**UnitedStatesSecurities and Exchange Commission**

**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, 2005.** |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|                                                                                                                                                       | **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**

 

**CarrekerCorporation**

(Exact name of registrant as specified in itscharter)

 
| **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 the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiods that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90days.  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

 

Indicate by check mark whether the registrantis a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  o    No  ý

 

Indicate the number of shares outstanding ofeach of the issuer’s classes of common stock, as of the latest practical date.

 

Common Stock, $.01 par value — 24,697,793shares as of November 30, 2005.

 

 

----

 

**CARREKER CORPORATION**

 

**Index**

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

 

2

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**PART I:  FINANCIALINFORMATION**

 

**Item 1.  FinancialStatements**

 

**CARREKER CORPORATION**

**Condensed Consolidated Balance Sheets(Unaudited)**

**(In thousands)**

 

**ASSETS**

 
| ** **                                                                                                                                        | ** ** | **October 31,  2005** | ** ** | **January 31,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                                                                        | ** ** | ** **            | ** ** | ** **            | ** ** |
| Current assets                                                                                                                                    |       |                  |       |                  |       |
| Cash and cash equivalents                                                                                                                         |       | $                     | 24,162     |                  | $          | 34,516 |   |
| Marketable securities                                                                                                                             |       | 4,500                 |       | —                |       |
| Accounts receivable, net of allowance of  $569 and $529 at October 31, 2005 and January 31, 2005, respectively                                    |       | 13,284                |       | 11,144                |       |
| Prepaid expenses and other current assets                                                                                                         |       | 3,060                 |       | 2,595                 |       |
| Total current assets                                                                                                                              |       | 45,006                |       | 48,255                |       |
|                                                                                                                                              |       |                  |       |                  |       |
| Property and equipment, net of accumulated  depreciation of $22,297 and $20,194 at October 31, 2005 and January 31, 2005,  respectively           |       | 6,022                 |       | 6,604                 |       |
| Capitalized software costs, net of  accumulated amortization of $13,313 and $12,426 at October 31, 2005 and  January 31, 2005, respectively       |       | 3,049                 |       | 3,245                 |       |
| Acquired developed technology, net of  accumulated amortization of $19,238 and $15,773 at October 31, 2005 and  January 31, 2005, respectively    |       | 6,462                 |       | 9,927                 |       |
| Goodwill, net of accumulated amortization  of $3,405 at October 31, 2005 and January 31, 2005                                                     |       | 20,765                |       | 20,765                |       |
| Customer relationships, net of accumulated  amortization of $6,183 and $5,133 at October 31, 2005 and January 31, 2005,  respectively             |       | 2,217                 |       | 3,267                 |       |
| Deferred loan costs, net of accumulated  amortization of $1,503 and $1,300 at October 31, 2005 and January 31, 2005,  respectively                |       | 204                   |       | 407                   |       |
| Other assets                                                                                                                                      |       | 804                   |       | 835                   |       |
| Total assets                                                                                                                                      |       | $                     | 84,529     |                  | $          | 93,305 |   |
|                                                                                                                                              |       |                  |       |                  |       |
| Current liabilities                                                                                                                               |       |                  |       |                  |       |
| Accounts payable                                                                                                                                  |       | $                     | 1,061      |                  | $          | 992 |   |
| Accrued compensation and benefits                                                                                                                 |       | 5,986                 |       | 7,818                 |       |
| Other accrued expenses                                                                                                                            |       | 3,928                 |       | 3,609                 |       |
| Income tax payable                                                                                                                                |       | 182                   |       | 339                   |       |
| Deferred revenue                                                                                                                                  |       | 16,960                |       | 22,181                |       |
| Accrued merger and restructuring costs                                                                                                            |       | 629                   |       | 1,004                 |       |
| Total current liabilities                                                                                                                         |       | 28,746                |       | 35,943                |       |
|                                                                                                                                              |       |                  |       |                  |       |
| Commitments and Contingencies                                                                                                                     |       |                  |       |                  |       |
|                                                                                                                                              |       |                  |       |                  |       |
| Stockholders’ equity                                                                                                                         |       |                  |       |                  |       |
| Preferred stock, $.01 par value: 2,000  shares authorized; no shares issued or outstanding                                                        |       | —                |       | —                |       |
| Common stock, $.01 par value: 100,000  shares authorized; 25,338 and 24,852 shares issued at October 31, 2005 and  January 31, 2005, respectively |       | 254                   |       | 249                   |       |
| Additional paid-in capital                                                                                                                        |       | 112,034               |       | 110,992               |       |
| Accumulated deficit                                                                                                                               |       | (53,274               | )          | (53,876               | )          |
| Less treasury stock, at cost                                                                                                                      |       | (3,231                | )          | (3                    | )          |
| Total stockholders’ equity                                                                                                                   |       | 55,783                |       | 57,362                |       |
| Total liabilities and stockholders’ equity                                                                                                   |       | $                     | 84,529     |                  | $          | 93,305 |   |

 

Seeaccompanying notes.

 

3

----

 

**CARREKER CORPORATION**

**Condensed Consolidated Statements of Operations**

**(Unaudited)**

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

 
| ** **                                                  | ** ** | **Three Months Ended  October 31,** | ** ** | **Nine Months Ended  October 31,** | ** ** |
|-------------------------------------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                                                  | ** ** | **2005**                            | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                  | ** ** | ** **                          | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Revenues:**                                               |       |                                |       |                               |       |   |   |   |   |
| Consulting                                                  |       | $                                   | 6,720      |                               | $          | 7,930 |   | $ | 24,540 |   | $ | 27,501 |   |
| Software license                                            |       | 5,322                               |       | 5,701                              |       | 12,463 |   | 16,134 |   |
| Software maintenance                                        |       | 10,822                              |       | 11,491                             |       | 32,710 |   | 32,807 |   |
| Software implementation and other services                  |       | 4,585                               |       | 4,622                              |       | 13,611 |   | 11,143 |   |
| Outsourcing service                                         |       | 220                                 |       | 50                                 |       | 718 |   | 60 |   |
| Out-of-pocket expense reimbursements                        |       | 701                                 |       | 813                                |       | 2,446 |   | 2,365 |   |
| Total revenues                                              |       | 28,370                              |       | 30,607                             |       | 86,488 |   | 90,010 |   |
|                                                        |       |                                |       |                               |       |   |   |   |   |
| **Cost of  revenues:**                                      |       |                                |       |                               |       |   |   |   |   |
| Consulting                                                  |       | 4,369                               |       | 4,555                              |       | 12,887 |   | 14,166 |   |
| Software license                                            |       | 2,155                               |       | 2,503                              |       | 5,519 |   | 5,771 |   |
| Software maintenance                                        |       | 3,588                               |       | 3,765                              |       | 10,999 |   | 10,949 |   |
| Software implementation and other services                  |       | 3,562                               |       | 4,002                              |       | 10,217 |   | 11,181 |   |
| Outsourcing service                                         |       | 424                                 |       | 222                                |       | 1,437 |   | 236 |   |
| Out-of-pocket expenses                                      |       | 701                                 |       | 738                                |       | 2,299 |   | 2,333 |   |
| Total cost of revenues                                      |       | 14,799                              |       | 15,785                             |       | 43,358 |   | 44,636 |   |
| Gross profit                                                |       | 13,571                              |       | 14,822                             |       | 43,130 |   | 45,374 |   |
|                                                        |       |                                |       |                               |       |   |   |   |   |
| **Operating  costs and expenses:**                          |       |                                |       |                               |       |   |   |   |   |
| Selling, general and administrative                         |       | 11,191                              |       | 11,320                             |       | 33,688 |   | 35,483 |   |
| Research and development                                    |       | 2,444                               |       | 2,520                              |       | 7,481 |   | 6,102 |   |
| Amortization of customer relationships                      |       | 350                                 |       | 350                                |       | 1,050 |   | 1,050 |   |
| Restructuring and other charges                             |       | 780                                 |       | 266                                |       | 903 |   | 2,978 |   |
| Total operating costs and expenses                          |       | 14,765                              |       | 14,456                             |       | 43,122 |   | 45,613 |   |
| Income  (loss) from operations                              |       | (1,194                              | )          | 366                                |       | 8 |   | (239 | ) |
|                                                        |       |                                |       |                               |       |   |   |   |   |
| **Other  income (expense):**                                |       |                                |       |                               |       |   |   |   |   |
| Interest income                                             |       | 185                                 |       | 92                                 |       | 495 |   | 207 |   |
| Interest expense                                            |       | (122                                | )          | (106                               | )          | (334 | ) | (336 | ) |
| Other income                                                |       | 283                                 |       | 275                                |       | 718 |   | 732 |   |
| Total other income, net                                     |       | 346                                 |       | 261                                |       | 879 |   | 603 |   |
| Income  (loss) before provision for income taxes            |       | (848                                | )          | 627                                |       | 887 |   | 364 |   |
| Provision for  income taxes                                 |       | 102                                 |       | 114                                |       | 285 |   | 464 |   |
| Net income  (loss)                                          |       | $                                   | (950       | )                                  | $          | 513 |   | $ | 602 |   | $ | (100 | ) |
| Basic  earnings (loss) per share                            |       | $                                   | (0.04      | )                                  | $          | 0.02 |   | $ | 0.03 |   | $ | 0.00 |   |
| Diluted  earnings (loss) per share                          |       | $                                   | (0.04      | )                                  | $          | 0.02 |   | $ | 0.03 |   | $ | 0.00 |   |
| Shares used  in computing basic earnings (loss) per share   |       | 23,906                              |       | 24,821                             |       | 24,152 |   | 24,623 |   |
| Shares used  in computing diluted earnings (loss) per share |       | 23,906                              |       | 25,589                             |       | 24,553 |   | 24,623 |   |

 

Seeaccompanying notes.

 

4

----

 

**CARREKER CORPORATION**

**Condensed Consolidated Statements of Stockholders’ Equity**

**(Unaudited)**

**(In thousands)**

 
| ** **                                                          | ** ** | ** **  | ** ** | ** **      | ** ** | **Additional**     | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | **Total**  | ** ** |
|---------------------------------------------------------------------|------------|-------------|------------|-----------------|------------|--------------------|------------|------------------------|------------|------------|------------|------------|------------|------------|------------|
| **Common Stock**                                                    | ** ** | **Paid-In** | ** ** | **Accumulated** | ** ** | **Treasury Stock** | ** ** | **Stockholders’** |
| ** **                                                          | ** ** | **Shares**  | ** ** | **Amount**      | ** ** | **Capital**        | ** ** | **Deficit**            | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Equity** | ** ** |
| Balance at January 31, 2005                                         |       | 24,852      |       | $               | 249        |               | $          | 110,992                |       | $          | (53,876    | )          | 1          |       | $          | (3 | ) | $ | 57,362 |   |
|                                                                |       |        |       |            |       |               |       |                   |       |       |       |       |       |       |       |
| Cancellation of restricted stock                                    |       | (5          | )          | —          |       | (12                | )          | —                 |       | —     |       | —     |       | (12        | )          |
| Compensation expense related to issuance of  restricted stock       |       | —      |       | —          |       | 140                |       | —                 |       | —     |       | —     |       | 140        |       |
| Issuance of shares of common stock upon  exercises of stock options |       | 10          |       | —          |       | 52                 |       | —                 |       | —     |       | —     |       | 52         |       |
| Common stock repurchases                                            |       | —      |       | —          |       | —             |       | —                 |       | 70         |       | (349       | )          | (349       | )          |
| Net income                                                          |       | —      |       | —          |       | —             |       | 498                    |       | —     |       | —     |       | 498        |       |
| Balance at April 30, 2005                                           |       | 24,857      |       | 249             |       | 111,172            |       | (53,378                | )          | 71         |       | (352       | )          | 57,691     |       |
|                                                                |       |        |       |            |       |               |       |                   |       |       |       |       |       |       |       |
| Cancellation of restricted stock                                    |       | (30         | )          | —          |       | (56                | )          | —                 |       | —     |       | —     |       | (56        | )          |
| Compensation expense related to issuance of  restricted stock       |       | 424         |       | 4               |       | 182                |       | —                 |       | —     |       | —     |       | 186        |       |
| Issuance of shares of common stock upon  exercises of stock options |       | 43          |       | —          |       | 214                |       | —                 |       | —     |       | —     |       | 214        |       |
| Restricted shares withheld for payroll  taxes                       |       | —      |       | —          |       | —             |       | —                 |       | 8          |       | (49        | )          | (49        | )          |
| Common stock repurchases                                            |       | —      |       | —          |       | —             |       | —                 |       | 560        |       | (2,824     | )          | (2,824     | )          |
| Net income                                                          |       | —      |       | —          |       | —             |       | 1,054                  |       | —     |       | —     |       | 1,054      |       |
| Balance at July 31, 2005                                            |       | 25,294      |       | 253             |       | 111,512            |       | (52,324                | )          | 639        |       | (3,225     | )          | 56,216     |       |
|                                                                |       |        |       |            |       |               |       |                   |       |       |       |       |       |       |       |
| Cancellation of restricted stock                                    |       | (13         | )          | —          |       | (7                 | )          | —                 |       | —     |       | —     |       | (7         | )          |
| Compensation expense related to issuance of  restricted stock       |       | —      |       | —          |       | 254                |       | —                 |       | —     |       | —     |       | 254        |       |
| Issuance of shares of common stock upon  exercises of stock options |       | 57          |       | 1               |       | 275                |       | —                 |       | —     |       | —     |       | 276        |       |
| Common stock repurchases                                            |       | —      |       | —          |       | —             |       | —                 |       | 1          |       | (6         | )          | (6         | )          |
| Net loss                                                            |       | —      |       | —          |       | —             |       | (950                   | )          | —     |       | —     |       | (950       | )          |
| Balance at October 31, 2005                                         |       | 25,338      |       | $               | 254        |               | $          | 112,034                |       | $          | (53,274    | )          | 640        |       | $          | (3,231 | ) | $ | 55,783 |   |

 

Seeaccompanying notes.

 

5

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**CARREKER CORPORATION**

**Condensed Consolidated Statements of Cash Flows**

**(Unaudited)**

**(In thousands)**

 
| ** **                                                                                | ** ** | **Three Months Ended  October 31,** | ** ** | **Nine Months Ended  October 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                | ** ** | **2005**                            | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Operating Activities:**                                                                 |       |                                |       |                               |       |   |   |   |   |
| Net income (loss)                                                                         |       | $                                   | (950       | )                                  | $          | 513 |   | 602 |   | (100 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by operating activities: |       |                                |       |                               |       |   |   |   |   |
| Depreciation and amortization of property  and equipment                                  |       | 793                                 |       | 826                                |       | 2,391 |   | 2,483 |   |
| Amortization of capitalized software costs                                                |       | 419                                 |       | 668                                |       | 887 |   | 1,146 |   |
| Amortization of acquired developed  technology                                            |       | 1,155                               |       | 1,155                              |       | 3,465 |   | 3,465 |   |
| Amortization of customer relationships                                                    |       | 350                                 |       | 350                                |       | 1,050 |   | 1,050 |   |
| Amortization of deferred loan costs                                                       |       | 68                                  |       | 67                                 |       | 203 |   | 204 |   |
| Compensation earned under restricted stock  plan                                          |       | 247                                 |       | 148                                |       | 505 |   | 324 |   |
| Minority share of loss in Carretek LLC                                                    |       | (269                                | )          | (234                               | )          | (799 | ) | (454 | ) |
| Non-cash charge for merger costs                                                          |       | —                              |       | —                             |       | (32 | ) | (1,215 | ) |
| Allowance for doubtful accounts                                                           |       | 95                                  |       | (275                               | )          | 54 |   | (667 | ) |
| Gain on sale of Cash Services Australia  Pty. Limited                                     |       | —                              |       | —                             |       | — |   | (539 | ) |
| Changes in operating assets and  liabilities:                                             |       |                                |       |                               |       |   |   |   |   |
| Accounts receivable                                                                       |       | 3,011                               |       | 3,571                              |       | (2,194 | ) | 10,468 |   |
| Prepaid expenses and other assets                                                         |       | (147                                | )          | 525                                |       | (456 | ) | 1,462 |   |
| Accounts payable and accrued expenses                                                     |       | 708                                 |       | (451                               | )          | (1,898 | ) | (2,729 | ) |
| Income taxes payable/receivable                                                           |       | 107                                 |       | 87                                 |       | (157 | ) | 41 |   |
| Deferred revenue                                                                          |       | (3,401                              | )          | (7,159                             | )          | (5,221 | ) | (7,665 | ) |
| Net cash provided by (used in) operating  activities                                      |       | 2,186                               |       | (209                               | )          | (1,600 | ) | 7,274 |   |
|                                                                                      |       |                                |       |                               |       |   |   |   |   |
| **Investing Activities:**                                                                 |       |                                |       |                               |       |   |   |   |   |
| Purchases of property and equipment                                                       |       | (523                                | )          | (1,346                             | )          | (1,809 | ) | (2,711 | ) |
| Purchases of marketable securities                                                        |       | —                              |       | —                             |       | (4,600 | ) | — |   |
| Sales of marketable securities                                                            |       | 100                                 |       | —                             |       | 100 |   | — |   |
| Computer software costs capitalized                                                       |       | —                              |       | (593                               | )          | (690 | ) | (2,201 | ) |
| Net cash used in investing activities                                                     |       | (423                                | )          | (1,939                             | )          | (6,999 | ) | (4,912 | ) |
|                                                                                      |       |                                |       |                               |       |   |   |   |   |
| **Financing Activities:**                                                                 |       |                                |       |                               |       |   |   |   |   |
| Payments on long-term debt                                                                |       | —                              |       | —                             |       | — |   | (6,250 | ) |
| Proceeds from exercises of stock options                                                  |       | 276                                 |       | 314                                |       | 542 |   | 1,638 |   |
| Purchase of treasury stock                                                                |       | (6                                  | )          | —                             |       | (3,228 | ) | — |   |
| Proceeds from minority shareholder equity  contributions to Carretek LLC                  |       | 380                                 |       | 172                                |       | 931 |   | 432 |   |
| Net cash provided by (used in) financing  activities                                      |       | 650                                 |       | 486                                |       | (1,755 | ) | (4,180 | ) |
| Net increase (decrease) in cash and cash  equivalents                                     |       | 2,413                               |       | (1,662                             | )          | (10,354 | ) | (1,818 | ) |
| Cash and cash equivalents at beginning of  period                                         |       | 21,749                              |       | 28,449                             |       | 34,516 |   | 28,605 |   |
| Cash and cash equivalents at end of period                                                |       | $                                   | 24,162     |                               | $          | 26,787 |   | $ | 24,162 |   | $ | 26,787 |   |
|                                                                                      |       |                                |       |                               |       |   |   |   |   |
| Supplemental disclosures of cash flow  information:                                       |       |                                |       |                               |       |   |   |   |   |
| Cash paid for interest                                                                    |       | $                                   | 39         |                               | $          | 38 |   | $ | 115 |   | $ | 147 |   |
| Cash paid for income taxes, net                                                           |       | $                                   | 16         |                               | $          | 11 |   | $ | 443 |   | $ | 393 |   |

 

Seeaccompanying notes.

 

6

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**Carreker Corporation**

**Notes to Condensed Consolidated Unaudited FinancialStatementsFor the Three and Nine Months Ended October 31, 2005 and 2004**

 

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

 

CarrekerCorporation (“the Company,” “Carreker,” “our,” “we”) provides payments-relatedsoftware, consulting and business process outsourcing solutions to financialinstitutions and financial service providers. These solutions help the Company’s customers set winning strategies intheir payments businesses; improve operational efficiency in how payments areprocessed; enhance revenue and profitability from payments-oriented productsand services; reduce losses associated with fraudulent payment transactions;and/or improve the alignment of product offerings with customer needs.

 

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

 

**Principles of Consolidation and Presentation**

 

The condensed consolidatedunaudited financial statements include the accounts of the Company and itswholly owned subsidiaries. All significant intercompany balances andtransactions have been eliminated in consolidation.

 

The consolidated financialstatements also reflect the operations of Carretek LLC, which is a 51% ownedsubsidiary.  The minority interest andminority share of net loss of Carretek LLC represent the 49% minority stockholder’sinvestment and share of the loss of this consolidated subsidiary.

 

The accompanying condensedconsolidated unaudited financial statements and notes have been prepared inaccordance with the rules and regulations of the Securities and ExchangeCommission for Form 10-Q and include all of the information and disclosuresrequired by generally accepted accounting principles for interim financialreporting.  The accompanying financialstatements reflect all adjustments (consisting of normal recurring entries)which in the opinion of management are necessary for a fair presentation of theresults for the interim periods presented. The results of operations for the three and nine months ended October31, 2005 are not necessarily indicative of full-year results.

 

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

 

**Cash and Cash Equivalents**

 

The Company considers allhighly liquid investments with original maturities of three months or less whenpurchased to be cash equivalents.  Cashand cash equivalents consist primarily of demand deposit accounts and demandmoney market accounts with nationally recognized financial institutions, alongwith domestic commercial paper.

 

**MarketableSecurities**

 

We classify our investmentsin marketable securities as “available-for-sale” in accordance with theprovisions of Statement of Financial Accounting Standards No. 115, *“Accounting for Certain Investments in Debt andEquity Securities”* (“SFAS 115”). We currently have no investments that we intend to hold for more thanone year and therefore all investments are classified as short terminvestments.

 

Available-for-salesecurities are carried at fair value with the unrealized gain or loss, net oftax, reported in other comprehensive income. Held-to-maturity securities are recorded at amortized cost.  Unrealized losses considered to be“other-than-temporary” are recognized currently in earnings.  The cost of securities sold is based on thespecific identification method.  The fairvalue of most investment securities is determined by currently available marketprices.  Where quoted market prices arenot available, we use the market price of similar types of securities that aretraded in the market to estimate fair value.

 

7

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The cost, gross unrealizedgains (losses) and fair value of our available-for-sale securities by majorsecurity type at October 31, 2005 is as follows (in thousands):

 
| ** **                                      | ** ** | **Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|-------------------------------------------------|------------|----------|------------|------------------------------|------------|-------------------------------|------------|----------------|------------|
|                                            |       |     |       |                         |       |                          |       |           |       |
| Available  for sale:                            |       |     |       |                         |       |                          |       |           |       |
| Corporate debt securities                       |       | $        | 700        |                         | $          | —                        |       | $              | —     |   | $ | 700 |   |
| Guaranteed student loan backed debt  securities |       | 3,800    |       | —                       |       | —                        |       | 3,800          |       |
|                                            |       |     |       |                         |       |                          |       |           |       |
| Total  available for sale                       |       | $        | 4,500      |                         | $          | —                        |       | $              | —     |   | $ | 4,500 |   |
|                                                 |            |          |            |                              |            |                               |            |                |            |  |  |  |  |  |

 

Currently all originalmaturities of debt securities classified as available for sale at October 31,2005 were due after 10 years.  All thedebt securities are auction rate notes and the interest rate for theseinvestments will adjust to current market rates at each interest reset date,which is typically on at least a monthly basis.

 

**Comprehensive Income**

 

The Company has no othercomprehensive income; accordingly, comprehensive income is the same as netincome for all periods presented.

 

**Foreign Currency Translation**

 

The Company considers theU.S. Dollar to be the functional currency for its internationalsubsidiaries.  All remeasurementadjustments are recorded in the consolidated statements of operations.

 

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

 

Financial instruments whichpotentially subject the Company to concentration of credit risk consistprincipally of temporary cash investments such as short term commercial paperand marketable debt securities along with accounts receivable.  The Company places temporary cash investmentswith major banks and limits its exposure with any one financial institution, orcommercial or municipal issuer.  TheCompany has not experienced any material credit losses on these investments.

 

A significant portion of theCompany’s business consists of providing consulting services and licensingsoftware to major domestic and international banks, which gives rise to aconcentration of credit risk in receivables. Because the Company’s accounts receivable are typically unsecured, theCompany periodically evaluates the collectibility of its accounts based on acombination of factors, including a particular customer’s ability to pay aswell as the age of receivables.  In caseswhere the evidence suggests a customer may not be able to satisfy itsobligation to the Company or if the collection of the receivable becomesdoubtful due to a dispute that arises subsequent to the delivery of theCompany’s products and services, the Company sets up a reserve in an amountdetermined appropriate for the perceived risk. Most of the Company’s contracts include multiple payment milestones,some of which occur in advance of revenue recognition, which mitigates the riskboth in terms of collectibility and adjustments to recorded revenue.  The Company had a recovery of a receivablepreviously written off of $28,000 during the three months ended October 31,2005.  Write-offs of receivables duringthe three months ended October 31, 2004 were $45,000.  Write-offs of receivables during the ninemonths ended October 31, 2005 and 2004 were $14,000 and $179,000, respectively.

 

The fair value of accountsreceivable approximates the carrying amount of accounts receivable.

 

8

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Gross accounts receivableincludes both amounts billed to customers and unbilled customer accountsreceivable.  Accounts receivable, net ofrelated deferred revenue and allowances, consist of the following (inthousands):

 
| ** **                            | ** ** | **October 31,  2005** | ** ** | **January 31,  2005** | ** ** |
|---------------------------------------|------------|-----------------------|------------|-----------------------|------------|
|                                  |       |                  |       |                  |       |
| Gross  accounts receivable            |       | $                     | 34,191     |                  | $          | 47,000 |   |
| Less related  deferred revenue        |       | (20,338               | )          | (35,327               | )          |
| Less  allowance for doubtful accounts |       | (569                  | )          | (529                  | )          |
| Net accounts  receivable              |       | $                     | 13,284     |                  | $          | 11,144 |   |

 

**Property and Equipment**

 

Property and equipment arestated at cost. Depreciation is calculated using the straight-line method overthe estimated useful lives of the respective assets, generally from two to fiveyears. Leasehold improvements are amortized using the straight-line method overthe shorter of the terms of the related leases or the respective useful livesof the assets.

 

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

 

The components of propertyand equipment are as follows (in thousands):

 
| ** **                                      | ** ** | **October 31,  2005** | ** ** | **January 31,  2005** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | ** **            | ** ** | ** **            | ** ** |
| Furniture                                       |       | $                     | 5,070      |                  | $          | 5,069 |   |
| Equipment  and software                         |       | 21,965                |       | 20,446                |       |
| Leasehold  improvements                         |       | 1,284                 |       | 1,283                 |       |
| Total cost                                      |       | 28,319                |       | 26,798                |       |
|                                            |       |                  |       |                  |       |
| Less  accumulated depreciation and amortization |       | (22,297               | )          | (20,194               | )          |
| Net property and equipment                      |       | $                     | 6,022      |                  | $          | 6,604 |   |

 

**Long Lived Assets**

 

The Company accounts forgoodwill and other intangible assets in accordance with Statement of FinancialAccounting Standards No. 142, *“Goodwill andOther Intangible Assets,”* (“SFAS 142”).  Under the provisions of SFAS 142, an annualassessment of goodwill impairment is performed. This assessment involves the use of estimates related to fair marketvalues of the Company’s reporting units with which the goodwill isassociated.  The assessment of goodwillimpairment in the future will be impacted if future operating cash flows of theCompany’s reporting units decline significantly, which could result indecreases in the related estimate of fair market value.  The Company performs its annual impairmentanalysis as of November 1st of each year and whenever facts andcircumstances indicate impairment may exist.

 

The Company accounts forlong lived assets in accordance with Statement of Financial AccountingStandards No. 144, *“Accounting for theImpairment or Disposal of Long-Lived Assets”* (“SFAS 144”).  Under the provisions of SFAS 144, long-livedassets, such as property, plant and equipment and purchased intangibles subjectto amortization, are tested for recoverability whenever events or changes incircumstances indicate that the carrying amount of an asset may not berecoverable.  Recoverability of assets tobe held and used is measured by a comparison of the carrying amount of an assetto estimated undiscounted future cash flows expected to be generated by theasset.  If the carrying amount of anasset exceeds its estimated future cash flows, an impairment charge isrecognized by the amount by which the carrying amount of the assets exceeds thefair value of the asset.

 

9

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**Deferred Loan Costs**

 

Deferred loan costs consistof loan closing costs and other administrative expenses associated with theRevolving Credit Agreement.  These costsare being amortized to interest expense over the 36 month life of the RevolvingCredit Agreement.

 

**Capitalized Software Costs and Acquired Developed Technology**

 

The Company capitalizes thedevelopment costs of software, other than internal-use software, in accordancewith Statement of Financial Accounting Standards No. 86, *“Accounting for Costs of Computer Software to beSold, Leased or Otherwise Marketed”* (“SFAS 86”).  The Company’s policy is to capitalizesoftware development costs incurred in developing a product once technologicalfeasibility of the product has been established. Technological feasibility ofthe product is determined after completion of a detailed program design and adetermination has been made that any uncertainties related to high-riskdevelopment issues have been resolved. If the process of developing the productdoes not include a detail program design, technological feasibility is determinedonly after completion of a working model. All capitalized software developmentcosts are amortized using an amount determined as the greater of: (1) the ratiothat current gross revenues for a capitalized software project bears to thetotal of current and estimated future gross revenues for that project or (2)the straight-line method over the estimated remaining economic life of theproduct (generally three to five years). The Company capitalized $0 and$593,000 in the three months ended October 31, 2005 and 2004,respectively.  The Company capitalized$690,000 and $2.2 million in the nine months ended October 31, 2005 and 2004,respectively.  The Company developed softwarefor sending and receiving check images, and has developed software for distributedcapture of checks and check images and extending the functionality of itsanti-money laundering software and other Risk solutions.  The Company has also recently completed thedevelopment of a product to verify cash logistic invoices with automatedprecision and an internet-based track and trace system that streamlines thecash delivery management process.

 

The Company recordedamortization relating to software development costs capitalized of $420,000 and$668,000 in the three months ended October 31, 2005 and 2004,respectively.  The Company recordedamortization relating to software development costs capitalized of $888,000 and$1.1 million in the nine months ended October 31, 2005 and 2004, respectively.  Amortization expense is recorded as a componentof cost of software license fees in the accompanying consolidated statements ofoperations.

 

Acquired developedtechnology includes purchased technology intangible assets associated withacquisitions.  These purchased technologyintangibles are initially recorded based on the fair value ascribed at the timeof acquisition.

 

Acquired developedtechnology with a useful life of 3-6 years is amortized on a straight-linebasis, resulting in amortization expense of $1.2 million for the three monthsended October 31, 2005 and 2004, respectively, and $3.5 million for the ninemonths ended October 31, 2005 and 2004. Amortization expense is recorded as a component of cost of softwarelicense fees in the accompanying consolidated statements of operations.

 

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

 
| **Year**           | ** ** | **Capitalized  Software  Costs** | ** ** | **Acquired  Developed  Technology** | ** ** |
|--------------------|------------|----------------------------------|------------|-------------------------------------|------------|
| Remainder of  2006 |       | $                                | 306        |                                | $          | 1,155 |   |
| 2007               |       | 1,223                            |       | 4,107                               |       |
| 2008               |       | 885                              |       | 1,200                               |       |
| 2009               |       | 327                              |       | —                              |       |
|                    |            |                                  |            |                                     |            |  |  |

 

The table does not includethe estimated amortization expense for $308,000 of capitalized softwareproducts that are currently being developed, and for which amortization has notcommenced.

 

10

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The Company continuallymonitors the net realizable value of software capitalized and acquireddeveloped technology for factors that would indicate impairment such as adecline in demand or a loss of a significant customer.  During the quarterly period ended January 31,2005, the Company performed its annual formal evaluation for impairment anddetermined that the carrying amount of these assets was not impaired and hassubsequently noted no factors that would indicate impairment.

 

**Revenue Recognition**

 

The Company’s revenuerecognition policies are in accordance with Statement of Position (“SOP”) 97-2,*“Software Revenue Recognition,”*as amended by SOP 98-9, “*Modification of SOP97-2,**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, *“Accountingfor Performance of Construction–Type and Certain Production–Type Contracts.”*

 

In the case of non-softwarearrangements, we apply EITF No. 00-21 and revenues related to arrangements withmultiple elements are allocated to each element based on the element’s relativefair value.  Revenue allocated toseparate elements is recognized for each element in accordance with ouraccounting policies described below.  Ifwe cannot account for items included in a multiple-element arrangement asseparate units of accounting, they are combined and accounted for as a singleunit of accounting and generally recognized as the undelivered items orservices are provided to the customer.

 

*Consulting.*  The Company employs threeprimary pricing methods in connection with its delivery of consulting services.First, the Company may price its 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 this case, theCompany is generally paid fees and related amounts usually on a monthly basis,and the Company recognizes revenues as the services are performed. Second, theCompany may deliver consulting services on a fixed-price basis. In this case,the Company is paid on a monthly basis or pursuant to an agreed upon paymentschedule, and the Company recognizes revenues on a proportionate performancebasis.  The Company believes that thismethod is appropriate because of its ability to determine performancemilestones and determine dependable estimates of its costs applicable to eachphase of a contract.  Because financialreporting of these contracts depends on estimates, which are assessed continuallyduring the term of the contract, costs are subject to revisions as the contractprogresses.  Anticipated losses onfixed-price contracts are recognized when estimable.  Third, the Company may deliver consultingservices pursuant to a value-priced contract with the customer. In this case,the Company is paid, on an agreed upon basis with the customer, either aspecified percentage of (1) the projected increased revenues and/ordecreased costs that are expected to be derived by the customer generally overa period of up to twelve months following implementation of its solution or (2)the actual increased revenues and/or decreased costs experienced by thecustomer generally over a period of up to twelve months followingimplementation of its solution, subject in either case to a maximum, if any isagreed to, on the total amount of payments to be made to the Company.  The Company must first commit time andresources to develop projections associated with value-pricing contracts beforea customer will commit to purchase its solutions, and the Company thereforeassumes the risk of making these commitments with no assurance that thecustomer will purchase the solution. Costs associated with these value-pricing contracts are expensed asincurred.  These contracts typicallyinclude payments to be made to the Company pursuant to an agreed upon scheduleranging from one to twelve months in length. The Company recognizes revenues generated from consulting services inconnection with value-priced contracts based upon projected results only uponcompletion of all services and agreement upon the actual fee to be paid (eventhough 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 services with payments to the Company, theCompany on occasion, may offer payment terms which extend beyond 12months.  When the Company enters into anagreement which has a significant component of the total amount payable underthe agreement due beyond 12 months or if it is determined payments are notfixed and determinable at the date the agreement was entered into, revenueunder the arrangement will be recognized as payments become due and payable.  When fees are to be paid based on apercentage of actual revenues and/or savings to customers, the Companyrecognizes revenues only upon completion of all services and as the amounts ofactual revenues or savings are confirmed by the customer with a fixed paymentdate.

 

Costs associated with timeand materials, fixed-priced and value-priced consulting fee arrangements areexpensed as incurred and are included as a component of the cost of consultingfees.

 

11

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The Company expects thatvalue-pricing contracts will continue to account for a significant portion ofits revenues in the future. As a consequence of the use of value-pricingcontracts and due to the revenue recognition policy associated with thosecontracts, the Company’s results of operations will likely fluctuatesignificantly from period to period.

 

Regardless of the pricingmethod employed by the Company in a given contract, the Company is typicallyreimbursed on a monthly basis for out-of-pocket expenses incurred on behalf ofits customers.

 

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

 

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

 

Software licenses are oftensold as part of a multiple element arrangement that may include maintenance,implementation or consulting.  TheCompany determines whether there is vendor specific objective evidence of fairvalue (“VSOEFV”) for each element identified in the arrangement to determinewhether the total arrangement fees can be allocated to each element.  If VSOEFV exists for each element, the totalarrangement fee is allocated based on the relative fair value of each element.  In cases where there is not VSOEFV for eachelement, or if it is determined services are essential to the functionality ofthe software being delivered, or if significant production, modification orcustomization of the software is required, the Company initially defers revenuerecognition of the software license fees until VSOEFV is established or theservices are performed.  However, ifVSOEFV is determinable for all of the undelivered elements, and assuming theundelivered elements are not essential to the delivered elements, the Companywill defer recognition of the full fair value related to the undeliveredelements and recognize the remaining portion of the arrangement value throughapplication of the residual method. Where VSOEFV has not been established for certain undelivered elements,revenue for all elements is deferred until those elements have been deliveredor their fair values have been determined. Evidence of VSOEFV is determined for software products based on actualsales prices for the product sold to a similar class of customer and based onpricing strategies set forth in the Company’s price book.  Evidence of VSOEFV for services(implementation and consulting) is based upon standard billing rates and theestimated level of effort for individuals expected to perform the related services.  The Company establishes VSOEFV formaintenance 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 allof the Company’s current software licenses provide for a fixed price licensefee, some licenses instead provide for the customer to pay a monthly licensefee 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.*  Inconnection with the sale of a software license, a customer may elect topurchase software maintenance services. Most of the customers that purchasesoftware licenses from the Company also purchase software maintenance services,which typically are renewed annually. The Company charges an annual maintenance fee, which is typically apercentage of the initial software license fee. The annual maintenance feegenerally is paid to the Company at the beginning of the maintenance period,and the Company recognizes these revenues ratably over the term of the relatedcontract.  If the annual maintenance feeis not paid at the beginning of the maintenance period, the Company defersrevenue recognition until the time that the maintenance fee is paid by thecustomer.  The Company normally continuesto provide maintenance service while awaiting payment from customers.  When the payment is received, revenue isrecognized for the period that revenue was previously deferred.  This may result in volatility in softwaremaintenance revenue from period to period.

 

12

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*Software Implementation and Other Services.*  Inconnection with the sale of a software license, a customer may elect topurchase software implementation services, including software enhancements andother software services. Most of the customers that purchase software licensesfrom the Company also purchase software implementation services.  The Company prices its implementationservices on a time-and-materials or on a fixed-price basis, and the Companyrecognizes the related revenues as services are performed.  Costs associated with these engagements areexpensed as incurred.

 

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

 

*Return Provisions.*  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 softwarelicense, maintenance, and consulting agreements, entered into with certainbanks and purchase agreements with vendors under which the Company acquiredsoftware technology used in products sold to its customers, the Company isrequired to pay royalties on sales of certain software products.  Under these arrangements, the Companyrecognizes royalty expense when the associated revenue is recognized.  For current product offerings, the royaltypercentages generally range from 20% to 50% of the associated revenues.  Approximately $665,000 and $685,000 ofroyalty expense was recorded under these agreements in the three months endedOctober 31, 2005 and 2004, respectively, and $1.4 million of royalty expensewas recorded under these agreements in the nine months ended October 31, 2005and 2004.  Royalty expense is included asa component of the cost of consulting fees, cost of software license fees andcost of software maintenance fees in the accompanying consolidated statementsof operations.

 

**Deferred Revenue**

 

Deferred revenue representsamounts paid by customers under terms specified in consulting, softwarelicensing, and maintenance contracts for which completion of contractual termsor delivery of the software has not occurred.

 

Deferred revenue consists ofthe following (in thousands):

 
| ** **                                         | ** ** | **October 31,  2005** | ** ** | **January 31,  2005** | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
|                                               |       |                  |       |                  |       |
| Deferred  software maintenance fees                |       | $                     | 20,585     |                  | $          | 33,850 |   |
| Deferred  software implementation and license fees |       | 16,713                |       | 23,658                |       |
|                                               |       | 37,298                |       | 57,508                |       |
| Less amounts  not yet collected                    |       | (20,338               | )          | (35,327               | )          |
| Net deferred  revenue                              |       | $                     | 16,960     |                  | $          | 22,181 |   |

 

**Research and Development Costs**

 

Research and developmentcosts which are not subject to capitalization under Statement of FinancialAccounting Standards No. 86, *“Accounting forthe Cost of Computer Software to be Sold, Leased, or Otherwise Marketed”*(“SFAS 86”), are expensed as incurred and relate mainly to the development ofnew products, new applications, new features or enhancements for existingproducts or applications.  Sustainingmaintenance activities are expensed as incurred and charged to cost of revenues— software maintenance fees.

 

13

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**Other income (expense)**

 

Other income (expense) iscomprised of the following (in thousands):

 
| ** **                                              | ** ** | **Three Months Ended  October 31,** | ** ** | **Nine Months Ended  October 31,** | ** ** |
|---------------------------------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                                              | ** ** | **2005**                            | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                    |       |                                |       |                               |       |   |   |   |   |
| Gain on sale of Cash Services Australia  Pty. Limited   |       | $                                   | —     |                               | $          | — |   | $ | — |   | $ | 539 |   |
| Equity in loss of Cash Services Australia  Pty. Limited |       | —                              |       | —                             |       | — |   | (17 | ) |
| Minority share of net loss of Carretek LLC              |       | 269                                 |       | 234                                |       | 799 |   | 454 |   |
| Foreign exchange (losses) / gains                       |       | 12                                  |       | 43                                 |       | (89 | ) | (245 | ) |
| Other                                                   |       | 2                                   |       | (2                                 | )          | 8 |   | 1 |   |
| Total                                                   |       | $                                   | 283        |                               | $          | 275 |   | $ | 718 |   | $ | 732 |   |

 

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

 

The Company owns a 51%interest in Carretek LLC (“Carretek”), which offers financial institutionsoffshore-centric outsourcing of their business processes.  The minority interest in this loss wasrecorded in other income (expense) and was $269,000 and $234,000 for the threemonths ended October 31, 2005 and 2004, respectively, and $799,000 and $454,000for the nine months ended October 31, 2005 and 2004.

 

**Income Taxes**

 

The Company accounts forincome taxes using the liability method, whereby deferred tax assets andliabilities are determined based on differences between financial reporting andthe tax basis of assets and liabilities measured using enacted tax rates andlaws that will be in effect when the differences are expected to reverse.  The measurement of deferred tax assets isadjusted by a valuation allowance, if necessary, to recognize the extent towhich, based on available evidence, it is more likely than not that the futuretax benefits will not be realized.

 

**Earnings Per Share**

 

Basic earnings per share iscomputed using the weighted average number of shares of common stockoutstanding during each period. Diluted earnings per share is computed usingthe weighted average number of shares of common stock outstanding during eachperiod and common equivalent shares consisting of stock options and unvestedrestricted stock (using the treasury stock method), if such stock options andunvested restricted stock have a dilutive effect.

 

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**Stock-Based Compensation**

 

The Company has elected tofollow Accounting Principles Board (“APB”) Opinion No. 25, “*Accounting for Stock Issued to Employees*,”in accounting for its employee and director stock options.  Under APB 25, if the exercise price of astock option equals or exceeds the market price of the underlying stock on thedate of grant, no compensation expense is recognized.  In October 1995, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards(“SFAS”) 123, *“Accounting for Stock-BasedCompensation.”*  SFAS 123allows the Company to continue to follow the present APB Opinion 25 guidelines,but requires pro-forma disclosures of net income and earnings per share as ifthe Company had adopted the provisions of the Statement.  In December 2002, the FASB issued SFAS 148, *“Accounting for Stock-Based Compensation – Transitionand Disclosure - an Amendment of FASB Statement No.123,”* which providesalternative methods of transition for an entity that voluntarily changes to thefair value based method of accounting for stock-based employeecompensation.  The Company continues toaccount for stock-based compensation under the provisions of APB Opinion 25using the intrinsic value method.

 

The stock compensationexpense recorded under the intrinsic value method is primarily the result ofrestricted common stock issued to employees and officers.  The Company is amortizing the compensationexpense on a straight line basis over the period that the restrictions on thecommon stock lapse.

 

The Company recorded$247,000 and $148,000 of compensation expense during the three months endedOctober 31, 2005 and 2004, respectively, and $505,000 and $324,000 during thenine months ended October 31, 2005 and 2004, respectively.  As of October 31, 2005, 754,168 unvestedrestricted common shares remain outstanding.

 

Had compensation cost forstock-based compensation plans been determined based on the fair value at thegrant dates for awards under those plans in accordance with the provisions ofSFAS 123, net income (loss) and net income (loss) per share would have been asfollows (in thousands, except per share data):

 
| ** **                                                                 | ** ** | **Three Months Ended  October 31,** | ** ** | **Nine Months Ended  October 31,** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                                                                 | ** ** | **2005**                            | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                       |       |                                |       |                               |       |   |   |   |   |
| Net income (loss), as reported                                             |       | $                                   | (950       | )                                  | $          | 513 |   | $ | 602 |   | $ | (100 | ) |
| Stock compensation expense recorded under  the intrinsic value method      |       | 247                                 |       | 148                                |       | 505 |   | 324 |   |
| Pro forma stock compensation expense  computed under the fair value method |       | (1,097                              | )          | (1,493                             | )          | (2,891 | ) | (3,914 | ) |
| Pro forma net loss                                                         |       | $                                   | (1,800     | )                                  | $          | (832 | ) | $ | (1,784 | ) | $ | (3,690 | ) |
|                                                                       |       |                                |       |                               |       |   |   |   |   |
| Basic earnings (loss) per common share, as  reported                       |       | $                                   | (0.04      | )                                  | $          | 0.02 |   | $ | 0.03 |   | $ | 0.00 |   |
| Diluted earnings (loss) per common share,  as reported                     |       | $                                   | (0.04      | )                                  | $          | 0.02 |   | $ | 0.03 |   | $ | 0.00 |   |
| Pro forma basic loss per common share                                      |       | $                                   | (0.08      | )                                  | $          | (0.03 | ) | $ | (0.07 | ) | $ | (0.15 | ) |
| Pro forma diluted loss per common share                                    |       | $                                   | (0.08      | )                                  | $          | (0.03 | ) | $ | (0.07 | ) | $ | (0.15 | ) |

 

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

 
| ** **                                      | ** ** | **Three Months Ended  October 31,** | ** ** | **Nine Months Ended  October 31,** | ** ** |
|-------------------------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                                      | ** ** | **2005**                            | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                            |       |                                |       |                               |       |   |   |   |   |
| Volatility                                      |       | 0.904                               |       | 0.746                              |       | 0.857 |   | 0.794 |   |
| Weighted-average expected lives                 |       | 5.000                               |       | 4.500                              |       | 4.300 |   | 4.500 |   |
| Expected dividend yields                        |       | —                              |       | —                             |       | — |   | — |   |
| Weighted-average risk-free interest rates       |       | 4.00                                | %          | 4.25                               | %          | 3.94 | % | 3.93 | % |
| Weighted-average fair value of options  granted |       | $                                   | 4.63       |                               | $          | 5.62 |   | $ | 3.93 |   | $ | 5.93 |   |
|                                                 |            |                                     |            |                                    |            |  |  |  |  |  |  |  |  |

 

15

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**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, rapid technological change and dependence on newproducts, focus on providing business process outsourcing with significantoffshore component, ability to attract and retain qualified personnel, customerconcentration, competition, proprietary rights, infringement claims, dependenceon third parties for technology licenses, liability claims, our ability toprotect our information technology infrastructure, international operations,changing government and tax regulations, stock price fluctuations, impairmentof goodwill or intangible assets, realization of revenue from contracted sales,potential sales and backlog, changes in the accounting treatment of stockoptions and other share-based compensation and pending class action andshareholder derivative lawsuits.

 

**Financial Guarantees**

 

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

 

Under the terms of themajority of the Company’s software license agreements with its customers, theCompany agrees that in the event the software sold infringes upon any patent,copyright, trademark, or any other proprietary right of a third party, it willindemnify its customer licensee against any loss, expense, or liability fromany damages that may be awarded against its customer.  The Company includes this infringementindemnification in most 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 generally terminatethe license 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 thisindemnification, as it is not aware of any pending or threatened infringementactions that are probable losses.  TheCompany believes the estimated fair value of these intellectual property indemnificationclauses is minimal.

 

The Company has agreed toindemnify members of the board of directors, officers and certain key employeesof the Company if they are made a party or are threatened to be made a party toany proceeding by reason of the fact that they are acting in their capacitieson behalf of the Company, or by reason of anything done or not done by them inany such capacities.  The indemnity isfor any and all expenses and liabilities of any type whatsoever (including butnot limited to, judgments, fines and amounts paid in settlement) actually andreasonably incurred by the directors, officers and key employees in connectionwith the investigation, defense, settlement or appeal of such proceeding,provided they acted in good faith.  The Companymaintains insurance coverage for directors and officers liability (“D&Oinsurance”).  No maximum liability isstipulated in these agreements that include indemnifications of members of theboard of directors, officers and certain key employees of the Company.  The Company has recorded no liabilityassociated with these indemnifications as it is not aware of any pending orthreatened actions or claims against the members of its board of directors orofficers that are probable losses in excess of amounts covered by its D&Oinsurance.  As a result of the insurancepolicy coverage, the Company believes the estimated fair value of theseindemnification agreements is minimal.

 

16

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**Recently Issued Accounting Standards**

 

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

 

•                  A “modified prospective” method in whichcompensation cost is recognized beginning with the effective date (a) based onthe requirements of SFAS No. 123 (R) for all share-based payments granted afterthe effective date and (b) based on the requirements of SFAS No. 123 for allawards granted to employees prior to the effective date of SFAS No. 123 (R)that remain unvested on the effective date.

 

•                  A “modified retrospective” method whichincludes the requirements of the modified prospective method described above,but also permits entities to restate based on the amounts previously recognizedunder SFAS No. 123 for purposes of pro forma disclosures either (a) all priorperiods presented or (b) prior interim periods of the year of adoption.

 

The Company expects toimplement the modified prospective method as described above.

 

As permitted by SFAS No.123, the Company currently accounts for share-based payments to employees usingthe APB No. 25 intrinsic value method and, as such, generally recognizes nocompensation cost for employee stock options. Accordingly, the adoption of SFAS No. 123 (R)’s fair value method willhave a significant impact on our results of operations, although it will haveno impact on our overall financial position and cash flows.  Had we adopted SFAS No. 123 (R) in priorperiods, the impact of that standard would have approximated the impact of SFASNo. 123 as described in the disclosure of pro forma net income and earnings pershare contained in Note 2 above under the caption *Stock Based Compensation*. Statement No. 123 (R) also requires the benefits of tax deductions inexcess of recognized compensation cost to be reported as a financing cash flow,rather than as an operating cash flow. This requirement currently does not have an effect on the Company as allof our deferred tax benefits are fully reserved with a valuation allowance.

 

As of October 31, 2005, theexpense related to unvested options granted to date is as follows for theindicated fiscal years ending January 31, (in thousands):

 
| **Year** | ** ** | **Amount** | ** ** |
|----------|------------|------------|------------|
|     |       |       |       |
| 2007     |       | $          | 2,138      |   |
| 2008     |       | 999        |       |
| 2009     |       | 404        |       |
| 2010     |       | 85         |       |
|          |            |            |            |  |

 

The Company is consideringaccelerating the vesting of a portion of the outstanding options in the yearending January 31, 2006 to reduce the stock option related expense in futureyears.

 

17

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

 

Goodwill and intangibleassets deemed to have indefinite lives are no longer amortized but are subjectto annual impairment tests.  Otherintangible assets, which include acquired developed technology and customerrelationships, are amortized over their estimated useful lives.

 

Customer relationships withfinite useful lives are amortized on a straight-line basis, which resulted inamortization expense of $350,000 during the three months ended October 31, 2005and 2004 and $1.1 million during the nine months ended October 31, 2005 and2004.

 

The following table setsforth the estimated amortization expense of customer relationships for theindicated fiscal years ending January 31 (in thousands):

 
| **Year**           | ** ** | **Amount** | ** ** |
|--------------------|------------|------------|------------|
| Remainder of  2006 |       | $          | 350        |   |
| 2007               |       | 1,400      |       |
| 2008               |       | 467        |       |
|                    |            |            |            |  |

 

**4.****             ****Revolving Credit Agreement**

 

The Company is a party to arevolving credit agreement with a group of banks providing for a commitmentamount of $30.0 million and a maturity date of July 31, 2006.  The Company did not have any borrowingsoutstanding under the revolving credit agreement at October 31, 2005.  Borrowings under the credit agreement currentlybear interest equal to either the greater of prime or federal funds rate plus amargin ranging from 1.25% to 2.25% depending on the Company’s ratio of fundeddebt to Earnings before Interest, Taxes, Depreciation and Amortization(“EBITDA”), or LIBOR plus a margin equal to 2.75% to 3.75% depending on theCompany’s ratio of funded debt to EBITDA. Interest payments are due quarterly. The Company is required to pay an annual commitment fee equal to 0.50%on the unused amount of the revolving credit agreement.  The revolving credit agreement containscustomary affirmative and negative covenants, including financial covenantsrequiring the maintenance of specified interest coverage, ratio of EBITDA tofunded debt, and ratio of 80% of accounts receivable, cash and short terminvestments to funded debt. Additionally, the payment of dividends is precluded except upon approvalof the banks.  Substantially all of theCompany’s assets collateralize the revolving credit agreement.  As of October 31, 2005, the Company is incompliance with the covenants of the revolving credit agreement.

 

Interest expense, includingthe commitment fee and exclusive of the amortization of deferred loan costs onthe credit agreement was $54,000 and $38,000 for the three months ended October31, 2005 and 2004, respectively, and $130,000 and $132,000 for the nine monthsended October 31, 2005 and 2004.

 

**5.****             ****Provision for Income Taxes**

 

The Company has establisheda valuation allowance to reserve its net deferred tax assets at October 31,2005 because the more likely than not criteria for future realization of the Company’snet deferred tax assets specified in Statement of Financial AccountingStandards No. 109, “*Accounting for IncomeTaxes,”* (“SFAS No. 109”) were not met.

 

The foreign tax provisionwas $102,000 and $114,000 for the three months ended October 31, 2005 and 2004,respectively, and $270,000 and $464,000 for the nine months ended October 31,2005 and 2004.  Additionally, the Companyrecorded $15,000 of U.S. Federal and State tax expense in the nine months endedOctober 31, 2005 for alternative minimum tax purposes due to the availabilityof net operating losses from prior years. No U.S. Federal tax benefit was recorded during the three months endedOctober 31, 2005 or during the nine months ended October 31, 2004 due to theuncertainty regarding the Company’s ability to generate taxable income, andresulting uncertainty relative to the recoverability of deferred tax assets.

 

18

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

 

**401(k) Plan**

 

The Company has adopted aplan pursuant to Section 401(k) of the Internal Revenue Code (“the Code”)whereby participants may contribute a percentage of compensation not in excessof the maximum allowed under the Code. The plan provides for a matchingcontribution by the Company which was reinstated as of January 31, 2004.  Employer matching contributions amounted to$215,000 and $102,000 for the three months ended October 31, 2005 and 2004,respectively, and $820,000 and $431,000 for the nine months ended October 31,2005 and 2004. The Company may make additional contributions at the discretionof the Board of Directors.  Nodiscretionary contributions were made during the three and nine months endedOctober 31, 2005 and 2004.

 

**Incentive Compensation Plans**

 

The Carreker Incentive BonusPlan (“CIBP”) awards employees bonuses based on the Company’s or the applicablebusiness unit’s operating results. Substantially all employees are eligible to receive cash awards underthe CIBP.  Awards from this plan are paidto employees subsequent to the end of the fiscal year.  The Company’s Compensation Committee of theBoard of Directors has the authority to determine the final amount of the bonusthat is ultimately paid to the officers of the Company.  In the three months ended October 31, 2005and 2004, the Company recorded expense under this plan of approximately$364,000 and $484,000, respectively.  Inthe nine months ended October 31, 2005 and 2004, the Company recorded expenseunder this plan of approximately $627,000 and $1.0 million, respectively.

 

The Company paysdiscretionary bonuses to key employees based primarily on the extent to whichindividuals meet agreed-upon objectives for the year. The Company recordeddiscretionary bonus expense of approximately $67,000 and $703,000 for the threemonths ended October 31, 2005 and 2004, respectively, and $791,000 and $1.1million for the nine months ended October 31, 2005 and 2004.

 

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

 

The following table setsforth the computation of basic and diluted earnings (loss) per share (inthousands, except per share amounts):

 
| ** **                                                                  | ** ** | **Three Months Ended  October 31,** | ** ** | **Nine Months Ended  October 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                                                                  | ** ** | **2005**                            | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                        |       |                                |       |                               |       |   |   |   |   |
| Basic earnings (loss) per share:                                            |       |                                |       |                               |       |   |   |   |   |
| Net income (loss)                                                           |       | $                                   | (950       | )                                  | $          | 513 |   | $ | 602 |   | $ | (100 | ) |
|                                                                        |       |                                |       |                               |       |   |   |   |   |
| Weighted average shares outstanding                                         |       | 23,906                              |       | 24,821                             |       | 24,152 |   | 24,623 |   |
|                                                                        |       |                                |       |                               |       |   |   |   |   |
| Basic earnings (loss) per share                                             |       | $                                   | (0.04      | )                                  | $          | 0.02 |   | $ | 0.03 |   | $ | 0.00 |   |
|                                                                        |       |                                |       |                               |       |   |   |   |   |
| Diluted earnings (loss) per share:                                          |       |                                |       |                               |       |   |   |   |   |
| Net income (loss)                                                           |       | $                                   | (950       | )                                  | $          | 513 |   | $ | 602 |   | $ | (100 | ) |
|                                                                        |       |                                |       |                               |       |   |   |   |   |
| Weighted average shares outstanding                                         |       | 23,906                              |       | 24,821                             |       | 24,152 |   | 24,623 |   |
| Assumed conversion of employee stock  options and unvested restricted stock |       | —                              |       | 768                                |       | 401 |   | — |   |
| Shares used in diluted earnings per share  calculation                      |       | 23,906                              |       | 25,589                             |       | 24,553 |   | 24,623 |   |
|                                                                        |       |                                |       |                               |       |   |   |   |   |
| Diluted earnings (loss) per share                                           |       | $                                   | (0.04      | )                                  | $          | 0.02 |   | $ | 0.03 |   | $ | 0.00 |   |

 

Options for 3,870,944 sharesand 1,955,533 shares for the three months ended October 31, 2005 and 2004,respectively, and 2,608,263 shares and 4,234,319 shares for the nine monthsended October 31, 2005 and 2004, respectively, 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 mutualagreement between the parties, *Smith v.Carreker Corporation, et. al*, Civil Action No. 303CV1211-M wasreinstated in the United States District Court for the Northern District ofTexas, Dallas Division. This action was originally filed on May 29, 2003, inthe United States District Court for the Northern District of Texas, DallasDivision as Civil Action no. 303CV1211-D. On January 15, 2004, the Court,acting upon the joint motion of the parties, dismissed the action withoutprejudice. This action was brought as a shareholders’ derivative actionpursuant 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 remedy theirindividual breaches of fiduciary duty, including their knowing violations ofGenerally 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 which includes, amongothers, unspecified amounts of compensatory damages, interest and costs,including legal fees) for injuries to the Company and its shareholders causedby Defendants’ misfeasance and/or malfeasance during the period from May 20,1998 through December 10, 2002.  The Companyhas filed a motion to dismiss and is awaiting a ruling from the judge.

 

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

##  

## On May 31, 2005, the plaintiffs filed an AmendedConsolidated Class Action Complaint on behalf of purchasers of the Company’scommon stock between July 30, 1999 and December 10, 2002, inclusive, whichreiterates the allegations in the first complaint, and alleges violations ofSection 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 against alldefendants (the Company, John D. Carreker Jr., Ronald Antinori and Terry L.Gage) except Ernst & Young LLP, violations of Section 20(a) of the ExchangeAct against the individual defendants, and violations of Section 20A of theSecurities Exchange Act against defendants John D. Carreker, Jr. and RonaldAntinori.  The plaintiffs are seekingunspecified amounts of compensatory damages, interest and costs, includinglegal fees.

 

On July 29, 2005, theCompany filed a motion to dismiss the Amended Consolidated Class ActionComplaint, primarily based on various provisions of the Private SecuritiesLitigation Reform Act of 1995.  The courthas not yet ruled on this motion.

 

The parties conducted amediation on November 23, 2005 for both the shareholder’s derivative action andthe shareholder class action.  Althoughthe mediation session did not result in a settlement, the parties have agreedto continue settlement discussions and have asked the court to postpone aruling on the motion to dismiss the shareholder class action until January 15,2006.

 

The Company and individualdefendants deny the allegations in these complaints and intend to defendthemselves vigorously.  It is notpossible at this time to predict whether the Company will incur any liabilityor to estimate the damages, or the range of damages, if any, that the Companymight incur in connection with these lawsuits. The ultimate resolution of these lawsuits could have a material adverseeffect on the Company’s business, results of operations, financial conditionand cash flows.

 

The Company is periodicallyinvolved in various other legal actions and claims which arise in the normalcourse of business.  In the opinion ofmanagement, the final disposition of these matters is not expected to have amaterial adverse effect on the Company’s financial position or results ofoperations.

 

20

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

 

Thetables below show revenues and income (loss) from operations for the periodsindicated for our three reportable business segments: Revenue Enhancement,Global Payments Technologies and Global Payments Consulting.  Our customer projects are sold on a solutionbasis, so it is necessary to break them down by segment and allocateaccordingly.  Included in “CorporateUnallocated” are costs related to selling and marketing and unallocatedcorporate overhead expense.  Businesssegment results, which include costs for research and development as well asproduct royalty expense, the amortization and impairment of goodwill andintangible assets, the write-off of capitalized software costs andrestructuring and other charges, were as follows (in thousands):

 
| ** **                                                                                                        | ** ** | **Three Months ended October 31, 2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                                        | ** ** | **Revenue  Enhancement**                | ** ** | **Global Payments  Technologies** | ** ** | **Global Payments  Consulting** | ** ** | **Corporate  Unallocated** | ** ** | **Total** | ** ** |
| Revenues:                                                                                                         |       |                                    |       |   |   |   |   |   |   |   |   |
| Consulting                                                                                                        |       | $                                       | 6,371      |   | $ | — |   | $ | 349 |   | $ | — |   | $ | 6,720 |   |
| Software license                                                                                                  |       | 235                                     |       | 5,056 |   | 31 |   | — |   | 5,322 |   |
| Software  maintenance                                                                                             |       | 286                                     |       | 10,325 |   | 211 |   | — |   | 10,822 |   |
| Software  implementation and other services                                                                       |       | 811                                     |       | 3,370 |   | 404 |   | — |   | 4,585 |   |
| Outsourcing  services                                                                                             |       | —                                  |       | — |   | — |   | 220 |   | 220 |   |
| Out-of-pocket  expense reimbursements                                                                             |       | 326                                     |       | 297 |   | 78 |   | — |   | 701 |   |
| Total revenues                                                                                                    |       | $                                       | 8,029      |   | $ | 19,048 |   | $ | 1,073 |   | $ | 220 |   | $ | 28,370 |   |
|                                                                                                              |       |                                    |       |   |   |   |   |   |   |   |   |
| Income (loss)  from operations before amortization of customer relationships and  restructuring and other charges |       | $                                       | 2,197      |   | $ | 3,514 |   | $ | (208 | ) | $ | (5,567 | ) | $ | (64 | ) |
|                                                                                                              |       |                                    |       |   |   |   |   |   |   |   |   |
| Amortization of  customer relationships                                                                           |       | —                                  |       | 350 |   | — |   | — |   | 350 |   |
| Restructuring  and other charges                                                                                  |       | —                                  |       | 752 |   | — |   | 28 |   | 780 |   |
| Income (loss)  from operations                                                                                    |       | $                                       | 2,197      |   | $ | 2,412 |   | $ | (208 | ) | $ | (5,595 | ) | $ | (1,194 | ) |

 
| ** **                                                                                                        | ** ** | **Three Months ended October 31, 2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                                        | ** ** | **Revenue  Enhancement**                | ** ** | **Global Payments  Technologies** | ** ** | **Global Payments  Consulting** | ** ** | **Corporate  Unallocated** | ** ** | **Total** | ** ** |
| Revenues:                                                                                                         |       |                                    |       |   |   |   |   |   |   |   |   |
| Consulting                                                                                                        |       | $                                       | 7,141      |   | $ | — |   | $ | 789 |   | $ | — |   | $ | 7,930 |   |
| Software license                                                                                                  |       | 25                                      |       | 5,676 |   | — |   | — |   | 5,701 |   |
| Software  maintenance                                                                                             |       | 371                                     |       | 10,956 |   | 164 |   | — |   | 11,491 |   |
| Software  implementation and other services                                                                       |       | 161                                     |       | 4,393 |   | 68 |   | — |   | 4,622 |   |
| Outsourcing  services                                                                                             |       | —                                  |       | — |   | — |   | 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 (credits)                                                                        |       | —                                  |       | — |   | 199 |   | 67 |   | 266 |   |
| Income (loss)  from operations                                                                                    |       | $                                       | 3,350      |   | $ | 4,404 |   | $ | (787 | ) | $ | (6,601 | ) | $ | 366 |   |

 

21

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| ** **                                                                                                        | ** ** | **Nine Months ended October 31, 2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                        | ** ** | **Revenue  Enhancement**               | ** ** | **Global Payments  Technologies** | ** ** | **Global Payments  Consulting** | ** ** | **Corporate  Unallocated** | ** ** | **Total** | ** ** |
| Revenues:                                                                                                         |       |                                   |       |   |   |   |   |   |   |   |   |
| Consulting                                                                                                        |       | $                                      | 22,925     |   | $ | 53 |   | $ | 1,562 |   | $ | — |   | $ | 24,540 |   |
| Software license                                                                                                  |       | 788                                    |       | 11,528 |   | 147 |   | — |   | 12,463 |   |
| Software  maintenance                                                                                             |       | 551                                    |       | 31,506 |   | 653 |   | — |   | 32,710 |   |
| Software  implementation and other services                                                                       |       | 2,463                                  |       | 10,442 |   | 706 |   | — |   | 13,611 |   |
| Outsourcing  services                                                                                             |       | —                                 |       | — |   | — |   | 718 |   | 718 |   |
| Out-of-pocket  expense reimbursements                                                                             |       | 1,198                                  |       | 968 |   | 280 |   | — |   | 2,446 |   |
| Total revenues                                                                                                    |       | $                                      | 27,925     |   | $ | 54,497 |   | $ | 3,348 |   | $ | 718 |   | $ | 86,488 |   |
|                                                                                                              |       |                                   |       |   |   |   |   |   |   |   |   |
| Income (loss)  from operations before amortization of customer relationships and restructuring  and other charges |       | $                                      | 11,605     |   | $ | 8,131 |   | $ | (524 | ) | $ | (17,251 | ) | $ | 1,961 |   |
|                                                                                                              |       |                                   |       |   |   |   |   |   |   |   |   |
| Amortization of  customer relationships                                                                           |       | —                                 |       | 1,050 |   | — |   | — |   | 1,050 |   |
| Restructuring  and other charges (credits)                                                                        |       | —                                 |       | 906 |   | (24 | ) | 21 |   | 903 |   |
| Income (loss)  from operations                                                                                    |       | $                                      | 11,605     |   | $ | 6,175 |   | $ | (500 | ) | $ | (17,272 | ) | $ | 8 |   |

 
| ** **                                                                                                        | ** ** | **Nine Months ended October 31, 2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                        | ** ** | **Revenue  Enhancement**               | ** ** | **Global Payments Technologies** | ** ** | **Global Payments Consulting** | ** ** | **Corporate  Unallocated** | ** ** | **Total** | ** ** |
| Revenues:                                                                                                         |       |                                   |       |   |   |   |   |   |   |   |   |
| Consulting                                                                                                        |       | $                                      | 24,979     |   | $ | 350 |   | $ | 2,172 |   | $ | — |   | $ | 27,501 |   |
| Software license                                                                                                  |       | 217                                    |       | 15,884 |   | 33 |   | — |   | 16,134 |   |
| Software  maintenance                                                                                             |       | 755                                    |       | 31,426 |   | 626 |   | — |   | 32,807 |   |
| Software  implementation and other services                                                                       |       | 476                                    |       | 10,234 |   | 433 |   | — |   | 11,143 |   |
| Outsourcing  services                                                                                             |       | —                                 |       | — |   | — |   | 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 (credits)                                                                        |       | 1,747                                  |       | (639 | ) | 199 |   | 1,671 |   | 2,978 |   |
| Income (loss)  from operations                                                                                    |       | $                                      | 11,212     |   | $ | 11,891 |   | $ | (1,616 | ) | $ | (21,726 | ) | $ | (239 | ) |

 

22

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During the three months ended July 31, 2003, theCompany 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 businesscontinues to be in the development phase and its operations are immaterial, thefinancial results for the three and nine months ended October 31, 2005 and 2004are contained in the Corporate-Unallocated business segment in the tablesabove.

 

For the three months ended October 31, 2005 andOctober 31, 2004, Carretek recorded revenue of $220,000 and $50,000,respectively, and recorded expense of $769,000 and $530,000, respectively.  For the nine months ended October 31, 2005and October 31, 2004, Carretek recorded revenue of $718,000 and $60,000,respectively, and recorded expense of $2.3 million and $986,000, respectively.  Accordingly, the 49% share relating to theminority interest in these losses, which was $269,000 and $234,000 for thethree months ended October 31, 2005 and 2004, respectively, and $799,000 and $454,000for the nine months ended October 31, 2005 and 2004, respectively, was recordedin other income in the accompanying consolidated statements of operations.  The Company and its partner have funded Carretekto date in the aggregate amount of $4.0 million of equity.

 

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,** | ** ** |
|--------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **         | ** ** | **2005**                            | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **         | ** ** | ** **                          | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Single customer    |       | 13.0                                | %          | 19.3                               | %          | 12.4 | % | 13.1 | % |
| Top five customers |       | 41.3                                | %          | 40.7                               | %          | 35.1 | % | 32.6 | % |

 

Wells Fargo was the Company’s largest customer in eachof the periods presented.

 

23

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The Company markets itssolutions in several foreign countries. Revenues, exclusive of out-of-pocket expense reimbursements, for theperiods indicated is attributed to countries based on the location of thecustomers, and were as follows (in thousands):

 
| ** **     | ** ** | **Three Months Ended****October 31****,  2005** | ** ** | **Three Months Ended****October 31****,  2004** | ** ** |
|----------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **     | ** ** | **Amount**                                      | ** ** | **Percent of  total  revenues**                 | ** ** | **Amount** | ** ** | **Percent of  total  revenues** | ** ** |
| United States  |       | $                                               | 19,993     |                                            | 72         | % | $ | 24,712 |   | 83 | % |
| Europe         |       | 3,646                                           |       | 13                                              |       | 1,966 |   | 7 |   |
| Canada         |       | 1,800                                           |       | 7                                               |       | 1,348 |   | 4 |   |
| Asia Pacific   |       | 1,428                                           |       | 5                                               |       | 946 |   | 3 |   |
| South Africa   |       | 142                                             |       | 1                                               |       | 631 |   | 2 |   |
| Other          |       | 660                                             |       | 2                                               |       | 191 |   | 1 |   |
| Total revenues |       | $                                               | 27,669     |                                            | 100        | % | $ | 29,794 |   | 100 | % |

 
| ** **     | ** ** | **Nine Months Ended  October 31,  2005** | ** ** | **Nine Months Ended  October 31,  2004** | ** ** |
|----------------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **     | ** ** | **Amount**                               | ** ** | **Percent of  total  revenues**          | ** ** | **Amount** | ** ** | **Percent of  total  revenues** | ** ** |
| United States  |       | $                                        | 60,838     |                                     | 72         | % | $ | 67,916 |   | 78 | % |
| Europe         |       | 7,113                                    |       | 9                                        |       | 6,511 |   | 7 |   |
| Canada         |       | 5,223                                    |       | 6                                        |       | 4,690 |   | 5 |   |
| Asia Pacific   |       | 4,227                                    |       | 5                                        |       | 3,261 |   | 4 |   |
| South Africa   |       | 4,563                                    |       | 6                                        |       | 4,628 |   | 5 |   |
| Other          |       | 2,078                                    |       | 2                                        |       | 639 |   | 1 |   |
| Total revenues |       | $                                        | 84,042     |                                     | 100        | % | $ | 87,645 |   | 100 | % |

 

24

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

 

**The Company recorded various restructuring and othercharges and (credits) during the nine months ended October 31, 2005 and 2004,respectively, as follows (in thousands):**

** **
| ** **                               | ** ** | **Workforce  Reductions** | ** ** | **EPG  Litigation  Settlement** | ** ** | **Legal and Professional  Fees** | ** ** | **Other**  | ** ** | **Total**  | ** ** |
|------------------------------------------|------------|---------------------------|------------|---------------------------------|------------|----------------------------------|------------|------------|------------|------------|------------|
| ** **                               | ** ** | ** **                | ** ** | ** **                      | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** |
| **YTD  2004:**                           | ** ** | ** **                | ** ** | ** **                      | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** |
| Quarterly period  ended April 30, 2004   |       | 308                       |       | 1,686                           |       | 521                              |       | —     |       | 2,515      |       |
| Quarterly period  ended July 31, 2004    |       | 192                       |       | 14                              |       | 1,206                            |       | (1,215     | )          | 197        |       |
| Quarterly period  ended October 31, 2004 |       | 246                       |       | —                          |       | 20                               |       | —     |       | 266        |       |
| Total YTD 2004                           |       | $                         | 746        |                            | $          | 1,700                            |       | $          | 1,747      |       | $          | (1,215 | ) | $ | 2,978 |   |
|                                     |       |                      |       |                            |       |                             |       |       |       |       |       |
| **YTD  2005:**                           | ** ** | ** **                | ** ** | ** **                      | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** |
| Quarterly period  ended April 30, 2005   |       | 127                       |       | —                          |       | —                           |       | (32        | )          | 95         |       |
| Quarterly period  ended July 31, 2005    |       | 28                        |       | —                          |       | —                           |       | —     |       | 28         |       |
| Quarterly period  ended October 31, 2005 |       | 780                       |       | —                          |       | —                           |       | —     |       | 780        |       |
| Total YTD 2005                           |       | $                         | 935        |                            | $          | —                           |       | $          | —     |       | $          | (32 | ) | 903 |   |
|                                          |            |                           |            |                                 |            |                                  |            |            |            |            |            |  |  |  |  |  |

 

**Quarter Ended April 30,2004**

 

The Company recorded $308,000 in restructuring andother charges during the three month period ended April 30, 2004, principallyassociated with the separation of 10 employees. The Company expensed $1.686 million for compensatory damages to EPGafter the jury returned a verdict in favor of EPG on one claim and Carreker onthree claims.  This litigation ultimatelysettled in June 2004 for $1.7 million. The Company recorded a charge of $521,000 relating to legal andprofessional fees relating to these legal actions.

 

**Quarter Ended July 31,2004**

 

The Company recorded $192,000 in restructuring andother charges 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.

 

On July 8, 2004, the Company settled with EPG for $1.7million.  An additional $14,000 wasexpensed and the settlement paid to the plaintiff.  Additionally, the Company recorded a chargefor the litigation costs related to this legal action totaling $1.2 million.

 

Finally, the Company received a final payment of$455,000 from a customer in the final settlement with one of its originalCheckFlow Suite customers.  This paymentwas recorded directly to this reserve. Concurrently, based on revised cost estimates, the Company lowered itsestimate of the cost to develop and install any additional software, orsoftware modifications, with these customers and reversed approximately $1.2million of this reserve.

 

**QuarterEnded October 31, 2004**

 

The Company recorded $246,000 in restructuring andother charges 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

----

 

**Quarter Ended April 30,2005**

 

The Company recorded $127,000 in restructuring andother charges during the three month period ended April 30, 2005, principallyassociated with the separation of 6 employees. The Company also lowered its estimate by $32,000 for the costsassociated with the discontinuance of one of its software offerings originallyrecorded in January 2004.

 

**Quarter Ended July 31,2005**

 

The Company recorded $28,000 in restructuring andother charges during the three month period ended July 31, 2005, principallyassociated with the separation of 2 employees.

 

**QuarterEnded October 31, 2005**

 

The Company recorded $780,000 in restructuring andother charges during the three month period ended October 31, 2005, principallyassociated with the separation of 29 employees primarily within the GPTbusiness segment.

 

Theactivity related to the accrued merger and restructuring costs during the nine monthsended October 31, 2005 is as follows (in thousands):

 
| ** **                       | ** ** | **Workforce  Reductions** | ** ** | **Charges  relating to  CheckFlow  Suite** | ** ** | **Facility  Closures** | ** ** | **Other** | ** ** | **Total** | ** ** |
|----------------------------------|------------|---------------------------|------------|--------------------------------------------|------------|------------------------|------------|-----------|------------|-----------|------------|
|                             |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Balance at  January 31, 2005     |       | $                         | 652        |                                       | $          | 200                    |       | $         | 49         |      | $          | 103 |   | $ | 1,004 |   |
|                             |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Additions to  reserve balance:   |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Severance  charges               |       | 127                       |       | —                                     |       | —                 |       | —    |       | 127       |       |
| Reductions to  reserve balances: |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Cash paid                        |       | (494                      | )          | —                                     |       | (44                    | )          | —    |       | (538      | )          |
| Change in  estimate              |       | —                    |       | —                                     |       | —                 |       | (32       | )          | (32       | )          |
| Balance at April  30, 2005       |       | $                         | 285        |                                       | $          | 200                    |       | $         | 5          |      | $          | 71 |   | $ | 561 |   |
|                             |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Additions to  reserve balance:   |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Severance  charges               |       | 28                        |       | —                                     |       | —                 |       | —    |       | 28        |       |
| Reductions to  reserve balances: |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Cash paid                        |       | (285                      | )          | —                                     |       | (5                     | )          | (24       | )          | (314      | )          |
| Balance at July  31, 2005        |       | $                         | 28         |                                       | $          | 200                    |       | $         | —     |      | $          | 47 |   | $ | 275 |   |
|                             |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Additions to  reserve balance:   |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Severance  charges               |       | 780                       |       | —                                     |       | —                 |       | —    |       | 780       |       |
| Reductions to  reserve balances: |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Cash paid                        |       | (426                      | )          | —                                     |       | —                 |       | —    |       | (426      | )          |
| Balance at  October 31, 2005     |       | $                         | 382        |                                       | $          | 200                    |       | $         | —     |      | $          | 47 |   | $ | 629 |   |

 

The Company anticipates the remaining reserve accrualsat October 31, 2005 will be paid or remaining customer obligations completedwithin the next 9 months.

 

26

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

 

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

 

**Overview**

 

For the last 27 yearsCarreker Corporation has designed, developed, sold and deliveredpayments-related software and consulting solutions to financial institutionsand financial service providers.  Ourproducts and services address a broad spectrum of payment activities and aredesigned to help our clients enhance the performance of their paymentsbusinesses; improve operational efficiency in payments processing; enhancerevenue and profitability from payments-oriented products and services; reducelosses associated with fraudulent payment transactions; facilitate compliancewith risk-related laws and regulations; and/or maximize clients’ customerincome streams by aligning their customer interactions and products withcustomer needs.  Carreker employed atotal of 501 employees at October 31, 2005.

 

We are organized intothree primary operating divisions: Global Payments Technologies (“GPT”),Revenue Enhancement (“RevE”) and Global Payments Consulting (“GPC”).  These operating divisions are operated indistinct yet synergistic ways to bring value to our clients.  In addition we have established a majority-ownedsubsidiary named Carretek LLC to address the payments outsourcing arena.

 

*GlobalPayments Technologies*. This division is responsible for design, development, sales, and supportof our technology solutions.   Revenue isprimarily derived from license fees, implementation fees and maintenance fees.  As of October 31, 2005, GPT had 287employees.

 

*RevenueEnhancement*.  Thishighly specialized practice group provides consulting and software solutionsfocused on increasing clients’ revenue streams. Areas of expertise include fee income, market segmentation, managementof customer price structures, account retention, acquisitions andprofitability.  A majority of the revenuegenerated by this division is through benefit-sharing agreements with ourcustomers, recorded as consulting revenue along with license fees, maintenancefees and implementation fees from our CVE software offering.  As of October 31, 2005, RevE had 87employees.

 

*GlobalPayments Consulting*. The objective of this professional services division is to provide ourclients with “applied thought leadership” related to the business ofpayments.  Revenue in the GPC division isprimarily derived through the delivery of consulting services offered primarilyon a time and materials basis to our clients, along with the license fees,maintenance fees and services fees associated with our Float Pricing Systemsoftware offering and Payments Clearing Model product offering.  As of October 31, 2005, GPC had 24 employees.

 

In addition to thesethree divisions, in fiscal 2003 we formed Carretek LLC.  Carretek is a transformational businessoutsourcer for payment and transaction processing jointly owned by CarrekerCorporation and Majesco Software, Inc., the U.S. subsidiary of Mastek Limited,a leading Indian outsourcing company with global operations.  As of October 31, 2005, Carretek had 3 U.S.based employees and 109 offshore personnel of Mastek Limited which performservices for Carretek on a contract basis.

 

27

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

 

*OperatingExpenses.*  Operatingexpenses, including selling, general and administrative and research anddevelopment, are substantially driven by personnel and overhead expenses.  Other significant operating expenses that wemonitor include professional fees, use of contractors, travel, insurance and officeservices expenses.  Additionally in thefirst two quarters of fiscal 2004, the settlement of the EPG legal action alongwith associated legal fees was recorded on the Restructuring and Other Chargesfinancial statement caption on the Consolidated Statement of Operations.  As of October 31, 2005, the Corporate Salesand Marketing staff had 20 employees and the Corporate staff which includesExecutive Management, Legal, Finance and Accounting, Human Resources,Facilities and IT had 80 employees.

 

Liquidityand Cash Flows.  Cash and cashequivalents at October 31, 2005 and January 31, 2005 totaled $24.2 million and$34.5 million, respectively.  In additionto our growth in accounts receivable, our primary utilization of cash in fiscal2005 was to invest in $4.5 million of marketable debt securities and $3.2million of treasury stock purchases.

 

**Products and Services**

 

The products and servicesof our three primary operating divisions are described below in this sequence:Global Payments Technologies (“GPT”), Revenue Enhancement (“RevE”) and GlobalPayments Consulting (“GPC”)

 

*Global Payments TechnologiesSolutions.*  Carreker’stechnology solutions help financial institutions address the needs of somecritical payment services and delivery functions that impact overall operatingrevenues and costs and risk management. These functions include presentment of checks in paper and electronicform, identification and mitigation of fraudulent payments, handling irregularitems such as checks returned unpaid (exceptions), maintaining a record of pasttransactions (archiving), responding to related customer inquiries (research),and correcting any errors that are discovered (adjustments).  Global Payments Technologies (“GPT”)solutions address these and other key functions in the context of improvingoperational efficiency and a gradual transition from paper to electronic-basedpayment systems.  In addition, we offertechnology solutions that optimize the inventory management of a bank’s cashstock levels and logistical service requirements, including managing how muchis needed, when it is needed and where it is needed.  Our solutions reduce the amount of cash banksneed to hold in reserve accounts and as cash-on-hand while ensuring a highlevel of customer service through timely replenishment of ATM cash supplies atminimal logistical services cost.

 

Specificsolutions in the GPT group include:

 
| **Solution**                                           | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                   | ** ** | **Products Offered**                                                                                                                                                                                                                                       |
|--------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                             | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                        | ** ** | ** **                                                                                                                                                                                                                                                 |
| **Risk Solutions:**                                    | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                        | ** ** | ** **                                                                                                                                                                                                                                                 |
| ** **                                             | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                        | ** ** | ** **                                                                                                                                                                                                                                                 |
| Fraud Mitigation and Anti-Money Laundering  Compliance |       | Automated fraud detection and prevention solutions  that reduce incidents of check fraud, deposit fraud, check kiting, and  electronic fraud. Anti-money laundering solutions screen names and related  data against industry blacklists, local high-risk lists and other customized  databases. The solution automatically alerts appropriate bank personnel for  timely and decisive action and reporting. Scalable solutions are offered for  community banks. |       | FraudLink On-Us, FraudLink Deposit, FraudLink  Deposit – Branch Access Option, Kite, FraudLink Positive Pay, FraudLink  eTracker, FraudLink ACHeCK, FraudLink PC, CORE Workflow Manager, CORE AML  Filter, eFraudLink.com, Fraud Solutions Consulting |
|                                                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                       |
| **Payment Solutions:**                                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                       |
| ** **                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                       |
| Exception Management                                   |       | Products that bring new efficiencies to back-office  operations through leading-edge image, workflow, and RECO (character  recognition) technologies.                                                                                                                                                                                                                                                                                                             |       | Adjustments/Express, Exceptions/Express, Express  Capture, Express Decision, Input/Express, Inbound Returns/Express, and All  Transactions File                                                                                                            |

 

28

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| **Solution**                                    | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   | ** ** | **Products Offered**                                                                                                                                                                                                                                                             |
|-------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                      | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | ** ** | ** **                                                                                                                                                                                                                                                                       |
| 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                                                                                                                                                     |
|                                            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                                             |
| Global Tracking                                 |       | A complete bar code tracking system eliminates  manual log sheets, automates data gathering and maximizes workflow by tracking  accountable mail, branch bags, item volumes, currency bags, incoming domestic  and international deposits, outgoing cash letters, exceptions and much more.                                                                                                                                                                                                       |       | Receive Sentry                                                                                                                                                                                                                                                                   |
|                                            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                                             |
|  eMetrics                                  |       | Performance-measurement software suite that uses  historical data to generate key performance indicators, item processing  volume data, productivity statistics and quality control benchmarks.                                                                                                                                                                                                                                                                                                   |       | Lumen, ProModel, eiMICR,  eiStats, eiQuality, eiPerform                                                                                                                                                                                                                          |
|                                            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |                                                                                                                                                                                                                                                                             |
| Electronic Check Presentment and Image Exchange |       | Enables banks to transition from paper-based to  electronic payment systems by automating key elements of the processing  stream, creation of image replacement documents (“IRD”) and image quality and  usability checking. 

Aided by Check 21 legislation, these solutions are designed  to reduce and eventually eliminate the movement of paper payments through the  system, improving productivity, reducing errors, increasing customer  satisfaction and reducing fraud.  |       | ExchgLink , IRD Create, IRD Author, Image Inspector,  CheckLink, CheckLink PC, Deposit Manager, Branch Truncation Manager and  Cnotes                                                                                                                                            |

 

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| **Solution**                            | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                               | ** ** | **Products Offered**                                               |
|-----------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|
| ** **                              | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | ** ** | ** **                                                         |
| **Cash & Cash Logistic Solutions:** |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |       |                                                               |
| ** **                              |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |       |                                                               |
| ATM Solutions                           |       | Advanced ATM monitoring and management, improving  ATM availability and ensuring service levels are met. These solutions include  an automated ATM monitoring and dispatching system for maximizing network  availability; and a real-time Internet-based system for efficient handling of  ATM service requests and responses.                                                                                                                                               |       | eiManager, eiGateway                                               |
|                                    |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |       |                                                               |
| Cash Solutions                          |       | A product suite, now optimized through Web-based  software solutions, that dramatically reduces the amount of cash banks,  financial institutions and companies need to hold as cash-on-hand throughout  vault, branch and ATM networks. These solutions also enable automation and  standardization of the cash ordering process and optimization of  transportation. Consulting solutions can drive further efficiency and  automation in vault, branch and ATM operations. |       | iCom, ReserveLink, ReserveLink Plus, Cash Supply  Chain Consulting |

 

*RevenueEnhancement.*  TheRevenue Enhancement division includes two business units:  RevE and Customer Value Enhancement (“CVE”).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 RevenueEnhancement offering is our CVE solutions that includes EnAct software,proprietary sales management methodologies and sales training programs. Our CVEsolutions assist financial institutions in leveraging central intelligence withlocal insight, translating strategy into specific actions to achieve sustainedorganizational performance. This enables our clients to improve theiridentification of those customers and prospects representing the greatest valueor potential, while aligning internal processes and behaviors with management’sfocus. Our approach is unique and complementary to many CRM investments thatbanks have made in recent years and is designed to focus their activities suchthat they can attain increased returns on these CRM investments.

 

*GlobalPayments Consulting.* Our Global Payments Consulting (“GPC”) division helps financial institutionsproactively plan, prepare and optimize for the regulatory, competitive andtechnological impacts affecting the financial payments environment.  The division provides strategic planning,program management, specialized tools, business applications and implementationadvisory services for financial institutions and specialized paymentsclients.  The focus areas for theseservices include:

 

**•**                  Enterprisepayment rationalization (strategy through performance optimization)

**•**                  Paymentresearch services

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

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

**•**                  Electronic paymentinfrastructure planning (image enablement through converged paymentenvironments)

**•**                  Consolidationand merger/integration planning

**•**                  EnterpriseRisk support for payments related functions

 

30

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

 

•                  Float Managementsoftware products – Float Analysis System and Float Management System - formanaging a bank’s float through float analysis and pricing to improveprofitability, 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.

 

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

 

*Outsourcing*.  Carretek LLC is a transformational businessoutsourcer for payment and transaction processing jointly owned by CarrekerCorporation (51%) and Majesco Software Inc. (49%), the U.S. subsidiary ofMastek Limited, a leading Indian outsourcing company with globaloperations.  Carretek was formed infiscal 2003.  While the venture hassigned its first client, it is still in the developmental phase and its resultsare contained in the Corporate-Unallocated business segment.

 

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

 

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

 

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**ExecutiveSummary**

 

***Comparison of Three Months Ended October 31, 2005 (“Q3 2005”) to ThreeMonths Ended October 31, 2004 (“Q3 2004”) and Nine Months Ended October 31,2005 (“YTD 2005”) to Nine Months Ended October 31, 2004 (“YTD 2004”)***

 

In Q3 2005, we generated revenue of $28.4 million and anet loss of $950,000.  These resultscompare to revenue of $30.6 million and net income of $513,000 in Q3 2004.  In YTD 2005, we generated revenue of $86.5 millionand net income of $602,000.  These resultscompare to revenue of $90.0 million and a net loss of $100,000 in YTD 2004.

 

Our revenue decline is primarily associated with ourGPT business segment.  Revenue withinthis segment declined $2.3 million or 11.0% on a quarterly basis and $4.3million or 7.4% on a YTD basis.  Thedecline is primarily in software license revenue within the Paymentsgroup.  The Payments group includes suchproducts as Image Archive and Exception Management Applications as well as SourceCapture, ExchgLink and Image replacement document solutions.  The decline, especially on a quarterly basis,was primarily the result of our two initial ExchgLink engagements reachingacceptance by our customers in Q3 2004 and $1.6 million of software and$826,000 of previously deferred services being recognized.  Additionally, in YTD 2004, the Payments groupof GPT derived $3.4 million from a software license sale to a single customerof our legacy Check Image Archive product, while YTD 2005 periods did notinclude any large single sales of this magnitude.  The GPT revenue trend was positive in Q3 2005,as compared to Q2 2005, as GPT revenue increased $1.6 million or 9%.

 

Our margins within our RevE business segment have decreasedas our traditional, high-margin RevE consulting revenues have declined 10.8% ona quarterly basis and 8.2% on a YTD basis. While RevE consulting revenues have declined, this decline has beencompletely offset by growth in lower margin Customer Value Enhancement (“CVE”)software and services revenue.

 

We continue to focus on increasing research anddevelopment to enhance our existing product offerings, and more importantly,develop new product offerings, particularly within GPT.  The reductions within selling, general andadministrative were primarily related to cost savings from reductions inpersonnel in our corporate sales function, D&O insurance costs, our newhealth care plan and provider, and reductions within office services andfacilities.  These reductions have beenpartially offset by increased contract labor and professional fees associatedwith our ERP system upgrade and business process reengineering project, whichbegan in Q1 2005.

 

In Q3 2005, we recorded a $780,000 restructuring chargeassociated with the severance and other personnel costs for 29 employeesterminated on August 31, 2005, primarily within the GPT business segment.  The reductions were implemented in an effortto position GPT for increased flexibility and improved long-termprofitability.  On an on-going basis, weexpect an annual benefit of approximately $2.4 million from this action.  YTD 2005 restructuring and other charges isapproximately $903,000 and is mostly related to severance costs.  YTD 2004 restructuring and other charges were$3.0 million and included a $1.7 million EPG litigation settlement,approximately $1.7 million of legal costs and $746,000 of severance, which was partiallyoffset by a $1.2 million reduction in our CheckFlow customer settlementreserve.

 

In Q3 2005, we generated $2.2 million of cash fromoperating activities and increased total cash by $2.4 million, as compared to $209,000of cash used in operating activities and a decrease in total cash of $1.6 millionin Q3 2004.  On a YTD basis, we used $1.6million of cash from operating activities and decreased total cash by $10.3 millionin 2005, as compared to $7.3 million of cash provided by operating activitiesand a decrease of total cash of $1.8 million in 2004.  In fiscal 2005, we increased marketable debtsecurities by $4.5 million and purchased $3.2 million of treasury stock pursuantto a publicly announced stock repurchase program which concluded on October 14,2005.  These two programs were theprimary reasons for our decreased cash and cash equivalent balance at October 31,2005.

 

We expect revenue for Q4 2005 to be the highestquarter of fiscal year 2005 due primarily to stronger consulting revenues andcontinued strength in license revenues. Q4 2005 operating income is expected to increase over all other quartersin fiscal 2005, primarily as a function of revenue growth and decreased costsassociated with expense reduction initiatives.

 

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**Results of Operations**

 

***Comparison of Three Months Ended October 31, 2005 (“Q3 2005”) to ThreeMonths Ended October 31, 2004 (“Q3 2004”) and Nine Months Ended October 31,2005 (“YTD 2005”) to Nine Months Ended October 31, 2004 (“YTD 2004”)***

 

***Revenues***

 

*Revenuesby Segment ($ in thousands):*

 
| ** **                      | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|---------------------------------|------------|-------------------------------------|------------|--------------|------------|------------------------------------|------------|--------------|------------|
| ** **                      | ** ** | **2005**                            | ** ** | **2004**     | ** ** | **$**                              | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                            |       |                                |       |         |       |                               |       |         |       |   |   |   |   |   |   |   |   |
| Revenue Enhancement             |       | $                                   | 8,029      |         | $          | 7,987                              |       | $            | 42         |   | 1.0 | % | $ | 27,925 |   | $ | 27,510 |   | $ | 415 |   | 1.5 | % |
| Global Payments Technologies    |       | 19,048                              |       | 21,394       |       | (2,346                             | )          | (11.0        | )          | 54,497 |   | 58,830 |   | (4,333 | ) | (7.4 | ) |
| Global Payments Consulting      |       | 1,073                               |       | 1,176        |       | (103                               | )          | (8.7         | )          | 3,348 |   | 3,610 |   | (262 | ) | (7.2 | ) |
| Corporate (Outsourcing) Revenue |       | 220                                 |       | 50           |       | 170                                |       | —       |       | 718 |   | 60 |   | 658 |   | — |   |
|                            |       |                                |       |         |       |                               |       |         |       |   |   |   |   |   |   |   |   |
| Total Revenues                  |       | $                                   | 28,370     |         | $          | 30,607                             |       | $            | (2,237     | ) | 7.3 | % | $ | 86,488 |   | $ | 90,010 |   | $ | (3,522 | ) | (3.9 | )% |

 

Our RevE business segment increased revenue $42,000, or1.0%, in Q3 2005 as compared to Q3 2004 and $415,000, or 1.5%, for YTD 2005 ascompared to YTD 2004.  A decline intraditional RevE consulting revenues on both a quarterly and YTD basis wasoffset by increased CVE software and services revenue.  CVE is our proprietary sales managementmethodologies and sales training programs. In the last nine months this group has entered into two large multi-yearterm CVE license engagements to provide software, services andmaintenance.  Additionally in Q2 2005,this group was engaged by another large international bank to provide CVErelated services over a multi-year period. The future period growth was partially offset on November 2, 2005 whenone CVE customer gave notice that they will not renew their term CVE licenseand maintenance contract for fiscal 2006 that would have otherwise provided$800,000 in annual revenue.

 

Our GPT business segment revenue declined $2.3million, or 11.0%, in Q3 2005 as compared to Q3 2004 and declined $4.3 million,or 7.4%, for YTD 2005 as compared to YTD 2004. These declines are both centered within software license revenue,particularly within our Payments product group. In response to Check 21 legislation in 2003, we began to develop severalsoftware products that enabled banks to transition from paper-based toelectronic payments systems.  Theseproducts include Image Exchange, Image-replacement document creation software,along with a suite of Source Capture products designed to capture these checkimages earlier in the payment processing stream.  In Q1 and Q2 2004, $3.4 million wasrecognized from a single customer of our legacy Check Image Archive product,and in Q3 2004 two first-time ExchgLink engagements reached acceptance and $1.6million of software license and $826,000 of previously deferred servicesrevenue was recognized.  We have notexperienced any large single sales of this magnitude in YTD 2005, although thesales opportunities for these new Payments products have recently shown some momentum.  The majority of software license revenuerecognized in Q3 2005 was related to legacy Payments, Cash and Risk softwaresolutions.  Revenue from new products is expectedto increase in Q4 2005 as compared to Q3 2005, as we anticipate a large SourceCapture installation will be complete and accepted by the customer.

 

The slight decline in the GPC business segmentrevenue, on a quarterly and YTD basis, was primarily the result of decreasedconsulting services.  The decline,particularly in Q3 2005, was primarily the result of the negative impact of thehurricanes with three customers.  Thesedeclines in consulting were partially offset by increases in software andservices derived from our Float product group. With recent increases in interest rates, we expect to have futureincreased customer demand for our Float product offerings.

 

Finally, Carretek is our 51% owned business outsourcerfor payment and transaction processing. Carretek signed its first agreement in Q2 2004.  In Q4 2004 and Q1 2005, we expanded the scopeof our outsourcing engagement with our first customer.  One outsourced process for this customer hasreached its target potential while the remaining two outsourced processes arestill in a pilot stage.  Revenue hasincreased to $220,000 in Q3 2005 and $718,000 on a YTD basis.  We expect the financial results for thisbusiness to improve as we expand the scope of our initial engagement and to theextent we achieve success in adding additional customers.

 

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*Consulting($ in thousands):*

 
| ** ** | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|------------|------------|-------------------------------------|------------|--------------|------------|------------------------------------|------------|--------------|------------|
| ** ** | ** ** | **2005**                            | ** ** | **2004**     | ** ** | **$**                              | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|       |       |                                |       |         |       |                               |       |         |       |   |   |   |   |   |   |   |   |
| Consulting |       | $                                   | 6,720      |         | $          | 7,930                              |       | $            | (1,210     | ) | (15.3 | )% | $ | 24,540 |   | $ | 27,501 |   | $ | (2,961 | ) | (10.8 | )% |
|            |            |                                     |            |              |            |                                    |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Most of our consulting revenue is derived from ourRevE business segment.  Consultingrevenue in the RevE segment decreased $771,000, or 10.8%, to $6.4 million in Q32005 from $7.2 million in Q3 2004. Domestically, consulting revenue for RevE decreased $2.7 million on aquarterly comparison basis, and there were 13 domestic revenue producingengagements in Q3 2005, as compared to 14 in Q3 2004.  International RevE consulting revenue increased$1.9 million in Q3 2005, when compared to Q3 2004.  There was 1 non-U.S. revenue producingengagement in both Q3 2005 and Q3 2004.

 

Consulting revenue in the RevE segment decreased $2.1 million,or 8.2%, to $22.9 million in YTD 2005 from $25.0 million in YTD 2004.  Domestically, consulting revenue decreased by$2.5 million, or 12.9%, to $16.7 million in YTD 2005 from $19.2 million in YTD2004.  There were 20 domestic revenueproducing engagements in both YTD 2005 and YTD 2004.  International RevE consulting revenue increased$410,000 in YTD 2005 to $6.2 million, when compared to $5.8 million in YTD2004.  In YTD 2005, there were 3 revenueproducing international engagements, as compared to 4 in YTD 2004.

 

Consulting revenue in our GPC segment decreased $440,000,or 55.9%, to $349,000 in Q3 2005 from $789,000 in Q3 2004, and decreased $610,000,or 28.1%, to $1.6 million in YTD 2005 as compared to $2.2 million in YTD 2004.  The decline, particularly in Q3 2005, wasprimarily the result of delays caused by the hurricanes with three of ourcustomers.

 

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*SoftwareLicense ($ in thousands):*

 
| ** **       | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|------------------|------------|-------------------------------------|------------|--------------|------------|------------------------------------|------------|--------------|------------|
| ** **       | ** ** | **2005**                            | ** ** | **2004**     | ** ** | **$**                              | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|             |       |                                |       |         |       |                               |       |         |       |   |   |   |   |   |   |   |   |
| Software License |       | $                                   | 5,322      |         | $          | 5,701                              |       | $            | (379       | ) | (6.7 | )% | $ | 12,463 |   | $ | 16,134 |   | $ | (3,671 | ) | (22.8 | )% |
|                  |            |                                     |            |              |            |                                    |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Most of our software license fees are derived from ourGPT business segment.  GPT softwarelicense revenue decreased $620,000, or 10.9%, to $5.1 million in Q3 2005 from $5.7million in Q3 2004.  Additionally, GPTsoftware license revenue decreased $4.4 million, or 27.4%, to $11.5 million inYTD 2005 as compared to $15.9 million in YTD 2004.  These declines are both centered withinsoftware license revenue, particularly within our Payments product group, asdescribed above under “Revenues by Segment.”

 

Thesoftware revenue derived from our CVE product offering, which is contained inour RevE business segment, increased $210,000 to $235,000 in Q3 2005, ascompared to $25,000 in Q3 2004, and increased $571,000 to $788,000 in YTD 2005as compared to $217,000 in YTD 2004. This increase is the result of reformulating our sales strategy toposition our CVE product as an enhancement to an existing CRM customerinstallation, as opposed to a replacement for an existing CRM customerinstallation.  Additionally, we beganmarketing a multi-year term software license as opposed to a traditionalperpetual software license, which reduces the up-front investment for ourcustomers, but results in recognition of the related revenue over a longerperiod of time.  In the last twelve months,the CVE group has entered into three large multi-year term license engagementsto provide varying combinations of software, maintenance and services underthis new strategy.  However, as discussedabove under “Revenues by Segment”, one of these customers recently gave usnotice of their intent to cancel their term software and maintenance license totalingapproximately $800,000 for fiscal 2006.

 

*SoftwareMaintenance ($ in thousands):*

 
| ** **           | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|----------------------|------------|-------------------------------------|------------|--------------|------------|------------------------------------|------------|--------------|------------|
| ** **           | ** ** | **2005**                            | ** ** | **2004**     | ** ** | **$**                              | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                 |       |                                |       |         |       |                               |       |         |       |   |   |   |   |   |   |   |   |
| Software Maintenance |       | $                                   | 10,822     |         | $          | 11,491                             |       | $            | (669       | ) | (5.8 | )% | $ | 32,710 |   | $ | 32,807 |   | $ | (97 | ) | — | % |
|                      |            |                                     |            |              |            |                                    |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Mostof our maintenance revenue is derived from our GPT business segment.  Software maintenance fees are invoiced andcollected pursuant to annually renewable product and telephone supportagreements with our software customers. The annual maintenance fee is generally paid by the customer at thebeginning of the maintenance period and revenue is recognized ratably over theterm of the related contract.  If theannual maintenance fee is not paid at the beginning of the maintenance period,we defer revenue recognition until the time that the maintenance fee is paid bythe customer.  When the payment isreceived, maintenance revenue is recognized for the period that maintenance revenuewas previously deferred.  Maintenancecontracts usually carry annual maintenance fee escalation clauses generallybased on an index, such as the consumer price index.  Because of our revenue recognition policy,maintenance revenue can vary from quarter-to-quarter based upon actual cashreceipts.

 

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

 
| ** **                                  | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|---------------------------------------------|------------|-------------------------------------|------------|--------------|------------|------------------------------------|------------|--------------|------------|
| ** **                                  | ** ** | **2005**                            | ** ** | **2004**     | ** ** | **$**                              | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                                        |       |                                |       |         |       |                               |       |         |       |   |   |   |   |   |   |   |   |
| Software  Implementation and Other Services |       | $                                   | 4,585      |         | $          | 4,622                              |       | $            | (37        | ) | (1.0 | )% | $ | 13,611 |   | $ | 11,143 |   | $ | 2,468 |   | 22.1 | % |
|                                             |            |                                     |            |              |            |                                    |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The majority of our software implementation fees arederived from our GPT business segment; however, the CVE product group withinthe RevE business segment has increased their service revenues in YTD 2005.

 

GPTsoftware services decreased $1.0 million, or 23.3%, to $3.4 million in Q3 2005as compared to $4.4 million in Q3 2004, and they increased $208,000, or 2.0%, to$10.4 million in YTD 2005 as compared to $10.2 million in YTD 2004.  The quarterly decrease in software implementationand other services within GPT is primarily the result of the recognition of$826,000 of ExchgLink software services in Q3 2004 when acceptance was achievedwith our development partner.

 

Withinthe CVE product group, services have increased $650,000 to $811,000 in Q3 2005,as compared to $161,000 in Q3 2004, and have increased $2.0 million to $2.5 millionin YTD 2005 as compared to $476,000 in YTD 2004.  In the last nine months this group hasentered into two large multi-year engagements to provide software, services andmaintenance.  In Q2 2005, this group wasalso engaged by another large international bank to provide CVE relatedservices over a multi-year period.

 

*OutsourcingServices ($ in**thousands):*

 
| ** **           | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|----------------------|------------|-------------------------------------|------------|--------------|------------|------------------------------------|------------|--------------|------------|
| ** **           | ** ** | **2005**                            | ** ** | **2004**     | ** ** | **$**                              | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                 |       |                                |       |         |       |                               |       |         |       |   |   |   |   |   |   |   |   |
| Outsourcing Services |       | $                                   | 220        |         | $          | 50                                 |       | $            | 170        |   | — | % | $ | 718 |   | $ | 60 |   | $ | 658 |   | — | % |
|                      |            |                                     |            |              |            |                                    |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Our outsourcing service revenue is derived throughCarretek, our 51% owned business which outsources payment and transactionprocessing.  Carretek was formed infiscal 2003 and signed its first agreement in Q2 2004.  The fiscal 2004 revenues were minimal;however in late Q4 2004, we expanded our scope of business with our initialcustomer to include a second set of transaction processing functions, and in Q12005 we added a third set of transaction processing functions and since thattime have continued to increase the number of business process outsourcing transactionsprocessed.

 

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

 
| ** **                            | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|---------------------------------------|------------|-------------------------------------|------------|--------------|------------|------------------------------------|------------|--------------|------------|
| ** **                            | ** ** | **2005**                            | ** ** | **2004**     | ** ** | **$**                              | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                                  |       |                                |       |         |       |                               |       |         |       |   |   |   |   |   |   |   |   |
| Out-of-Pocket  Expense Reimbursements |       | $                                   | 701        |         | $          | 813                                |       | $            | (112       | ) | (13.8 | )% | $ | 2,446 |   | $ | 2,365 |   | $ | 81 |   | 3.4 | % |
|                                       |            |                                     |            |              |            |                                    |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Thedecrease in these reimbursements on a quarterly basis occurred primarily due toa $76,000 decline within the GPC business segment, and corresponds with the decreasein consulting revenue noted above.  Mostof our software services and consulting engagements require our employees to beat the customer location for extended periods of time, which gives rise toout-of-pocket expense reimbursements.  Thesereimbursements are recognized as revenue when they are billable to the customerand can fluctuate from period to period.

 

36

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***Cost of Revenues***

 

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

 
| ** **                       | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|----------------------------------|------------|-------------------------------------|------------|--------------|------------|------------------------------------|------------|--------------|------------|
| ** **                       | ** ** | **2005**                            | ** ** | **2004**     | ** ** | **$**                              | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                             |       |                                |       |         |       |                               |       |         |       |   |   |   |   |   |   |   |   |
| Revenue Enhancement              |       | $                                   | 5,185      |         | $          | 4,139                              |       | $            | 1,046      |   | 25.3 | % | $ | 14,566 |   | $ | 13,114 |   | $ | 1,452 |   | 11.1 | % |
| % of revenue                     |       | 64.6                                | %          | 51.8         | %          |                               |       |         |       | 52.2 | % | 47.7 | % |   |   |   |   |
|                             |       |                                |       |         |       |                               |       |         |       |   |   |   |   |   |   |   |   |
| Global Payments Technologies     |       | $                                   | 8,303      |         | $          | 10,138                             |       | $            | (1,835     | ) | (18.1 | )% | $ | 24,694 |   | $ | 27,315 |   | $ | (2,621 | ) | (10.0 | )% |
| % of revenue                     |       | 43.6                                | %          | 47.4         | %          |                               |       |         |       | 45.3 | % | 46.4 | % |   |   |   |   |
|                             |       |                                |       |         |       |                               |       |         |       |   |   |   |   |   |   |   |   |
| Global Payments Consulting       |       | $                                   | 887        |         | $          | 1,285                              |       | $            | (398       | ) | (31.0 | )% | $ | 2,661 |   | $ | 3,971 |   | $ | (1,310 | ) | (33.0 | )% |
| % of revenue                     |       | 82.7                                | %          | 109.3        | %          |                               |       |         |       | 79.5 | % | 110.0 | % |   |   |   |   |
|                             |       |                                |       |         |       |                               |       |         |       |   |   |   |   |   |   |   |   |
| Corporate (Outsourcing Services) |       | $                                   | 424        |         | $          | 223                                |       | $            | 201        |   | 90.1 | % | $ | 1,437 |   | $ | 236 |   | $ | 1,201 |   | — | % |
| % of revenue                     |       | 192.7                               | %          | 446.0        | %          |                               |       |         |       | 200.1 | % | 393.3 | % |   |   |   |   |
|                             |       |                                |       |         |       |                               |       |         |       |   |   |   |   |   |   |   |   |
| Total Cost of Revenues           |       | $                                   | 14,799     |         | $          | 15,785                             |       | $            | (986       | ) | (6.2 | )% | $ | 43,358 |   | $ | 44,636 |   | $ | (1,278 | ) | (2.9 | )% |
| % of revenue                     |       | 52.2                                | %          | 51.6         | %          |                               |       |         |       | 50.1 | % | 49.6 | % |   |   |   |   |

 

Theincrease in the cost of revenues on an absolute dollar basis in the RevEbusiness segment, on both a quarterly and YTD basis, was primarily the resultof increases in the cost of services within the CVE product group as theymanaged and staffed three new large engagements.  The significant increases in the cost ofrevenues as a percentage of total RevE revenue on a quarterly and YTD basis wasprimarily the result of a decline in higher margin RevE consulting revenue beingreplaced by lower margin CVE services and software license revenue.

 

Thedecrease in the cost of revenues on an absolute basis within the GPT businesssegment, on both a quarterly and YTD basis, was the result of personnelreductions in the last half of fiscal 2004 and more recently in August2005.  We have also increasedcross-utilization of services personnel on maintenance and research anddevelopment projects.  The YTDimprovements in the software services margins within GPT have been partiallyoffset by declines in software license revenue margins due primarily todeclines in software license revenue and the relatively fixed nature of theamortization of software license costs, which is included in the cost ofsoftware licenses.

 

Theabsolute dollar cost reductions, on both a quarterly and YTD basis, within GPCwere primarily attributable to personnel reductions achieved during the latterhalf of fiscal 2004 to bring our costs in line with expected consultingrevenues.  With total revenue for GPCbasically flat, on both a quarterly and YTD basis, cost of revenues as apercentage of total GPC revenue decreased dramatically.

 

Thedirect cost increase related to Carretek, our 51% owned business whichoutsources payment and transaction processing, is related to the direct costs attributableto our single customer which began in Q2 2004. We expect the financial results for this business to improve as weexpand the scope of our initial engagement and to the extent we achieve successin adding additional customers.

 

37

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*Cost ofConsulting ($ in thousands):*

 
| ** **               | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|--------------------------|------------|-------------------------------------|------------|--------------|------------|------------------------------------|------------|--------------|------------|
| ** **               | ** ** | **2005**                            | ** ** | **2004**     | ** ** | **$**                              | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                     |       |                                |       |         |       |                               |       |         |       |   |   |   |   |   |   |   |   |
| Cost of Consulting       |       | $                                   | 4,369      |         | $          | 4,555                              |       | $            | (186       | ) | (4.1 | )% | $ | 12,887 |   | $ | 14,166 |   | $ | (1,279 | ) | (9.0 | )% |
| % of consulting  revenue |       | 65.0                                | %          | 57.4         | %          |                               |       |         |       | 52.5 | % | 51.5 | % |   |   |   |   |
|                          |            |                                     |            |              |            |                                    |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Thecost of consulting within the GPC business segment decreased $375,000, or 38.7%,to $593,000 in Q3 2005 as compared to $968,000 in Q3 2004 and decreased $1.1million, or 37.7%, to $1.9 million for YTD 2005 as compared to $3.0 million forYTD 2004.  The decline in costs, on botha quarterly and YTD basis, was achieved through personnel reductions made inthe latter half of fiscal year 2004 to bring costs in line with expected GPCconsulting revenues.

 

The cost of consulting within the RevE businesssegment increased $225,000, or 6.4%, to $3.7 million in Q3 2005 as compared to $3.5million in Q3 2004 and decreased $56,000, or 1.0%, to $10.9 million in YTD 2005as compared to $10.9 million in Q3 2004. The increase in Q3 2005 can be attributed to higher personnel costs,contractor costs and non-billable travel.

 

*Cost ofSoftware Licenses ($ in thousands):*

 
| ** **                     | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|--------------------------------|------------|-------------------------------------|------------|--------------|------------|------------------------------------|------------|--------------|------------|
| ** **                     | ** ** | **2005**                            | ** ** | **2004**     | ** ** | **$**                              | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                           |       |                                |       |         |       |                               |       |         |       |   |   |   |   |   |   |   |   |
| Cost of Software Licenses      |       | $                                   | 2,155      |         | $          | 2,503                              |       | $            | (348       | ) | (13.9 | )% | $ | 5,519 |   | $ | 5,771 |   | $ | (252 | ) | (4.4 | )% |
| % of software  license revenue |       | 40.5                                | %          | 43.9         | %          |                               |       |         |       | 44.3 | % | 35.8 | % |   |   |   |   |
|                                |            |                                     |            |              |            |                                    |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Thecost of software licenses consists primarily of amortization of capitalized andacquired software costs along with royalties payable to third parties recordedin the GPT business segment.  Theamortization of capitalized software was $419,000 and $668,000 in Q3 2005 andQ3 2004, respectively, and was $887,000 and $1.1 million in YTD 2005 and YTD2004, respectively.  The amortization ofacquired developed technology is $1.2 million in both Q3 2005 and Q3 2004, and$3.5 million in both YTD 2005 and YTD 2004. The acquired developed technology will be fully amortized in Q22007.  The decrease in the cost ofsoftware license revenue, on a quarterly and YTD basis, is primarily the resultof lower capitalized software amortization and slightly lower royalty expensein both periods.  The decline in softwarerevenue on a YTD basis, along with slightly decreased costs, resulted in asignificant increase in the cost of software license revenue as a percentage ofsoftware license revenue on a YTD basis.

 

In connection with software license and maintenanceagreements entered into with certain banks and purchase agreements entered intowith vendors under which we acquired software technology used in products soldto our customers, we are required to pay royalties on sales of certain softwareproducts.  Under these arrangements, weaccrue royalty expense when the associated revenue is recognized.  The royalty percentages generally range from20% to 50% of the associated revenue.  InQ3 2005, we recorded $569,000 of software royalty expense compared to $658,000 ofsoftware royalty expense recorded in Q3 2004. In YTD 2005, we recorded $1.1 million of software royalty expense, thesame amount recorded in YTD 2004. Depending on our future product mix, our margins from software licensefees may be positively or negatively impacted by fluctuations in softwareroyalty expense.

 

38

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*Cost ofSoftware Maintenance ($ in thousands):*

 
| ** **                         | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|------------------------------------|------------|-------------------------------------|------------|--------------|------------|------------------------------------|------------|--------------|------------|
| ** **                         | ** ** | **2005**                            | ** ** | **2004**     | ** ** | **$**                              | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                               |       |                                |       |         |       |                               |       |         |       |   |   |   |   |   |   |   |   |
| Cost of Software Maintenance       |       | $                                   | 3,588      |         | $          | 3,765                              |       | $            | (177       | ) | (4.7 | )% | $ | 10,999 |   | $ | 10,949 |   | $ | 50 |   | 0.5 | % |
| % of software  maintenance revenue |       | 33.2                                | %          | 32.8         | %          |                               |       |         |       | 33.6 | % | 33.4 | % |   |   |   |   |
|                                    |            |                                     |            |              |            |                                    |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Cost of software maintenance consists primarily ofpersonnel and facility costs to provide telephone support, product defectsupport and other enhancements to our existing products, which are notsignificant enough to extend the product’s life cycle or substantially increaseits marketability. The cost of maintenance decreased $177,000 or 4.7% for Q3 2005,as compared to Q3 2004, and increased $50,000, or 1.0%, on a YTD basis.

 

Thecost of software maintenance as a percentage of related maintenance revenue isconsistent on both a quarterly and YTD basis.  As discussed above, the annual maintenance feeis generally paid by the customer at the beginning of the maintenance periodand revenue 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 the revenue recognition untilthe time that the maintenance fee is paid by the customer.  When the payment is received, maintenancerevenue is recognized for the period that maintenance revenue was previouslydeferred.  As a result, our cost ofsoftware maintenance as a percentage of related maintenance revenue mayfluctuate.

 

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

 
| ** **                                               | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|----------------------------------------------------------|------------|-------------------------------------|------------|--------------|------------|------------------------------------|------------|--------------|------------|
| ** **                                               | ** ** | **2005**                            | ** ** | **2004**     | ** ** | **$**                              | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                                                     |       |                                |       |         |       |                               |       |         |       |   |   |   |   |   |   |   |   |
| Cost of Software  Implementation and Other Services      |       | $                                   | 3,562      |         | $          | 4,002                              |       | $            | (440       | ) | (11.0 | )% | $ | 10,217 |   | $ | 11,181 |   | $ | (964 | ) | (8.6 | )% |
| % of software  implementation and other services revenue |       | 77.7                                | %          | 86.6         | %          |                               |       |         |       | 75.1 | % | 100.3 | % |   |   |   |   |
|                                                          |            |                                     |            |              |            |                                    |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Costsof software implementation and other services consist primarily of personneland facility costs to provide software implementation and project managementsupport to customer software implementations within our GPT business segmentand the CVE software product within our RevE segment.  The cost of software implementation and otherservices in our GPT segment decreased $1.1 million, or 31.1%, to $2.5 millionin Q3 2005 as compared to $3.6 million in Q3 2004, and decreased $2.2 million,or 22.1%, to $7.9 million in YTD 2005 as compared to $10.1 million in YTD2004.  The decline in costs of softwareimplementation reflect decreased personnel costs within our GPT businesssegment.  These headcount reductions wereachieved in the latter half of fiscal 2004 and more recently in August 2005 toimprove utilization.  These declines werepartially offset by increases within the CVE group of our RevE segment.  The cost of software implementation and otherservices within CVE increased $686,000, or 333.6%, to $892,000 in Q3 2005 ascompared to $206,000 in Q3 2004, and increased by $1.3 million, or 175.8%, to $2.0million in YTD 2005 as compared to $700,000 in YTD 2004.  The increase in costs is primarily related tothird party contract labor costs used to manage and staff the three large CVEengagements.  The decline in the costs ofsoftware implementation and other services, as a percentage of softwareimplementation revenue and other services, was the result of improvedefficiency and utilization particularly within the Payments group of the GPTbusiness segment, along with an increased volume of active service engagementswithin the CVE group of the RevE business segment.

 

39

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

 
| ** **                         | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|------------------------------------|------------|-------------------------------------|------------|--------------|------------|------------------------------------|------------|--------------|------------|
| ** **                         | ** ** | **2005**                            | ** ** | **2004**     | ** ** | **$**                              | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                               |       |                                |       |         |       |                               |       |         |       |   |   |   |   |   |   |   |   |
| Cost of Outsourcing Service        |       | $                                   | 424        |         | $          | 222                                |       | $            | 202        |   | 91.0 | % | $ | 1,437 |   | $ | 236 |   | $ | 1,201 |   | — | % |
| % of outsourcing  services revenue |       | 192.7                               | %          | 444.0        | %          |                               |       |         |       | 200.1 | % | 393.3 | % |   |   |   |   |
|                                    |            |                                     |            |              |            |                                    |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The increase in the cost of outsourcing service feesis due to the creation of Carretek, our 51% owned business outsourcer forpayment and transaction processing.  InQ2 2004, this business retained its first customer.  We expect the margins for this business toimprove as we expand the scope of our initial engagement and to the extent weachieve success in adding additional customers.

 

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

 
| ** **                                 | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|--------------------------------------------|------------|-------------------------------------|------------|--------------|------------|------------------------------------|------------|--------------|------------|
| ** **                                 | ** ** | **2005**                            | ** ** | **2004**     | ** ** | **$**                              | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                                       |       |                                |       |         |       |                               |       |         |       |   |   |   |   |   |   |   |   |
| Cost of Out-of-Pocket Expenses             |       | $                                   | 701        |         | $          | 738                                |       | $            | (37        | ) | (5.0 | )% | $ | 2,299 |   | $ | 2,333 |   | $ | (34 | ) | (1.5 | )% |
| % of  out-of-pocket expense reimbursements |       | 100.0                               | %          | 90.8         | %          |                               |       |         |       | 94.0 | % | 98.6 | % |   |   |   |   |
|                                            |            |                                     |            |              |            |                                    |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Thesecosts represent travel, meals and other sundry expenses incurred by ouremployees.  These costs are invoiced tothe customer, without mark-up, usually on a monthly basis.  The absolute costs have increased on aquarterly basis due to increased CVE and GPT service engagements.  In addition, certain customer contractscontain expense maximums, so in certain cases not all expenses incurred can bepassed along to the customer without contractual revisions or the customer’sexpress written approval, which can increase the volatility of the cost ofout-of-pocket expenses as a percentage of out-of-pocket expense reimbursements.

 

40

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***Operating Costs and Expenses:***

 

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

 
| ** **                                   | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|----------------------------------------------|------------|------------------------------------------|------------|--------------|------------|-----------------------------------------|------------|--------------|------------|
| ** **                                   | ** ** | **2005**                                 | ** ** | **2004**     | ** ** | **$**                                   | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                                         |       |                                     |       |         |       |                                    |       |         |       |   |   |   |   |   |   |   |   |
| Selling, General and Administrative Expenses |       | $                                        | 11,191     |         | $          | 11,320                                  |       | $            | (129       | ) | (1.1 | )% | $ | 33,688 |   | $ | 35,483 |   | $ | (1,795 | ) | (5.1 | )% |
| % of total revenue                           |       | 39.4                                     | %          | 37.0         | %          |                                    |       |         |       | 39.0 | % | 39.4 | % |   |   |   |   |
|                                              |            |                                          |            |              |            |                                         |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Selling,general and administrative expenses generally consist of personnel costs suchas salaries, commissions, incentive compensation and non-reimbursable travel.Additionally, the provision for doubtful accounts, insurance, includingdirectors and officers insurance, as well as professional services such aslegal and accounting expense and other related costs are classified withinselling, general and administrative expense.

 

Wecontinue to focus on decreasing costs throughout the organization.  SG&A costs were essentially flat on aquarterly basis; however, some of the primary drivers of the overall decreasein SG&A costs in YTD 2005 as compared to YTD 2004, were as follows:

 

•                  Decreased corporate selling andmarketing costs and business unit software sales and product management costsof $1.8 million in YTD 2005 as compared to YTD 2004 due primarily to personnelreductions within our corporate sales function.

 

•                  Due to competitive realignment of ouremployee benefit costs we have decreased employee benefits costs of $579,000 inYTD 2005 as compared to YTD 2004 due primarily to savings achieved through the selectionof a new, lower cost health care plan and provider and passing a higherpercentage of the health care costs to our employees.  These declines in health care costs have beenpartially offset by increases in other employee benefits such as thereinstatement of the employer matching contribution in our 401(k) plan.

 

•                  Increased general and administrativecosts of $886,000 in YTD 2005, as compared to YTD 2004, were primarily drivenby increased contract labor and third party consulting costs related to an ERPsystem upgrade and business process reengineering project begun in late Q12005.  This effort, which is supposed tobe largely completed in Q2 2006, is expected to enhance management information systemsand produce operating cost efficiencies. Additionally because of a significant reduction in our delinquentaccounts receivable in 2004, our allowance for doubtful accounts was reduced $275,000in Q3 2004 and $667,000 in YTD 2004 as compared to an increase of $95,000 in Q32005 and $54,000 in YTD 2005.  These YTD increasesin general and administrative costs were partially offset by decreasedDirectors and Officers’ liability insurance and telecommunication expense.

 

41

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

 
| ** **                        | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|-----------------------------------|------------|------------------------------------------|------------|--------------|------------|-----------------------------------------|------------|--------------|------------|
| ** **                        | ** ** | **2005**                                 | ** ** | **2004**     | ** ** | **$**                                   | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                              |       |                                     |       |         |       |                                    |       |         |       |   |   |   |   |   |   |   |   |
| Research and Development Expenses |       | $                                        | 2,444      |         | $          | 2,520                                   |       | $            | (76        | ) | (3.0 | )% | $ | 7,481 |   | $ | 6,102 |   | $ | 1,379 |   | 22.6 | % |
| % of total revenue                |       | 8.6                                      | %          | 8.2          | %          |                                    |       |         |       | 8.6 | % | 6.8 | % |   |   |   |   |
|                                   |            |                                          |            |              |            |                                         |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Research and development expenses consist primarilyof personnel, contract labor, travel and facilities expenses incurred by ourresearch and development organization primarily within the GPT businesssegment.  Research and development costshave remained relatively flat on a quarterly basis and have increased $1.4million or 22.6% in YTD 2005, as compared to YTD 2004, as a result of lesssoftware costs capitalized in the 2005 YTD period.  Beginning in the latter half of fiscal 2003and carrying through fiscal 2004 and fiscal 2005, we have developed or arecurrently developing 9 new software offerings within the GPT segment and 2within our GPC segment.  Research anddevelopment costs are typically limited to development of new softwareproducts, or enhancements to existing software products, which extend theproduct’s life cycle and/or substantially increase its marketability.  Specific customer funded software developmentcosts are contained in “Cost of Software Implementation and Other Services.”

 

In accordance with SFAS No. 86, “*Accounting for Costs of Computer Equipment**to be Sold, Leased or Otherwise Marketed,”*we capitalized $0 in Q3 2005, as compared to $593,000 in Q3 2004, and wecapitalized $690,000 in YTD 2005 as compared to $2.2 million in YTD 2004.  In Q1 2005, we began to develop two new Cashsolutions and the costs associated with these two products represented 98% ofthe amount capitalized in YTD 2005.  Thefirst product verifies cash logistic invoices with automated precision and thesecond product is an internet-based track and trace system that streamlines thecash delivery management process.  In YTD 2004, 100% of the capitalization wasrelated to the development of payments products, primarily ExchgLink, ourproduct offering to send and receive check images, and Source Capture, a suiteof products which enables bank customers to capture check images at bankbranches, ATMs and corporate sites and to extend the functionality of ouranti-money laundering software and other risk solutions.  These product development projects in YTD2004 were of a larger scale and effort and therefore the amount of costscapitalized was larger in 2004 as compared to 2005 on both a quarterly and YTDbasis.  Based on our current softwaredevelopment plan, we do not expect to capitalize a material amount of softwaredevelopment costs in Q4 2005.

 

Software development costs of a product arecapitalized from the time technological feasibility is reached until thegeneral release of the product.  Weestablish technological feasibility either through the process of creating adetailed program design and reviewing the detailed program design for any highrisk development issues or the creation of a working model.  Capitalization only occurs if we believecosts capitalized are recoverable through future sales of the software productunder development.

 

*Amortization of Intangible Assets:*

 

Amortization of intangible assets was $350,000 for Q32005 and Q3 2004, and $1.1 million for YTD 2005 and YTD 2004.  The amortization results from the periodicrecognition of amortization expense, through the second quarter of fiscal 2007,of intangible customer relationships acquired in the Check Solutionsacquisition in 2001.  These intangibleassets will be fully amortized in Q2 2007.

 

42

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

** **

| ** **                                   | ** ** | **Workforce  Reductions** | ** ** | **EPG  Litigation  Settlement** | ** ** | **Legal and  Professional  Fees** | ** ** | **Other**  | ** ** | **Total**  | ** ** |
|----------------------------------------------|------------|---------------------------|------------|---------------------------------|------------|-----------------------------------|------------|------------|------------|------------|------------|
| ** **                                   | ** ** | ** **                | ** ** | ** **                      | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| **YTD 2004:**                                |       |                      |       |                            |       |                              |       |       |       |       |       |
| Quarterly period ended April 30, 2004   | ** ** | 308                       |       | 1,686                           |       | 521                               |       | —     |       | 2,515      |       |
| Quarterly period ended July 31, 2004    | ** ** | 192                       |       | 14                              |       | 1,206                             |       | (1,215     | )          | 197        |       |
| Quarterly period ended October 31, 2004 | ** ** | 246                       |       | —                          |       | 20                                |       | —     |       | 266        |       |
| Total YTD 2004                               | ** ** | $                         | 746        |                            | $          | 1,700                             |       | $          | 1,747      |       | $          | (1,215 | ) | $ | 2,978 |   |
| ** **                                   | ** ** |                      |       |                            |       |                              |       |       |       |       |       |
| **YTD 2005:**                                |       |                      |       |                            |       |                              |       |       |       |       |       |
| Quarterly period ended April 30, 2005   | ** ** | 127                       |       | —                          |       | —                            |       | (32        | )          | 95         |       |
| Quarterly period ended July 31, 2005    | ** ** | 28                        |       | —                          |       | —                            |       | —     |       | 28         |       |
| Quarterly period ended October 31, 2005 | ** ** | 780                       |       | —                          |       | —                            |       | —     |       | 780        |       |
| Total YTD 2005                               | ** ** | $                         | 935        |                            | $          | —                            |       | $          | —     |       | $          | (32 | ) | 903 |   |
|                                              |            |                           |            |                                 |            |                                   |            |            |            |            |            |  |  |  |  |  |

** **

**Quarter Ended April 30, 2004**

** **

Werecorded $308,000 in restructuring and other charges during the three monthperiod ended April 30, 2004, principally associated with the separation of10 employees.  We expensed approximately$1.686 million for compensatory damages to EPG after the jury returned averdict in favor of EPG on one claim and Carreker on three claims.  This litigation was ultimately settled in June 2004for $1.7 million.  We recorded a chargeof $521,000 relating to legal and professional fees relating to these legalactions.

** **

**Quarter Ended July 31, 2004**

 

Werecorded $192,000 in restructuring and other charges during the three monthperiod ended July 31, 2004, principally associated with the separation of8 employees.  During the quarter ended July 31,2004, we recorded a charge of $36,000 relating to legal and professional feesrelating to our shareholder legal actions described in Note 8 to CondensedConsolidated Unaudited Financial Statements.

 

On July 8,2004, we settled with EPG for $1.7 million. An additional $14,000 was expensed and the settlement paid to theplaintiff.  Additionally, we recorded acharge for the litigation costs related to this legal action totaling $1.2million.

 

Finally,we received a final payment of $455,000 from a customer in the final settlementwith 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**

 

Werecorded $246,000 in restructuring and other charges during the three monthperiod ended October 31, 2004, principally associated with the separationof 6 employees.  During the quarter endedOctober 31, 2004, we recorded a charge of $20,000 relating to legal andprofessional fees relating to the Company’s shareholder legal actions describedin Note 8.

** **

**43**

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** **

**Quarter Ended April 30, 2005**

** **

Werecorded $127,000 in restructuring and other charges during the three monthperiod ended April 30, 2005, principally associated with the separation of6 employees.  We also lowered ourestimate by $32,000 for the costs associated with the discontinuance of one ofour software offerings, originally recorded in January 2004.

** **

**Quarter Ended July 31, 2005**

** **

**Werecorded $28,000 in restructuring and other charges during the three monthperiod ended July 31, 2005, principally associated with the separation of2 employees.**

 

**QuarterEnded October 31, 2005**

 

**Werecorded $780,000 in restructuring and other charges during the three monthperiod ended October 31, 2005, principally associated with the separationof 29 employees primarily within the GPT business segment.**

** **

Theactivity related to the accrued merger and restructuring costs during the threemonths ended October 31, 2005 is as follows (in thousands):

 
| ** **                       | ** ** | **Workforce  Reductions** | ** ** | **Charges  relating to  CheckFlow  Suite** | ** ** | **Facility  Closures** | ** ** | **Other** | ** ** | **Total** | ** ** |
|----------------------------------|------------|---------------------------|------------|--------------------------------------------|------------|------------------------|------------|-----------|------------|-----------|------------|
|                             |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Balance at January 31, 2005 |       | $                         | 652        |                                       | $          | 200                    |       | $         | 49         |      | $          | 103 |   | $ | 1,004 |   |
|                             |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Additions to reserve balance:    |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Severance charges                |       | 127                       |       | —                                     |       | —                 |       | —    |       | 127       |       |
| Reductions to reserve balances:  |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Cash paid                        |       | (494                      | )          | —                                     |       | (44                    | )          | —    |       | (538      | )          |
| Change in estimate               |       | —                    |       | —                                     |       | —                 |       | (32       | )          | (32       | )          |
| Balance at April 30, 2005   |       | $                         | 285        |                                       | $          | 200                    |       | $         | 5          |      | $          | 71 |   | $ | 561 |   |
|                             |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Additions to reserve balance:    |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Severance charges                |       | 28                        |       | —                                     |       | —                 |       | —    |       | 28        |       |
| Reductions to reserve balances:  |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Cash paid                        |       | (285                      | )          | —                                     |       | (5                     | )          | (24       | )          | (314      | )          |
| Balance at July 31, 2005    |       | $                         | 28         |                                       | $          | 200                    |       | $         | —     |      | $          | 47 |   | $ | 275 |   |
|                             |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Additions to reserve balance:    |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Severance charges                |       | 780                       |       | —                                     |       | —                 |       | —    |       | 780       |       |
| Reductions to reserve balances:  |       |                      |       |                                       |       |                   |       |      |       |      |       |
| Cash paid                        |       | (426                      | )          | —                                     |       | —                 |       | —    |       | (426      | )          |
| Balance at October 31, 2005 |       | $                         | 382        |                                       | $          | 200                    |       | $         | —     |      | $          | 47 |   | $ | 629 |   |

 

Weanticipate the remaining reserve accruals at October 31, 2005 will be paidor remaining customer obligations completed within the next 9 months.

 

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

 

*Interest Income ($ in thousands):*

 
| ** **      | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|-----------------|------------|------------------------------------------|------------|--------------|------------|-----------------------------------------|------------|--------------|------------|
| ** **      | ** ** | **2005**                                 | ** ** | **2004**     | ** ** | **$**                                   | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|            |       |                                     |       |         |       |                                    |       |         |       |   |   |   |   |   |   |   |   |
| Interest Income |       | $                                        | 185        |         | $          | 92                                      |       | $            | 93         |   | 101.1 | % | $ | 495 |   | $ | 207 |   | $ | 288 |   | 139.1 | % |
|                 |            |                                          |            |              |            |                                         |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Interestincome consists of interest earned on cash and cash equivalents and marketablesecurities.  The increases on both aquarterly and YTD basis are primarily the result of higher average invested balancesduring Q3 2005 as compared to Q3 2004, and YTD 2005 as compared to YTD 2004,and higher yields on these investments.

 

*Interest Expense ($ in thousands):*

 
| ** **       | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|------------------|------------|------------------------------------------|------------|--------------|------------|-----------------------------------------|------------|--------------|------------|
| ** **       | ** ** | **2005**                                 | ** ** | **2004**     | ** ** | **$**                                   | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|             |       |                                     |       |         |       |                                    |       |         |       |   |   |   |   |   |   |   |   |
| Interest Expense |       | $                                        | 122        |         | $          | 106                                     |       | $            | 16         |   | 15.1 | % | $ | 334 |   | $ | 336 |   | $ | (2 | ) | (1 | )% |
|                  |            |                                          |            |              |            |                                         |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Interestexpense is primarily the result of the commitment fees associated with themaintenance of our $30.0 million revolving credit agreement.  Additionally, the amortization of thedeferred loan costs is also included in interest expense.  There have been no borrowings outstandingunder this credit agreement since Q1 2004.

 

*Other income ($ in thousands):*

 
| ** **                                                  | ** ** | **Three Months Ended  October 31,** | ** ** | **Variance** | ** ** | **Nine Months Ended  October 31,** | ** ** | **Variance** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------|------------|--------------|------------|-----------------------------------------|------------|--------------|------------|
| ** **                                                  | ** ** | **2005**                                 | ** ** | **2004**     | ** ** | **$**                                   | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                                                        |       |                                     |       |         |       |                                    |       |         |       |   |   |   |   |   |   |   |   |
| Gain on sale of Cash Services Australia Pty. Limited        |       | $                                        | —     |         | $          | —                                  |       | $            | —     |   | — | % | $ | — |   | $ | 539 |   | (539 | ) | (100.0 | )% |
| Equity in earnings of Cash Services Australia Pty.  Limited |       | —                                   |       | —       |       | —                                  |       | —       | %          | — |   | (17 | ) | 17 |   | 100.0 | % |
| Minority share of net loss of Carretek LLC                  |       | 269                                      |       | 234          |       | 35                                      |       | 15.0         | %          | 799 |   | 454 |   | 345 |   | 76.0 | % |
| Foreign exchange (losses) / gains                           |       | 12                                       |       | 43           |       | (31                                     | )          | (72.1        | )%         | (89 | ) | (245 | ) | 156 |   | 63.7 | % |
| Other                                                       |       | 2                                        |       | (2           | )          | 4                                       |       | 200.0        | %          | 8 |   | 1 |   | 7 |   | 700.0 | % |
|                                                        |       |                                     |       |         |       |                                    |       |         |       |   |   |   |   |   |   |   |   |
| Total                                                       |       | $                                        | 283        |         | $          | 275                                     |       | $            | 8          |   | 2.9 | % | $ | 718 |   | $ | 732 |   | $ | (14 | ) | (1.9 | )% |
|                                                             |            |                                          |            |              |            |                                         |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

We owna 51% interest in Carretek LLC (“Carretek”), through which we offer financialinstitutions offshore-centric outsourcing of their business processes.  Carretek has generated approximately $549,000and $480,000 in losses for Q3 2005 and Q3 2004, respectively, and $1.6 millionand $926,000 in losses for YTD 2005 and YTD 2004, respectively.  Accordingly, the 49% share relating to theminority interest in these losses, or $269,000 and $234,000 on a quarterlybasis and $799,000 and $454,000 on a YTD basis, was recorded in other income(expense).

 

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*Provision for Income Taxes:*

 

The Company has established a valuation allowance toreserve its net deferred tax assets at October 31, 2005 because the morelikely than not criteria for future realization of the Company’s net deferredtax assets specified in Statement of Financial Accounting Standards No. 109,“*Accounting for Income Taxes,”* (“SFASNo. 109”) were not met.

 

The foreign tax provision was $102,000 and $270,000 forthe three and nine months ended October 31, 2005 and consists primarily ofa provision for foreign taxes.  Additionally,we recorded $15,000 of U.S. Federal tax expense has been recorded in the nine monthsended October 31, 2005 for alternative minimum tax purposes due to theavailability of net operating losses from prior years.  No U.S. Federal income tax benefit wasrecorded at October 31, 2005 due to the uncertainty regarding the Company’sability to generate taxable income, and resulting uncertainty relative to therecoverability of deferred tax assets.

 

In May 2004, the federal tax law changed toallow software license revenue to be deferred for tax purposes similar to thepercent-complete revenue recognition model we use for financial statementpurposes.  The impact of this change inthe tax law increased the amount of the net operating loss carryforwards by$8.6 million.

 

**Liquidityand Capital Resources**

 

Historically,we have funded our operations and cash expenditures primarily with cashgenerated from operating activities.  At October 31,2005, we had working capital of $16.3 million compared to $12.3 million at January 31,2005.  We had $24.2 million in cash andcash equivalents at October 31, 2005, a decrease of $10.3 million from$34.5 million in cash and cash equivalents at January 31, 2005.  However, we also had $4.5 million of “availablefor sale” marketable securities at October 31, 2005, compared to nomarketable securities at January 31, 2005. At October 31, 2005 and January 31, 2005, we did not have anyborrowings outstanding under our revolving line of credit.  We expect that existing cash, marketablesecurities and cash generated from operating activities will be sufficient tomeet our presently anticipated requirements for the foreseeable future.

 

Cash providedby operating activities was $2.2 million for the three months ended October 31,2005 compared to cash used in operating activities of $209,000 in the threemonths ended October 31, 2004.  Cashused in operating activities was $1.6 million for the nine months ended October 31,2005 compared to cash provided by operating activities of $7.3 million for the ninemonths ended October 31, 2004.  Thisdecline in YTD 2005 was primarily the result of the timing of the collection of2005 calendar year maintenance billings as compared to the prior year.  An increased percentage of these 2005maintenance renewals was collected in Q4 2004 and therefore the cash wasreceived in fiscal 2004 as opposed to fiscal 2005.

 

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, 2005 |       | 42      |       |
| July 31, 2005    |       | 49      |       |
| April 30, 2005   |       | 35      |       |
| January 31, 2005 |       | 35      |       |
| October 31, 2004 |       | 35      |       |
| July 31, 2004    |       | 46      |       |
| April 30, 2004   |       | 46      |       |

 

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Cashused in investing activities decreased to $423,000 during the three monthsended October 31, 2005 as compared to $1.9 million during the three monthsended October 31, 2004.  The cashused in investing activities increased to $7.0 million during the nine monthsended October 31, 2005 as compared to $4.9 million during the nine monthsended October 31, 2004.  This declineon a quarterly basis can be attributed to less computer software costscapitalized and less purchases of property and equipment.  Basedon our current software development plan, we do not expect to capitalize amaterial amount of software development costs in Q4 2005.  In 2004, our capital expenditure levelhad increased primarily as the result of replacing certain development hardwareand software within our technology group in Charlotte, North Carolina.  The increase on a YTD 2005 basis wasprimarily the result of the purchase of $4.6 million of marketable securitiesduring the three months ended July 31, 2005, partially offset by a declinein both capital expenditures and capitalized software development.

 

Financingactivities provided cash of $650,000 in the three months ended October 31,2005 as compared to $486,000 in the three months ended October 31,2004.  The sources of cash in bothquarterly periods were primarily the proceeds from the exercise of stockoptions along with equity contributions to Carretek LLC from our minorityshareholder.

 

Financingactivities used cash of $1.8 million for the nine months ended October 31,2005 as compared to a use of cash of $4.2 million during the nine months ended October 31,2004.  During the nine months ended October 31,2005, we purchased a total of $3.2 million of treasury stock under the programdescribed above.  These treasury stockpurchases were offset by $931,000 of equity contributions by the minorityshareholder of Carretek LLC and $542,000 related to the proceeds from theexercise of stock options.  During the ninemonths ended October 31, 2004, we made a $6.3 million debt payment, whichwas offset by $1.6 million of proceeds related to stock options and $432,000 equitycontributions by the minority shareholder of Carretek LLC.

 

We area party to a revolving credit agreement with a group of banks providing for acommitment amount of $30.0 million and a maturity date of July 31,2006.  At October 31, 2005 and October 31,2004, the Company did not have any borrowings outstanding.  Borrowings under the credit agreementcurrently bear interest equal to either the greater of prime or federal fundsrate plus a margin ranging from 1.25% to 2.25% depending on our ratio of fundeddebt to Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”);or London Interbank Offered Rate (“LIBOR”) plus a margin equal to 2.75% to3.75% depending on our ratio of funded debt to EBITDA.  Interest payments are due quarterly.  We are required to pay an annual commitmentfee equal to 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 andthe purchase of treasury stock is precluded subject to the approval of thebanks.  We obtained a written waiver tothis covenant in April 2005 when we announced our stock repurchase program.  Substantially all of our assets collateralizethis revolving credit agreement.  As of October 31,2005, we are in compliance with the covenants of the revolving creditagreement, as amended.

 

Thefollowing summarizes our contractual obligations at October 31, 2005 andthe effect these contractual obligations are expected to have on our liquidityand cash flows in future periods (in thousands):

 
| ** **       | ** ** | **Payments Due by Period** | ** ** |
|------------------|------------|----------------------------|------------|
| ** **       | ** ** | **Total**                  | ** ** | **1 Year  or Less** | ** ** | **Years 2-3** | ** ** | **Years 4-5** | ** ** | **After  5 Years** | ** ** |
|             |       |                       |       |   |   |   |   |   |   |   |   |
| Operating leases |       | $                          | 12,806     |   | $ | 3,401 |   | $ | 5,766 |   | $ | 3,639 |   | $ | — |   |
|                  |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Webelieve that current cash balances and marketable securities and expectedfuture cash flows will be sufficient to meet our anticipated cash needs forworking capital, capital expenditures and other activities during fiscal 2005and fiscal 2006.  However, if currentsources are not sufficient to meet our needs, we may seek additional equity ordebt financing.  There can be noassurance that additional financing would be available on acceptable terms, ifat all.

 

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Weexpect to adopt SFAS No. 123(R) which requires all share-based payments toemployees including grants for stock options to be recognized in the Statementof Operations based on their fair values on February 1, 2006.  As of October 31, 2005, the expenserelated to unvested options granted to date is as follows for the indicatedfiscal years ending January 31, (in thousands):

 
| **Year** | ** ** | **Amount** | ** ** |
|----------|------------|------------|------------|
|     |       |       |       |
| 2007     |       | $          | 2,138      |   |
| 2008     |       | 999        |       |
| 2009     |       | 404        |       |
| 2010     |       | 85         |       |
|          |            |            |            |  |

 

We areconsidering accelerating the vesting of a portion of the outstanding options inQ4 2005, principally to reduce the stock option related expense in futureyears.

 

We arepresently involved in a number of lawsuits. While we do not expect any negative outcomes, the final resolutions ofthe lawsuits are unknown, and could include judgments against us, orsettlements that could require additional substantial payments by us.  See Note 8 in our Notes to Condensed ConsolidatedUnaudited Financial Statements.  Thetiming of the final resolution of these matters is uncertain.  We believe that a material adverse outcome oroutcomes with respect to the lawsuits could have a material adverse effect onour financial results, our business or our management including but not limitedto, significantly impacting our liquidity in a negative manner as well ascausing covenant violations under our revolving credit agreement, possiblyresulting in a default thereunder. Further, we may in the future pursue acquisitions of businesses,products or technologies that could complement or expand our business andproduct offerings, and change our financing needs.  Our forecast of the period of time throughwhich our financial resources will be adequate to support our operations is aforward looking statement that involves risks and uncertainties, and actualresults could vary.  The failure tosecure additional financing when needed could have a material adverse effect onour business, financial condition and results of operations.

 

Critical AccountingPolicies

 

In preparing ourconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States, we use certain estimates andassumptions that affect the reported amounts and related disclosures and ourestimates may vary from actual results. We consider the following seven accounting policies the most importantto the portrayal of our financial condition and those that require the mostsubjective judgment.  Although we believethat our estimates and assumptions are reasonable, actual results may differ,and such differences could be significant to our financial results.

 

RevenueRecognition

 

Ourrevenue recognition policies are in accordance with Statement of Position (“SOP”)97-2, *“Software Revenue Recognition,”* asamended by SOP 98-9, “*Modification of SOP 97-2,Software Revenue Recognition with Respect to Certain Transactions,”*and Staff Accounting Bulletin (“SAB”) No. 104, *“RevenueRecognition,”* and EmergingIssues Task Force (“EITF”) No. 00-21,*“RevenueArrangements with 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.”*

 

In thecase of non-software arrangements, we apply EITF No. 00-21 and revenuesrelated to arrangements with multiple elements are allocated to each elementbased on the element’s relative fair value. Revenue allocated to separate elements is recognized for each element inaccordance with our accounting policies described below.  If we cannot account for items included in amultiple-element arrangement as separate units of accounting, they are combinedand accounted for as a single unit of accounting and generally recognized asthe undelivered items or services are provided to the customer.

 

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*Consulting.*  We employ three primary pricing methods inconnection with our delivery of consulting services. First, we may price ourdelivery of consulting services on the basis of time and materials, in whichcase the customer is charged agreed-upon daily rates for services performed andout-of-pocket expenses. In this case, we are generally paid fees and relatedamounts usually on a monthly basis, and we recognize revenues as the servicesare performed. Second, we may deliver consulting services on a fixed-pricebasis. In this case, we are generally paid on a monthly basis or pursuant to anagreed upon payment schedule, and we recognize revenues on a proportionateperformance basis. We believe that this method is appropriate because of ourability to determine performance milestones and determine dependable estimatesof our costs applicable to each phase of a contract.  Because financial reporting of thesecontracts depends on estimates, which are assessed continually during the termof the contract, costs are subject to revisions as the contractprogresses.  Anticipated losses onfixed-priced contracts are recognized when estimable.  Third, we may deliver consulting services pursuantto a value-priced contract with the customer. In this case, we are paid, on anagreed upon basis with the customer, either a specified percentage of (1) theprojected increased revenues and/or decreased costs that are expected to bederived by the customer generally over a period of up to twelve monthsfollowing implementation of our solution or (2) the actual increasedrevenues and/or decreased costs experienced by the customer generally over aperiod of up to twelve months following implementation of our solution, subjectin either case to a maximum, if any is agreed to, on the total amount ofpayments to be made to us.  We must firstcommit time and resources to develop projections associated with value-pricingcontracts before a bank will commit to purchase our solutions, and we thereforeassume the risk of making these commitments with no assurance that the customerwill purchase the solution.  Costsassociated with these value-pricing contracts are expensed as incurred**.** These contracts typically include payments to be made to us pursuant toan agreed upon schedule ranging from one to twelve months in length. Werecognize revenues generated from consulting services in connection with value-pricedcontracts based upon projected results only upon completion of all services andagreement upon the actual fee to be paid (even though billings for theseservices may be delayed by mutual agreement for periods not to exceed twelvemonths). In an effort to allow customers to more closely match expected benefitsfrom our services with payments to us, we may on occasion, offer payment termswhich extend beyond 12 months.  When weenter into an agreement that has a significant component of the total amountpayable under the agreement due beyond 12 months or if it is determinedpayments are not fixed and determinable at the date the agreement is enteredinto, revenue under the arrangement will be recognized as payments become dueand payable.  When fees are to be paidbased on a percentage of actual revenues and/or savings to our customers, werecognize revenues only upon completion of all services and as the amounts ofactual revenues or savings are confirmed by the customer with a fixed paymentdate.

 

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.

 

Weexpect that value-priced contracts will continue to account for a significantportion of our revenues in the future. As a consequence of the use of value-pricedcontracts and due to the revenue recognition policy associated with thosecontracts, our results of operations will likely fluctuate significantly fromperiod to period.

 

Regardlessof the pricing method employed by us in a given contract, we are typicallyreimbursed on a monthly basis for out-of-pocket expenses incurred on behalf ofour customers.

 

*SoftwareLicense.*  A perpetual softwarelicense is sold either together with implementation services or on a stand-alonebasis.  We are usually paid softwarelicense fees in one or more installments, as provided in the customer’scontract but not to exceed 12 months.  Werecognize software license revenue upon execution of a contract and delivery ofthe software, provided that the license fee is fixed and determinable, nosignificant production, modification or customization of the software isrequired and collection is considered probable by management.  When the software license arrangementrequires us to provide implementation services that are essential to thefunctionality of the software or significant production, customization ormodification of the software is required, both the product license revenue andimplementation fees are recognized as services are performed.  A term software license is sold eithertogether with implementation services and/or with maintenance services.  These term licenses are usually paid inannual installments over the term of the license.  If the term software license is sold withoutessential implementation services, the revenue is recognized ratably over thenon-cancelable license term.  If the termlicense is sold with essential implementation services, the license revenue isrecognized as the lesser of the amount of license revenue recognized asservices are performed or on a ratable basis.

 

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

 

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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 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, we initially defer revenue recognition of the software license feesuntil VSOEFV is established or the services are performed.  However, if VSOEFV is determinable for all ofthe undelivered elements, and assuming the undelivered elements are notessential to the delivered elements, we will defer recognition of the full fairvalue related to the undelivered elements and recognize the remaining portionof the arrangement value through application of the residual method.  Where VSOEFV has not been established forcertain undelivered elements, revenue for all elements is deferred until thoseelements have been delivered or their fair values have been determined.  Evidence of VSOEFV is determined for softwareproducts based on actual sales prices for the product sold to a similar classof customer and based on pricing strategies set forth in our price book.  Evidence of VSOEFV for services(installation, implementation and consulting) is based upon standard billingrates and the estimated level of effort for individuals expected to perform therelated services.  We establish VSOEFVfor maintenance agreements using the percentage method such that VSOEFV formaintenance is a percentage of the license fee charged annually for specificsoftware product, which in most instances is 20% of the portion of arrangementfees allocated to the software license element.

 

Althoughsubstantially all of our current software licenses provide for a fixed-pricelicense fee, some licenses provide for the customer to pay a monthly licensefee based on the actual use of the software product.  The level of license fees earned by us underthis arrangement will vary based on the actual amount of use by the customer.  Revenue under these arrangements isrecognized on a monthly basis as the usage becomes determinable.

 

*SoftwareMaintenance.*  Inconnection with our sale of a software license, a customer may elect topurchase software maintenance services. Most of the customers that purchasesoftware licenses from us also purchase software maintenance services, whichtypically are renewed annually. We charge an annual maintenance fee, which istypically a percentage of the initial software license fee. The annualmaintenance fee generally is paid to us at the beginning of the maintenanceperiod, and we recognize these revenues ratably over the term of the relatedcontract.  If the annual maintenance feeis not paid at the beginning of the maintenance period, we defer revenuerecognition until the time that the maintenance fee is paid by thecustomer.  We normally continue toprovide maintenance service while awaiting payment from customers.  When the payment is received, revenue isrecognized for the period that revenue was previously deferred.  This may result in volatility in softwaremaintenance revenue from period-to-period.

 

*Software Implementation and Other Services.*  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.

 

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

 

*ReturnProvisions.*  Ourcontracts typically do not include right of return clauses, and as a result, wedo not record a provision for returns.

 

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Royalties

 

Inconnection with software license and maintenance agreements entered into withcertain banks and purchase agreements with vendors under which we acquiredsoftware technology used in products sold to our customers, we are required topay royalties on sales of certain software products.  Under these arrangements, we accrue royaltyexpense 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 statements of operations.

 

Allowancefor Doubtful Accounts

 

Alarge proportion of our revenues and receivables are attributable to ourcustomers in the banking industry.  Ourtrade accounts receivable balance is recorded net of allowances for amounts notexpected to be collected from our customers. Because our accounts receivable are typically unsecured, we periodicallyevaluate the collectibility of our accounts based on a combination of factors,including a particular customer’s ability to pay as well as the age ofreceivables.  In cases where the evidencesuggests a customer may not be able to satisfy its obligation to us or if thecollection of the receivable becomes doubtful due to a dispute that arisessubsequent to the delivery of our products and services, we set up a specificreserve in an amount 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.

 

SoftwareCosts Capitalized, Acquired Developed Technology, Goodwill, Other IntangibleAssets and Other Long-Lived Assets

 

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

 

Goodwillis assessed on an annual basis for impairment at the reporting unit level byapplying a fair value based test.  Weperformed the initial impairment test of goodwill at February 1, 2002 anda follow up test at November 1, 2002 to determine if an impairment chargeshould be recognized under SFAS 142.  Theinitial impairment analysis did not result in any write-down of capitalizedcosts.  We perform an annual impairmentassessment on November 1st of each year or when factorsindicate that other long-lived assets should be evaluated for possibleimpairment.  We use an estimate ofundiscounted future net cash flows over the remaining life of the asset todetermine 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 quarterly period ended January 31,2005, we performed our annual evaluation for goodwill impairment and determinedthat the carrying amount of goodwill was not impaired and have not noted anyfactors subsequent that would indicate impairment.  Goodwill at October 31, 2005 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

 

Duringfiscal year 2001, we recorded reserves in connection with our acquisition ofCheck Solutions and subsequent operational restructurings.  Additional reserves were recorded during eachof the succeeding fiscal years.  Thesereserves contain significant estimates pertaining to work force reductions, andthe settlement of contractual obligations resulting from our actions.  Although we do not anticipate any significantchanges in the future, the actual costs may differ from these estimates.

 

Contingencies

 

We aresubject to proceedings, lawsuits and other claims.  We are required to assess the likelihood ofany adverse judgments or 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

 

Werecognize deferred tax assets or liabilities for the expected future taxconsequences of temporary differences between the book and tax basis of assetsand liabilities.  We review our deferredtax assets for recoverability and establish a valuation allowance based on historicaltaxable income, projected future taxable income and the expected timing of thereversals of existing temporary differences. As a result of our cumulative net losses we have provided a fullvaluation allowance against our net deferred tax assets.  In addition, we expect to provide a fullvaluation allowance of any future tax benefits until we can sustain a level ofprofitability that demonstrates our ability to utilize these assets.

 

**RecentlyIssued Accounting Standards**

 

See “RecentlyIssued Accounting Standards” in Note 2 of the Notes to Condensed Consolidated UnauditedFinancial Statements.

 

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

 

**InterestRate Risk**

 

Weinvest our cash in a variety of financial instruments.  The vast majority of these investments aredenominated in U.S. dollars and maintained with nationally recognized financialinstitutions.

 

Investmentsin both fixed rate and floating rate interest earning instruments carry adegree of interest rate risk.  Fixed ratesecurities may have their fair market value adversely impacted due to a rise ininterest rates, while floating rate securities may produce less income thanexpected if interest rates fall.  Due inpart to these factors, our future investment income may fall short ofexpectations due to changes in interest rates, or we may suffer losses inprincipal if forced to sell securities which have seen a decline in marketvalue due to changes in interest rates. At October 31, 2005, we held $4.5 million of auction ratenotes.  The interest rate for these noteswill adjust to the current market interest rate at each interest reset date,which is typically on at least a monthly basis.

 

We hadno outstanding borrowings under our revolving credit agreement at October 31,2005.  As described in Note 4 of ourNotes to Condensed Consolidated Unaudited Financial Statements, the interestrate under the revolving credit agreement is variable.

 

**Foreign Currency Risk**

 

Wecurrently have sales and marketing operations in several internationallocations including Canada, United Kingdom, South Africa and Australia.  As a result, we have assets and liabilitiesoutside the United States that are subject to fluctuations in foreign currencyexchange rates.  Due to the nature ofthese operations, we currently utilize the U.S. Dollar as the functionalcurrency for all international operations. Within Carretek LLC, our 51% owned subsidiary which offers financialinstitutions offshore-centric outsourcing of their business processes, themajority of the labor costs is denominated in Indian Rupees while the revenuesfrom this operation are denominated in U.S. Dollars.  As our operations increase, fluctuating laborcosts may increase our foreign currency risk.

 

An insignificant portion of our accounts receivablebalance at October 31, 2005 was denominated in a foreign currency.  Our exposure to adverse movements in foreignexchange rates is typically not significant. Therefore, we do not currently hedge our foreign currency exposure;however, we do try to limit our foreign currency exposure by negotiating theseforeign contracts in U.S. Dollars.  Inthe future we may change this practice. We will continue to evaluate the need to adopt a hedge strategy in thefuture and may implement a formal strategy in future periods.

 

Foreign exchange gains were $12,000 and $43,000 inthe three months ended October 31, 2005 and 2004, respectively, and $89,000and $245,000 losses in the nine months ended October 31, 2005 and 2004,respectively.

 

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**Item 4.  Controls andProcedures**

 

*DisclosureControls and Procedures*

 

Wemaintain disclosure controls and procedures designed to ensure that we are ableto collect the information we are required to disclose in the reports we fileunder the Securities Exchange Act of 1934 (“Exchange Act”), and to process,summarize and disclose this information within the time periods specified inthe rules under the Exchange Act.

 

Ourmanagement, under the supervision and with the participation of our ChiefExecutive and Chief Financial Officers, is responsible for evaluating theeffectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) of the Exchange Act).  Asof October 31, 2005, they carried out an evaluation of our disclosurecontrols and procedures, and the Chief Executive and Chief Financial Officersbelieve that these disclosure****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.

 

Indesigning and evaluating the disclosure controls and procedures, managementrecognized that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives, and management necessarily was required to apply itsjudgment in evaluating the cost-benefit relationship of possible controls andprocedures.

 

*Changesin Internal Control over Financial Reporting*

 

Therehave been no changes in our internal control over financial reporting duringour most recently completed fiscal quarter that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

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**PART II:   OTHER INFORMATION**

 

**ITEM 1.****     LEGAL PROCEEDINGS**

 

Theinformation with respect to certain legal proceedings set forth under “Contingencies”in Note 8 of the Notes to Condensed Consolidated Unaudited Financial Statements,is hereby incorporated by reference. Reference is also made to the information contained in Part I, Item3. Legal Proceedings in our Form 10-K for the period ended January 31,2005 and in Part II, Item 1. Legal Proceedings in our Forms 10-Q for theperiods ended April 30, 2005 and July 31, 2005.

 

Theparties conducted a mediation on November 23, 2005 for both theshareholder’s derivative action and the shareholder class action.  Although the mediation session did not resultin a settlement, the parties have agreed to continue settlement discussions andhave asked the court to postpone a ruling on the motion to dismiss theshareholder class action until January 15, 2006.

 

TheCompany and individual defendants deny the allegations in the complaintsreferenced in the information incorporated herein by reference and intend todefend themselves vigorously.  It is notpossible at this time to predict whether we will incur any liability or toestimate the damages, or the range of damages, if any, that we might incur inconnection with such lawsuits.  Theultimate resolution of such lawsuits could have a material adverse effect onour business, results of operations, financial condition and cash flows.

 

**ITEM 2.****     UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

 

Thefollowing table provides information about the Company’s purchases of shares ofits common stock in the open market during the nine months ended October 31,2005:

 
| **Period**                 | ** ** | **Total  Number of  Shares  Purchased** | ** ** | **Average  Price Paid  Per Share** | ** ** | **Total Number of  Shares Purchased as  part of Publicly  Announced Plans or  Programs** | ** ** | **Maximum Number  of Shares that may  yet be Purchased  under the Plans or  Programs** | ** ** |
|----------------------------|------------|-----------------------------------------|------------|------------------------------------|------------|------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
|                       |       |                                    |       |                               |       |                                                                                     |       |                                                                                   |       |
| 4/1/2005 – 4/30/2005  |       | 70,000                                  |       | $                                  | 4.98       |                                                                                     | 70,000     |                                                                                   |       | (1) |
| 5/1/2005 – 7/31/2005  |       | 560,511                                 |       | 5.04                               |       | 560,511                                                                                  |       |                                                                                   | (1)        |
| 8/1/2005 – 10/14/2005 |       | 900                                     |       | 6.02                               |       | 900                                                                                      |       |                                                                                   | (1)        |
| Total                      |       | 631,411                                 |       | $                                  | 5.03       |                                                                                     | 631,411    |                                                                                   |       | (1) |

 

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(1)          Under ashare repurchase program approved by the Board of Directors of CarrekerCorporation on April 18, 2005, the Company was authorized to repurchase upto $5.0 million of its common stock through October 14, 2005.  The repurchase program was designed to complywith Rules 10b5-1 and 10b-18 under the Securities Exchange Act of 1934under which an agent appointed by the Company determined the time, amount, andprice at which purchases of common stock would be made, subject to certainparameters established in advance by the Company.  The program expired on October 14, 2005.

 

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**ITEM 3.**     DEFAULTSUPON SENIOR SECURITIES

 

None.

 

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

 

None

 

 

**ITEM 5.****     OTHER INFORMATION**

 

None.

 

**ITEM 6.**     EXHIBITS

 
| **Number** | ** ** | **Exhibit Description**                                                                                                       |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                               |
| 10.1       |       | Form of  Stock Option Agreement for Executive Officers                                                                        |
|       |       |                                                                                                                               |
| 10.2       |       | Form of  Restricted Stock Agreement for Executive Officers                                                                    |
|       |       |                                                                                                                               |
| 31.1       |       | Certification  Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002                                              |
|       |       |                                                                                                                               |
| 31.2       |       | Certification  Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002                                              |
|       |       |                                                                                                                               |
| 32.1       |       | Certification  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 |
|       |       |                                                                                                                               |
| 32.2       |       | Certification  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 |

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Act of 1934, the Registrant has duly caused thisreport to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 

 
|   | CARREKER CORPORATION           |
|--------|--------------------------------|
|   |                           |
|   |                           |
| By:    | /s/ John D. Carreker, Jr. |   | Date: |   December 7,  2005 |   |
|   | John D. Carreker, Jr.     |   |
|   | Chairman of the  Board and     |   |
|   | Chief Executive  Officer       |   |
|   |                           |
|   |                           |
| By:    | /s/ Lisa K. Peterson           |   | Date: |   December 7,  2005 |   |
|   | Lisa K. Peterson               |   |
|   | Chief Financial  Officer       |   |
|        |                                |  |  |  |  |  |  |

 

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