |            |                                   |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

       In April 2004, we sold our 25% interest in Cash ServicesAustralia Pty. Limited.  The carryingvalue of our investment was approximately $383,000 and we received $922,000 inproceeds collected in May 2004.  As aresult of this transaction, we recorded a $539,000 gain.

 

       During Q2 2003, we formed Carretek LLC (“Carretek”), in whichthe Company owns a 51% interest, to offer financial institutions off-shorecentric outsourcing of their business processes.  To date, Carretek has generated minimalrevenue and has incurred approximately $926,000 in losses for the nine monthsended October 31, 2004.  Accordingly, the49% share, or $234,000 on a quarterly basis and $454,000 on a YTD basis of theminority interest in this loss was recorded in other income (expense.)

 

 

44

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*Provision for Income Taxes:*

 

       The Company has established a valuationallowance to reserve its net deferred tax assets at October 31, 2004 becausethe more likely than not criteria for future realization of the Company’s netdeferred tax assets specified in Statements of Financial Accounting StandardsNo. 109, “*Accounting for Income Taxes,”*(“SFAS No. 109”) were not met.

 

       The net tax provision was $114,000 and$464,000 for the three and nine months ended October 31, 2004, respectively,and consists of a provision for foreign taxes. The net tax provision of $146,000 and $372,000 for the three and ninemonths ended October 31, 2003, respectively, consists of a provision forforeign and state taxes.  No U.S. Federalincome tax benefit was recorded at October 31, 2004 due to the uncertaintyregarding the Company’s ability to generate taxable income, and resultinguncertainty relative to the recoverability of deferred tax assets.

 

       In May2004, the federal tax law changed to allow software license revenue to bedeferred for tax purposes similar to the percent-complete revenue recognitionmodel we use for financial statement purposes. The impact of this change in the tax law increased the amount of the netoperating loss carryforwards by $8.6 million and thereby further reduce oureffective tax rate at such time as we begin to generate taxable income.

 

 

**Liquidity and Capital Resources**

 

       Historically, we have funded our operations and cashexpenditures primarily with cash generated from operating activities.  At October 31, 2004 and January 31, 2004, wehad working capital of $11.7 million.  Wehad $26.8 million in cash and cash equivalents at October 31, 2004, a decreaseof $1.8 million from $28.6 million in cash and cash equivalents at January 31,2004.  At October 31, 2004, we had nolong-term debt compared to $6.3 million at January 31, 2004.  We expect that existing cash and cashgenerated from operating activities will be sufficient to meet our presentlyanticipated requirements for the foreseeable future.

 

       Cash used in operating activities was$209,000 in the three months ended October 31, 2004 compared to cash used inoperating activities of $4.8 million in the three months ended October 31,2003.  This improvement is primarilyrelated to reductions in accounts receivable balances.  Cash provided by operating activities was$7.3 million in the nine months ended October 31, 2004, compared to cashprovided by operating activities of $9.2 million in the nine months endedOctober 31, 2003.  Operating cash flowsdecreased as a result of the EPG litigation settlement of $1.7 million andrelated legal costs of $1.6 million paid out primarily in the first half offiscal 2004.

 

       Averagedays’ sales outstanding fluctuate for a variety of reasons, including thetiming of billings specified by contractual agreement, and receivables forexpense reimbursements.  The followingtable contains the quarterly days’ sales outstanding (DSO):

 

| **Quarter ended** | ** ** | **DSO** | ** ** |
|-------------------|------------|---------|------------|
| October 31, 2004  |       | 35      |       |
| July 31, 2004     |       | 46      |       |
| April 30, 2004    |       | 46      |       |
| January 31, 2004  |       | 59      |       |
| October 31, 2003  |       | 56      |       |

 

       Cashused in investing activities during the three months ended October 31, 2004 was$1.9 million compared to $2.0 million during the three months ended October 31,2003.  Cash used in investing activitiesduring the nine months ended October 31, 2004 was $4.9 million, compared to$2.6 million during the nine months ended October 31, 2003.  In the three and nine months ended October31, 2004, increased investments in capital expenditures were made especiallyfor a project to replace certain development hardware and software within ourtechnology group in Charlotte, NC. Additionally, increased software development led to additional softwarecosts being capitalized.  In the threemonths ended October 31, 2003, an investment was made to purchase an anti-moneylaundering software product for $1.5 million.

 

 

45

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       Financing activities provided cash of$486,000 in the three months ended October 31, 2004, and provided cash of$482,000 in the three months ended October 31, 2003 and consisted of proceedsfrom stock option exercises and receipts related to the minority interest andshareholder loan associated with Carretek LLC. The cash used in financing activitiesin the nine months ended October 31, 2004 was $4.2 million and the cash used infinancing activities in the nine months ended October 31, 2003 was $12.5million.  The cash used during the ninemonths ended October 31, 2004 was primarily a $6.3 million debt payment, offsetby $1.6 million of proceeds from the exercise of stock options and $432,000received related to the minority interest and shareholder loan associated withCarretek LLC.  The cash used during thenine months ended October 31, 2003 included a $12.5 million debt payment andthe $456,000 of deferred loan costs to amend our revolving credit agreementcompleted in July 2003, along with $384,000 of proceeds from stock optionexercises and $98,000 of receipts related to the minority interest andshareholder loan associated with Carretek LLC.

 

       We are a party to a revolving creditagreement with a group of banks providing for a commitment amount of $30.0million and a maturity date of July 31, 2006. At October 31, 2004, the Company did not have any borrowingsoutstanding.  At October 31, 2003, we hadoutstanding borrowings of $12.5 million under the credit agreement.  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 October 31, 2004, weare in compliance with the covenants of the revolving credit agreement, asamended.

 

       The following summarizes our contractualobligations at October 31, 2004 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 |       | $                          | 16,552     |   | $ | 3,715 |   | $ | 6,349 |   | $ | 5,155 |   | $ | 1,333 |   |
|                  |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

       We believe that current cash balances andexpected future cash flows will be sufficient to meet our anticipated cashneeds for working capital, capital expenditures and other activities duringfiscal 2004.  However, if current sourcesare not sufficient to meet our needs, we may seek additional equity or debtfinancing.  There can be no assurancethat additional financing would be available on acceptable terms, if at all.  We are presently involved in a number oflawsuits.  While we do not expect anynegative outcomes, the final resolutions of the lawsuits are unknown, and couldinclude judgments against us, or settlements that could require additionalsubstantial payments by us.  See Note 8in our Notes to Condensed Consolidated Unaudited Financial Statements.  The timing of the final resolution of thesematters is uncertain.  We believe that amaterial adverse outcome or outcomes with respect to the lawsuits could have amaterial adverse effect on our financial results, our business or ourmanagement including but not limited to, significantly impacting our liquidityin a negative manner as well as causing covenant violations under our revolvingcredit agreement, possibly resulting in a default thereunder.  Further, we may in the future pursueacquisitions of businesses, products or technologies that could complement orexpand our business and product offerings, and could change our financingneeds.  Our forecast of the period oftime through which our financial resources will be adequate to support ouroperations is a forward looking statement that involves risks anduncertainties, and actual results could vary. The failure to secure additional financing when needed could have amaterial adverse effect on our business, financial condition and results ofoperations.

 

 

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**Critical Accounting Policies**

 

       In preparing our condensed consolidatedfinancial statements in conformity with accounting principles generallyaccepted in the United States, we use certain estimates and assumptions thataffect the reported amounts and related disclosures and our estimates may varyfrom actual results.  We consider thefollowing seven accounting policies the most important to the portrayal of ourfinancial condition and those that require the most subjective judgment.  Although we believe that our estimates andassumptions are reasonable, actual results may differ, and such differencescould be significant to our financial results.

 

       Revenue Recognition

 

       Our revenue recognition policies are in accordance withStatement 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. 101, *“RevenueRecognition in Financial Statements,”* SAB No. 104,**Revenue Recognition and Emerging Issues TaskForce (“EITF”) No. 00-21,*“Revenue Arrangementswith Multiple Deliverables.”* In the case of software arrangements thatrequire significant production, modification, or customization of software, orthe license agreement requires us to provide implementation services that aredetermined to be essential to other elements of the arrangement, we follow theguidance in SOP 81-1, *“Accounting forPerformance of Construction — Type and Certain Production — Type Contracts.”*

 

*       ConsultingFees.*  We employthree primary pricing methods in connection with our delivery of consultingservices. First, we may price our delivery of consulting services on the basisof time and materials, in which case the customer is charged agreed-upon dailyrates for services performed and out-of-pocket expenses. In thiscase, we are generally paid fees and related amounts usually on a monthlybasis, and we recognize revenues as the services are performed. Second, we maydeliver consulting services on a fixed-price basis. In this case, we aregenerally paid on a monthly basis or pursuant to an agreed upon paymentschedule, and we recognize revenues on a percentage-of-completionbasis. We believe that this method is appropriate because of our ability todetermine performance milestones and determine dependable estimates of ourcosts applicable to each phase of a contract. Because financial reporting of these contracts depends on estimates,which are assessed continually during the term of the contract, costs aresubject to revisions as the contract progresses.  Anticipated losses on fixed-priced contractsare recognized when estimable.  Third, wemay deliver consulting services pursuant to a value-priced contract withthe customer. In this case, we are paid, on an agreed upon basis with thecustomer, either a specified percentage of (1) the projected increasedrevenues and/or decreased costs that are expected to be derived by the customergenerally over a period of up to twelve months following implementation of oursolution or (2) the actual increased revenues and/or decreased costsexperienced by the customer generally over a period of up to twelve monthsfollowing implementation of our solution, subject in either case to a maximum,if any is agreed to, on the total amount of payments to be made to us.  We must first commit time and resources to developprojections associated with value-pricing contracts before a bank will committo purchase our solutions, and we therefore assume the risk of making thesecommitments with no assurance that the customer will purchase the solution.  Costs associated with these value-pricingcontracts are expensed as incurred**.**  These contracts typically include payments tobe made to us pursuant to an agreed upon schedule ranging from one to twelvemonths in length. We recognize revenues generated from consulting services inconnection with value-priced contracts based upon projected results onlyupon completion of all services and agreement upon the actual fee to be paid(even though billings for these services may be delayed by mutual agreement forperiods not to exceed twelve months). In an effort to allow customers to moreclosely match expected benefits from our services with payments to us, we mayon occasion, offer payment terms which extend beyond 12 months.  When we enter into an agreement that has asignificant component of the total amount payable under the agreement duebeyond 12 months or if it is determined payments are not fixed and determinableat the date the agreement is entered into, revenue under the arrangement willbe recognized as payments become due and payable.  When fees are to be paid based on apercentage of actual revenues and/or savings to our customers, we recognizerevenues only upon completion of all services and as the amounts of actualrevenues or savings are confirmed by the customer with a fixed payment date.

 

       Costsassociated with time and materials, fixed-priced and value-priced consultingfee arrangements are expensed as incurred and are included as a component ofthe 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 dueto the revenue recognition policy associated with those contracts, our resultsof operations will likely fluctuate significantly from period to period.

 

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

 

 

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*       SoftwareLicense 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 certaininstances, especially with recently developed software, we defer softwarelicense revenue recognition until the services are completed and the project isaccepted by the customer.  This practiceis followed for the first two installations of a recently developed softwareproduct.  After two successfulimplementations, the product is considered generally available (“GA”).

 

       Softwarelicenses are often sold as part of a multiple element arrangement that mayinclude maintenance, implementation or consulting.  We determine whether there is vendor specificobjective evidence of fair value (“VSOEFV”) for each element identified in thearrangement to determine whether the total arrangement fees can be allocated toeach element.  If VSOEFV exists for eachelement, the total arrangement fee is allocated based on the relative fair valueof each element.  In cases where there isnot VSOEFV for each element, or if it is determined services are essential tothe functionality of the software being delivered, or if significantproduction, modification or customization of the software is required, weinitially defer 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, we will defer recognition of the full fair value related to theundelivered 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 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 substantially all of our currentsoftware licenses provide for a fixed-price license fee, some licenses providefor the customer to pay a monthly license fee based on the actual use of thesoftware product.  The level of licensefees earned by us under this arrangement will vary based on the actual amountof use by the customer.  Revenue underthese arrangements is recognized on a monthly basis as the usage becomesdeterminable.

 

*       SoftwareMaintenance 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.

 

       *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 the customers that purchase softwarelicenses from us also purchase software implementation services.  We price our implementation services on atime-and-material or on a fixed-price basis, and we recognize the relatedrevenues as services are performed. Costs associated with these engagements are expensed as incurred.

 

       Our contractstypically do not include right of return clauses, and as a result, we do notrecord a provision for returns.

 

 

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       Royalties

 

       In connection with software license andmaintenance agreements entered into with certain banks and purchase agreementswith vendors under which we acquired software technology used in products soldto its customers, we are required to pay royalties on sales of certain softwareproducts.  Under these arrangements, weaccrue royalty expense when the associated revenue is recognized.  For current product offerings, the royaltypercentages generally range from 20%-50% of the associated revenues.  Royalty expense is included as a component ofthe cost of software license fees and cost of software maintenance fees in theaccompanying condensed consolidated statement of operations.

 

       Allowance for Doubtful Accounts

 

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

 

       Software Costs Capitalized, Goodwill, Other Intangible Assetsand Other Long-Lived Assets

 

       Software costs capitalized include developed technologyacquired in acquisitions and costs incurred by us in developing our productsthat qualify for capitalization.  Wecapitalize our software development costs, other than costs for internal-usesoftware, in accordance with Statement of Financial Accounting Standards No.86, “*Accounting for Costs of ComputerSoftware to be Sold, Leased or Otherwise Marketed”* (“SFAS 86”).  Our policy is to capitalize softwaredevelopment 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 reached technologicalfeasibility. Technological feasibility of the product is determined aftercompletion of a detailed program design and a determination has been made thatany uncertainties related to high-risk development issues have been resolved.If the process of developing the product does not include a detailed programdesign, technological feasibility is determined only after completion of aworking model. All capitalized software development costs are amortized usingan amount determined as the greater of: (1) the ratio that current grossrevenues for a capitalized software project bears to the total of current andfuture projected gross revenues for that project or (2) the straight-linemethod over the remaining economic life of the product (generally three to sixyears).

 

       Goodwill and intangibles with indefinite lives are assessed onan annual basis for impairment at the reporting unit level by applying a fairvalue based test.  We performed theinitial impairment test of goodwill and intangibles with indefinite livesassets at February 1, 2002 and a follow up test at November 1, 2002 todetermine 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 1st ofeach 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 carryingvalue.  Management believes thatassumptions used to determine cash flows are reasonable, but actual future cashflows may differ from those estimated. If we determine an asset has been impaired, the impairment is recordedbased on the estimated fair value of the impaired asset.  During the fourth quarter of the year endedJanuary 31, 2004, we performed our annual evaluation for goodwill impairmentand determined that the carrying amount of goodwill was not impaired and havenot noted any factors subsequent that would indicate impairment.  Goodwill at October 31, 2004 totaled $20.8million.  Any deterioration in marketconditions, increases in interest rates and changes in our projections withrespect to the Global Payments Technologies reporting unit to which goodwill isallocated would result in additional impairment charges in the future.

 

 

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**       Restructuringand Other Charges**

 

       During fiscal year 2001, we recordedreserves in connection with our acquisition of Check Solutions and subsequentoperational restructurings.  Additionalreserves were recorded during fiscal 2002, 2003 and the first three quarters of2004.  These reserves contain significantestimates pertaining to work force reductions, and the settlement ofcontractual obligations resulting from our actions.  In Q2 2004, we revised our estimate tocomplete our remaining costs to develop and install any additional software, orsoftware modifications, with two customers and reversed approximately $1.2million of our reserve.  Although we donot anticipate any significant changes in the future, the actual costs maydiffer from these estimates.

 

**       Contingencies**

 

       We are subject to proceedings, lawsuits and other claims.  We are required to assess the likelihood ofany adverse judgments of outcomes to these matters as well as potential rangesof probable losses.  A determination ofthe amount or reserves required, if any, for these contingencies is made aftercareful analysis of each individual issue. The required reserves may change in the future due to new developmentsin each matter or changes in insurance coverage or approach such as change insettlement strategy.

 

**       IncomeTaxes**

 

       We recognize deferred tax assets or liabilities for theexpected future tax consequences of temporary differences between the book andtax basis of assets and liabilities.  Wereview our deferred tax assets for recoverability and establish a valuationallowance based on historical taxable income, projected future taxable incomeand the expected timing of the reversals of existing temporarydifferences.  As a result of ourcumulative net losses we have provided a full valuation allowance against ournet deferred tax assets.  In addition, weexpect to provide a full valuation allowance of any future tax benefits untilwe can sustain a level of profitability that demonstrates our ability toutilize these assets.

 

       RecentlyIssued Accounting Standards

 

       See “Recently Issued Accounting Standards”in Note 2 of the Condensed Consolidated Unaudited Financial Statements.

 

 

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**Item 3****.  Quantitative and Qualitative DisclosuresAbout Market Risk**

 

**       Interest Rate Risk**

 

Weinvest our cash in a variety of financial instruments.  These investments are denominated in U.S.dollars and maintained with nationally recognized financial institutions.

 

Investments in both fixed rate andfloating rate interest earning instruments carry a degree of interest raterisk.  Fixed rate securities may havetheir fair market value adversely impacted due to a rise in interest rates,while floating rate securities may produce less income than expected ifinterest rates fall.  Due in part tothese factors, our future investment income may fall short of expectations dueto changes in interest rates, or we may suffer losses in principal if forced tosell securities which have seen a decline in market value due to changes ininterest rates.  Our investmentsecurities are held for purposes other than trading.  At October 31, 2004, we did not hold anyfixed-rate investments.

 

We had no outstandingborrowings under our revolving credit agreement at October 31, 2004.  As described in Note 4 of our Notes toCondensed Consolidated Unaudited Financial Statements, the interest rate underthe revolving credit agreement is variable.

 

**       Foreign Currency Risk**

 

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

 

       An insignificant portion of our accountsreceivable balance at October 31, 2004 was denominated in a foreigncurrency.  Our exposure to adversemovements in foreign exchange rates is not significant.  Therefore, we do not currently hedge ourforeign currency exposure; however, we do try to limit our foreign currencyexposure by negotiating these foreign contracts in U.S. Dollars.  We will continue to evaluate the need toadopt a hedge strategy in the future and may implement a formal strategy if ourbusiness transacted in foreign currencies increases.

 

       Foreign exchange gains and losses were a$43,000 gain and a $161,000 gain for the three months ended October 31, 2004and 2003, respectively, and a $245,000 loss and a $114,000 gain for the ninemonths ended October 31, 2004 and 2003, respectively.

 

 

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**Item 4****.  Controls and Procedures**

 

*Disclosure Controls*

 

       We maintain disclosure controls and procedures designed toensure that we are able to collect the information we are required to disclosein the reports we file with the SEC, and to process, summarize and disclosethis information within the time periods specified in the rules of the SEC.

 

       Our management, under the supervision andwith the participation of our Chief Executive and Chief Financial Officers, isresponsible for evaluating the effectiveness of our disclosure controls andprocedures.  As of October 31, 2004, theycarried out an evaluation of our disclosure controls and procedures, and theChief Executive and Chief Financial Officers believe that these controls andprocedures are effective to ensure that we are able to collect, process anddisclose the information we are required to disclose in the reports we filewith the SEC within the required time periods.

 

       In designing and evaluating the disclosure controls andprocedures, management recognized that any controls and procedures, no matterhow 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.

 

*Internal Controls*

 

       There have been no changes in ourinternal control over financial reporting during our most recently completedfiscal quarter that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

 

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**PART II****:                OTHERINFORMATION**

 

**ITEM 1.          LEGALPROCEEDINGS**

 

       Except as noted below, the informationcontained in Part II, Item 1, Legal Proceedings in our Form 10-Q for the periodended July 31, 2004 and the information contained in Part I, Item 3. LegalProceedings in our Form 10-K for the period ended January 31, 2004 is herebyincorporated by reference.

 

       The Company and individual defendants deny the allegations inthe complaints referenced in the information incorporated herein by referenceand intend to defend themselves vigorously. It is not possible at this time to predict whether we will incur anyliability or to estimate the damages, or the range of damages, if any, that wemight incur in connection with such lawsuits. The ultimate resolution of such lawsuits could have a material adverseeffect on our business, results of operations, financial condition and cashflows.

 

       On September 16, 2004, the Court of Chancery of the State ofDelaware in and for New Castle County, by stipulation of all of the parties,dismissed the shareholders’ derivative action brought by Barbara I. Smith forthe benefit of Nominal Defendant Carreker Corporation against John D. Carreker,Jr., James D. Carreker, Richard R. Lee, Jr., James L. Fischer, Donald L. House,David K. Sias, Terry L. Gage, James R. Erwin, Ronald G. Steinhart, RonaldAntinori and Ernst & Young. As a result of this agreed upon dismissal, thederivative claims brought by Barbara I. Smith against the Company and the namedcurrent and former officers and directors are to be litigated in Civil ActionNo. 303CV1211-D in the United States District Court for the Northern Districtof Texas, Dallas Division, which was reinstated on June 15, 2004, as reportedin the Company’s Quarterly report on Form 10-Q for the period ended July 31,2004.

 

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

 

       None.

 

**ITEM 3.          DEFAULTSUPON SENIOR SECURITIES**

 

       None.

 

**ITEM 4.          SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

 

       None.

 

**ITEM 5.          OTHERINFORMATION**

 

       Fromtime to time management provides information regarding our contracted sales,potential sales and our backlog for contracted services, contracted contingentservices, contracted licenses and contracted maintenance.  Management also provides our expectationswith regard to the realization of revenue from such contracted sales, potentialsales and backlog.  These expectationscan be influenced by many factors, some of which are beyond our control, andinclude but are not limited to the following:

 

•                  Customer buying decisions and implementation timelines and schedules

•                  Customer budget cycles and priorities

•                  Our ability to develop new technologies and services in a timely manner

•                  Customer acceptance of our new technologies or services

•                  Receipt of cash payment

 

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**ITEM 6.         **EXHIBITS

 
| **Number** | ** ** | **Exhibit Description**                                                                                                  |
|------------|------------|--------------------------------------------------------------------------------------------------------------------------|
| 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**

 

Pursuantto the requirements of the Securities Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 

 
|   |                                               | CARREKER  CORPORATION |
|--------|----------------------------------------------------|-----------------------|
|   |                                               |                  |   |
| By:    | /s/  John D. Carreker, Jr.                         |                  | Date: | December 10, 2004 |
|   | John D. Carreker, Jr.                              |                  |   |
|   | Chairman of the Board and  Chief Executive Officer |                  |   |
|   |                                               |                  |   |
|   |                                               |                  |   |
| By:    | /s/  Lisa K. Peterson                              |                  | Date: | December 10, 2004 |
|   | Lisa K. Peterson                                   |                  |   |
|   | Chief Financial Officer                            |                  |   |
|   |                                               |                  |   |
|        |                                                    |                       |  |  |  |

 

 

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