**UnitedStatesSecurities and Exchange Commission**

**Washington,D.C.  20549**

 

# **FORM 10-Q**

 

**ý****Quarterly Report Pursuant to Section 13 or 15(d) of theSecurities Exchange Act of 1934**

**for thePeriod Ended April 30, 2004.**

 

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

**for theTransition Period from                                         to                                         .**

 

**Commissionfile number   0-24201**

 

**CarrekerCorporation**

(Exact name ofregistrant as specified in its charter)

 

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

 

**(972)458-1981**

(Registrant’stelephone number, including area code)

 

** **

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

 

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

 

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

Yes  ý   No  o

 

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

 

Common Stock, $.01 parvalue — 24,564,897 shares as of May 28, 2004.

 

 

----

 

**CARREKERCORPORATION**

 

**Index**

 
| **PART 1:**    |   | **FINANCIAL INFORMATION**                                                                                      |   |
|----------------|--------|----------------------------------------------------------------------------------------------------------------|--------|
|           |   |                                                                                                           |   |
| **Item 1.**    |   | **Financial Statements  (unaudited)**                                                                          |   |
|           |   |                                                                                                           |   |
|           |   | **Condensed Consolidated  Balance Sheets at April 30, 2004 and January 31, 2004**                              |   |
|           |   |                                                                                                           |   |
|           |   | **Condensed  Consolidated Statements of Operations for the three months ended April 30, 2004 and 2003**        |   |
|           |   |                                                                                                           |   |
|           |   | **Condensed  Consolidated Statements of Stockholders’ Equity for the three months ended  April 30, 2004** |   |
|           |   |                                                                                                           |   |
|           |   | **Condensed  Consolidated Statements of Cash Flows for the three months ended April 30, 2004 and 2003**        |   |
|           |   |                                                                                                           |   |
|           |   | **Notes  to Condensed Consolidated Unaudited Financial Statements**                                            |   |
|           |   |                                                                                                           |   |
| **Item  2.**   |   | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations**                |   |
|           |   |                                                                                                           |   |
| **Item  3.**   |   | **Quantitative  and Qualitative Disclosures about Market Risk**                                                |   |
|           |   |                                                                                                           |   |
| **Item 4.**    |   | **Controls and  Procedures**                                                                                   |   |
|           |   |                                                                                                           |   |
| **PART II:**   |   | **OTHER INFORMATION**                                                                                          |   |
|           |   |                                                                                                           |   |
| **Item 1.**    |   | **Legal Proceedings**                                                                                          |   |
|           |   |                                                                                                           |   |
| **Item  2.**   |   | **Changes  in 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 and  Reports on Form 8-K**                                                                          |   |
|           |   |                                                                                                           |   |
| **SIGNATURES** |   |

 

2

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**PARTI:  FINANCIAL INFORMATION**

 

**Item1.  Financial Statements**

 

**CARREKER CORPORATION**

**CondensedConsolidated Balance Sheets**

**(Unaudited)**

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

** **

**ASSETS**

 
|                                                                                                                                             |   | **April 30,  2004** |   | **January  31,  2004** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|--------|------------------------|--------|
|                                                                                                                                             |   |                |   |                   |   |
| Current assets                                                                                                                                   |   |                |   |                   |   |
| Cash and cash  equivalents                                                                                                                       |   | $                   | 31,486 |                   | $      | 28,605 |   |
| Accounts  receivable, net of allowance of $1,333 and $1,512 at April 30, 2004 and  January 31, 2004, respectively                                |   | 15,158              |   | 21,751                 |   |
| Prepaid expenses  and other current assets                                                                                                       |   | 4,048               |   | 3,331                  |   |
| Total current  assets                                                                                                                            |   | 50,692              |   | 53,687                 |   |
|                                                                                                                                             |   |                |   |                   |   |
| Property and  equipment, net of accumulated depreciation of $17,953 and $17,140 at April  30, 2004 and January 31, 2004, respectively            |   | 6,099               |   | 6,690                  |   |
| Capitalized  software costs, net of accumulated amortization of $11,290 and $11,050 at  April 30, 2004 and January 31, 2004, respectively        |   | 2,699               |   | 2,028                  |   |
| Acquired  developed technology, net of accumulated amortization of $12,308 and $11,153  at April 30, 2004 and January 31, 2004, respectively     |   | 13,392              |   | 14,547                 |   |
| Goodwill, net of  accumulated amortization of $3,405 at April 30, 2004 and January 31, 2004                                                      |   | 20,806              |   | 21,193                 |   |
| Customer  relationships, net of accumulated amortization of $4,083 and $3,733 at April  30, 2004 and January 31, 2004, respectively              |   | 4,317               |   | 4,667                  |   |
| Deferred loan  costs, net of accumulated amortization of $1,096 and $1,028 at April 30, 2004  and January 31, 2004, respectively                 |   | 612                 |   | 680                    |   |
| Other assets                                                                                                                                     |   | 694                 |   | 1,087                  |   |
| Total assets                                                                                                                                     |   | $                   | 99,311 |                   | $      | 104,579 |   |
|                                                                                                                                             |   |                |   |                   |   |
| Current  liabilities                                                                                                                             |   |                |   |                   |   |
| Accounts payable                                                                                                                                 |   | $                   | 696    |                   | $      | 913 |   |
| Accrued  compensation and benefits                                                                                                               |   | 6,470               |   | 9,219                  |   |
| Other accrued  expenses                                                                                                                          |   | 5,650               |   | 4,520                  |   |
| Income tax  payable                                                                                                                              |   | 148                 |   | 181                    |   |
| Deferred revenue                                                                                                                                 |   | 28,475              |   | 25,231                 |   |
| Accrued merger  and restructuring costs                                                                                                          |   | 1,760               |   | 1,898                  |   |
| Total current  liabilities                                                                                                                       |   | 43,199              |   | 41,962                 |   |
| Long-term debt                                                                                                                                   |   | —              |   | 6,250                  |   |
| Other long-term  liabilities                                                                                                                     |   | 196                 |   | 49                     |   |
| Total  liabilities                                                                                                                               |   | 43,395              |   | 48,261                 |   |
|                                                                                                                                             |   |                |   |                   |   |
| Commitments and  Contingencies                                                                                                                   |   |                |   |                   |   |
|                                                                                                                                             |   |                |   |                   |   |
| Stockholders’  equity                                                                                                                       |   |                |   |                   |   |
| Preferred stock,  $.01 par value:  2,000 shares authorized; no shares issued or outstanding                                                      |   | —              |   | —                 |   |
| Common stock,  $.01 par value:  100,000 shares authorized; 24,411 and 24,357 shares issued at April 30, 2004 and  January 31, 2004, respectively |   | 244                 |   | 244                    |   |
| Additional  paid-in capital                                                                                                                      |   | 109,167             |   | 108,757                |   |
| Accumulated  deficit                                                                                                                             |   | (53,492             | )      | (52,680                | )      |
| Less treasury  stock, at cost:  1 common share at  April 30, 2004 and January 31, 2004                                                      |   | (3                  | )      | (3                     | )      |
| Total  stockholders’ equity                                                                                                                 |   | 55,916              |   | 56,318                 |   |
| Total  liabilities and stockholders’ equity                                                                                                 |   | $                   | 99,311 |                   | $      | 104,579 |   |

 

See accompanying notes.

 

3

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**CARREKERCORPORATION**

**Condensed Consolidated Statements ofOperations**

**(Unaudited)**

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

 
|                                                       |   | **Three  Months Ended  April 30,** |   |
|------------------------------------------------------------|--------|------------------------------------|--------|
|                                                       |   | **2004**                           |   | **2003** |   |
|                                                       |   |                               |   |   |   |
| **Revenues:**                                              |   |                               |   |   |   |
| Consulting fees                                            |   | $                                  | 9,057  |   | $ | 6,751 |   |
| Software license  fees                                     |   | 5,856                              |   | 6,578 |   |
| Software  maintenance fees                                 |   | 11,084                             |   | 8,710 |   |
| Software  implementation fees                              |   | 2,879                              |   | 4,894 |   |
| Out-of-pocket  expense reimbursements                      |   | 890                                |   | 1,323 |   |
| Total revenues                                             |   | 29,766                             |   | 28,256 |   |
|                                                       |   |                               |   |   |   |
| **Cost  of revenues:**                                     |   |                               |   |   |   |
| Consulting fees                                            |   | 4,529                              |   | 4,969 |   |
| Software license  fees                                     |   | 1,598                              |   | 1,721 |   |
| Software  maintenance fees                                 |   | 3,798                              |   | 3,176 |   |
| Software  implementation fees                              |   | 3,369                              |   | 4,855 |   |
| Out-of-pocket  expenses                                    |   | 943                                |   | 1,253 |   |
| Total cost of  revenues                                    |   | 14,237                             |   | 15,974 |   |
| Gross profit                                               |   | 15,529                             |   | 12,282 |   |
|                                                       |   |                               |   |   |   |
| **Operating  costs and expenses:**                         |   |                               |   |   |   |
| Selling, general  and administrative                       |   | 12,654                             |   | 11,933 |   |
| Research and  development                                  |   | 1,708                              |   | 1,866 |   |
| Amortization of  goodwill and intangible assets            |   | 350                                |   | 350 |   |
| Litigation loss  provision                                 |   | 1,686                              |   | — |   |
| Restructuring  and other charges                           |   | 367                                |   | 684 |   |
| Total operating  costs and expenses                        |   | 16,765                             |   | 14,833 |   |
| Loss from  operations                                      |   | (1,236                             | )      | (2,551 | ) |
|                                                       |   |                               |   |   |   |
| **Other  income (expense):**                               |   |                               |   |   |   |
| Interest income                                            |   | 48                                 |   | 80 |   |
| Interest expense                                           |   | (108                               | )      | (418 | ) |
| Other income                                               |   | 484                                |   | 16 |   |
| Total other  income (expense)                              |   | 424                                |   | (322 | ) |
| Loss before  provision for income taxes                    |   | (812                               | )      | (2,873 | ) |
| Provision for  income taxes                                |   | —                             |   | 94 |   |
| Net loss                                                   |   | $                                  | (812   | ) | $ | (2,967 | ) |
| Basic and  diluted loss per share                          |   | $                                  | (0.03  | ) | $ | (0.13 | ) |
| Shares used in  computing basic and diluted loss per share |   | 24,376                             |   | 23,547 |   |

 

See accompanying notes.

 

4

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**CARREKER CORPORATION**

**Condensed Consolidated Statements of Stockholders’ Equity**

**(Unaudited)**

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

 
|                                                               |                |       |       |   |       | **Additional  Paid-In  Capital** |   | **Accumulated  Deficit** |   |   |    |   |   | **Total  Stockholders’  Equity** |   |
|--------------------------------------------------------------------|---------------------|------------|------------|--------|------------|----------------------------------|--------|--------------------------|--------|--------|---------|--------|--------|---------------------------------------|--------|
| **Common  Stock**                                                  | **Treasury  Stock** |
| **Shares**                                                         |                | **Amount** | **Shares** |   | **Amount** |
| Balance at  January 31, 2004                                       |                | 24,357     |       | $      | 244        |                             | $      | 108,757                  |   | $      | (52,680 | )      | 1      |                                  | $      | (3 | ) | $ | 56,318 |   |
|                                                               |                |       |       |   |       |                             |   |                     |   |   |    |   |   |                                  |   |
| Cancellation of  restricted stock                                  |                | (20        | )          | — |       | —                           |   | —                   |   | — |    | — |   | —                                |   |
| Compensation  expense related to issuance of restricted stock      |                | —     |       | — |       | 35                               |   | —                   |   | — |    | — |   | 35                                    |   |
| Issuance of  shares of common stock upon exercise of stock options |                | 74         |       | — |       | 375                              |   | —                   |   | — |    | — |   | 375                                   |   |
| Net loss                                                           |                | —     |       | — |       | —                           |   | (812                     | )      | — |    | — |   | (812                                  | )      |
| Balance at April  30, 2004                                         |                | 24,411     |       | $      | 244        |                             | $      | 109,167                  |   | $      | (53,492 | )      | 1      |                                  | $      | (3 | ) | $ | 55,916 |   |

 

See accompanying notes.

 

5

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**CARREKER CORPORATION**

**CondensedConsolidated Statements of Cash Flows**

**(Unaudited)**

**(In thousands)**

 
|                                                                             |   | **Three  Months Ended  April 30,** |   |
|----------------------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                             |   | **2004**                           |   | **2003** |   |
| **Operating  Activities:**                                                       |   |                               |   |   |   |
| Net loss                                                                         |   | $                                  | (812   | ) | $ | (2,967 | ) |
| Adjustments to  reconcile net loss to net cash provided by operating activities: |   |                               |   |   |   |
| Depreciation and  amortization of property and equipment                         |   | 822                                |   | 874 |   |
| Amortization of  capitalized software costs and acquired developed technology    |   | 1,394                              |   | 1,336 |   |
| Amortization of  customer relationships                                          |   | 350                                |   | 350 |   |
| Compensation  expense related to issuance of restricted stock                    |   | 35                                 |   | — |   |
| Minority share  of loss in Carretek LLC                                          |   | (86                                | )      | — |   |
| Gain on sale of  Cash Services Australia Pty. Limited                            |   | (539                               | )      | — |   |
| Litigation loss  provision                                                       |   | 1,686                              |   | — |   |
| Credit for  doubtful accounts                                                    |   | (180                               | )      | (52 | ) |
| Amortization of  deferred loan costs                                             |   | 68                                 |   | 108 |   |
| Changes in operating  assets and liabilities, net of effects of acquisitions:    |   |                               |   |   |   |
| Accounts  receivable                                                             |   | 6,773                              |   | 6,722 |   |
| Prepaid expenses  and other assets                                               |   | 301                                |   | (141 | ) |
| Accounts payable  and accrued expenses                                           |   | (3,273                             | )      | (1,702 | ) |
| Income taxes  payable/receivable                                                 |   | (33                                | )      | — |   |
| Deferred revenue                                                                 |   | 3,244                              |   | 7,684 |   |
| Net cash  provided by operating activities                                       |   | 9,750                              |   | 12,212 |   |
| **Investing  Activities:**                                                       |   |                               |   |   |   |
| Purchases of  property and equipment                                             |   | (231                               | )      | (311 | ) |
| Computer  software costs capitalized                                             |   | (910                               | )      | — |   |
| Net cash used in  investing activities                                           |   | (1,141                             | )      | (311 | ) |
| **Financing  Activities:**                                                       |   |                               |   |   |   |
| Payments on  long-term debt                                                      |   | (6,250                             | )      | (10,000 | ) |
| Proceeds from  exercises of stock options                                        |   | 375                                |   | — |   |
| Minority  interest and minority shareholder loan to Carretek LLC                 |   | 147                                |   | — |   |
| Net cash used in  financing activities                                           |   | (5,728                             | )      | (10,000 | ) |
| Net increase in  cash and cash equivalents                                       |   | 2,881                              |   | 1,901 |   |
| Cash and cash  equivalents at beginning of period                                |   | 28,605                             |   | 26,986 |   |
| Cash and cash  equivalents at end of period                                      |   | $                                  | 31,486 |   | $ | 28,887 |   |
| Supplemental  disclosures of cash flow information:                              |   |                               |   |   |   |
| Cash paid for  interest                                                          |   | $                                  | 71     |   | $ | 347 |   |
| Cash paid for  income taxes, net                                                 |   | $                                  | 33     |   | $ | 94 |   |

 

See accompanying notes.

 

6

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**Carreker Corporation**

**Notes to Condensed Consolidated Unaudited FinancialStatements****For the Three Months Ended April 30, 2004 and 2003**

 

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

 

Carreker Corporation (“the Company,” “Carreker,”“our,” “we”) provides payments-related software and consulting solutions tofinancial institutions and financial service providers.  These solutions help the Company’s customersset winning strategies in their payment businesses; improve operationalefficiency in how payments are processed; enhance revenue and profitabilityfrom payments-oriented products and services; reduce losses associated withfraudulent payment transactions; and/or improve the alignment of productofferings with customer needs.

 

**2.****              Summaryof Significant Accounting Procedures**

 

**Principles of Consolidation and Presentation**

 

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

 

The accompanying condensed consolidated unauditedfinancial statements and notes have been prepared in accordance with the rulesand regulations of the Securities and Exchange Commission for Form 10-Q andinclude all of the information and disclosures required by generally acceptedaccounting principles for interim financial reporting.  The results of operations, for the threemonths ended April 30, 2004, are not necessarily indicative of full-yearresults.

 

Certain prior year amounts have been reclassified toconform to the current year presentation. For the three months ended April 30, 2003, selling, general andadministrative expenses have been reduced by $153,000, while cost ofsales-software maintenance fees, cost of sales-software implementation fees andresearch and development were increased $61,000, $31,000 and $61,000,respectively.  These reclassificationswere made to conform to the presentation of certain information technologycosts in the three months ended April 30, 2004.

 

In the three months ended April 30, 2004, theconsolidated financial statements also contain Carretek LLC which is a 51%owned subsidiary.  The minority interestand minority interest in income (loss) of Carretek LLC represents the 49%minority stockholders’ investment and share of the loss of this consolidatedsubsidiary.

 

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States requires theuse of estimates and assumptions that affect the amounts reported in thefinancial statements and accompanying notes. As discussed below, the Company makes significant estimates andassumptions in the areas of accounts receivable, impairment of intangibles andrevenue recognition.  Although theCompany believes that the estimates and assumptions are reasonable, actualresults may differ, and such differences could be significant to the Company’sfinancial results.

 

**Cash and Cash Equivalents**

 

The Company considers all highly liquid investmentswith maturities of three months or less when purchased to be cash equivalents.Cash and cash equivalents consist primarily of demand deposit accounts andshares in a demand money market account comprised of domestic and foreigncommercial paper, certificates of deposit and U.S. government obligations whichare maintained with nationally recognized financial institutions.

 

**Foreign Currency Translation**

 

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

 

7

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

 

Financial instruments, which potentially subject theCompany to concentration of credit risk consist principally of temporary cashinvestments and accounts receivable. The Company places temporary cash investments with financialinstitutions and limits its exposure with any one financial institution.

 

A significant portion of the Company’s businessconsists of providing consulting services and licensing software to majordomestic and international banks, which gives rise to a concentration of creditrisk in receivables.  Because theCompany’s accounts receivable are typically unsecured, the Company periodicallyevaluates the collectibility of its accounts based on a combination of factors,including a particular customer’s ability to pay as well as the age ofreceivables.  In cases where theevidence suggests a customer may not be able to satisfy its obligation to theCompany or if the collection of the receivable becomes doubtful due to adispute that arises subsequent to the delivery of the Company’s products andservices, the Company sets up a reserve in an amount determined appropriate forthe perceived risk.  Most of theCompany’s contracts include multiple payment milestones, some of which occur inadvance of revenue recognition, which mitigates the risk both in terms ofcollectibility and adjustments to recorded revenue. Write-offs of receivablesduring the three months ended April 30, 2004 and 2003 were $0 and $73,000,respectively.

 

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

 

Accounts receivable, net of related deferred revenueand allowances, consist of the following (in thousands):

 
|                                  |   | **April 30,  2004** |   | **January  31,  2004** |   |
|---------------------------------------|--------|---------------------|--------|------------------------|--------|
|                                  |   |                |   |                   |   |
| Gross accounts  receivable            |   | $                   | 44,773 |                   | $      | 65,109 |   |
| Less related  deferred revenue        |   | (28,282             | )      | (41,846                | )      |
| Less allowance  for doubtful accounts |   | (1,333              | )      | (1,512                 | )      |
| Net accounts  receivable              |   | $                   | 15,158 |                   | $      | 21,751 |   |

 

**Property and Equipment**

 

Property and equipment are stated at cost.Depreciation is calculated using the straight-line method over the estimateduseful lives of the respective assets, generally from three to five years.Leasehold improvements are amortized using the straight-line method over theshorter of the terms of the related leases or the respective useful lives ofthe assets.  The components of propertyand equipment are as follows (in thousands):

 
|                                            |   | **April 30,  2004** |   | **January  31,  2004** |   |
|-------------------------------------------------|--------|---------------------|--------|------------------------|--------|
|                                            |   |                |   |                   |   |
| Furniture                                       |   | $                   | 5,088  |                   | $      | 5,070 |   |
| Equipment and  software                         |   | 17,891              |   | 17,686                 |   |
| Leasehold  improvements                         |   | 1,073               |   | 1,074                  |   |
| Total cost                                      |   | 24,052              |   | 23,830                 |   |
|                                            |   |                |   |                   |   |
| Less accumulated  depreciation and amortization |   | (17,953             | )      | (17,140                | )      |
| Net property and  equipment                     |   | $                   | 6,099  |                   | $      | 6,690 |   |

 

The Company accounts for the costs of computersoftware developed or obtained for internal use in accordance with Statement ofPosition 98-1, *“Accounting for the Costs ofComputer Software Developed or Obtained for Internal Use”.*  The Company capitalizes costs ofconsultants, and payroll and payroll-related costs for employees incurred indeveloping internal-use computer software. These costs are included in “Equipment and Software”.  Costs incurred during preliminary projectand post-implementation stages are charged to expense.

 

8

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**LongLived Assets**

 

The Company accounts for goodwill and other intangibleassets in accordance with Statement of Financial Accounting Standards No. 142, *“Goodwill and Other Intangible Assets,”*(SFAS 142).  Under the provisions ofSFAS 142, an annual assessment of goodwill impairment is performed.  This assessment involves the use ofestimates related to fair market values of the Company’s reporting units withwhich the goodwill is associated.  Theassessment of goodwill impairment in the future will be impacted if futureoperating cash flows of the Company’s reporting units decline, which wouldresult in decreases 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. Intangible assets not subject to amortization are tested annually forimpairment, and are tested for impairment more frequently if events andcircumstances indicate that an asset might be impaired.  An impairment loss is recognized to theextent that the carrying amount exceeds the asset’s fair value.

 

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

 

**DeferredLoan Costs**

 

Deferredloan costs consist of loan closing costs and other administrative expensesassociated with the Revolving Credit Agreement.  On July 31, 2003, the Revolving Credit Agreement was amended asdescribed in Note 4.  In connection withthis amendment, the Company incurred approximately $456,000 of deferred loancosts.  These costs, along with the netbook value of the original deferred loan costs, are being amortized to interestexpense over the 36 month life of the Revolving Credit Agreement.

 

**Capitalized Software Costs and Acquired Developed Technology**

 

The Company capitalizes the development costs ofsoftware, other than internal-use software, in accordance with Statement ofFinancial Accounting Standards No. 86, *“Accountingfor Costs of Computer Software to be Sold, Leased or Otherwise Marketed”*(“SFAS 86”).  The Company’s policy is tocapitalize software development costs incurred in developing a product oncetechnological feasibility of the product has been established. Technologicalfeasibility of the product is determined after completion of a detailed programdesign and a determination has been made that any uncertainties related tohigh-risk development issues have been resolved. If the process of developingthe product does not include a detail program design, technological feasibilityis determined only after completion of a working model. All softwaredevelopment costs capitalized are amortized using an amount determined as thegreater of: (1) the ratio that current gross revenues for a capitalizedsoftware project bears to the total of current and estimated future grossrevenues for that project or (2) the straight-line method over the remainingeconomic life of the product (generally three to six years). The Companycapitalized $910,000 and $0 in the three months ended April 30, 2004 and 2003,respectively.  The Company is currentlydeveloping software for sending and receiving check images, distributingcapture of checks and check images and extending the functionality of theanti-money laundering software discussed below.  The products reached technological feasibility in the latter halfof fiscal 2003 and accordingly certain costs subsequently incurred werecapitalized under SFAS 86.

 

The Company recorded amortization relating to softwaredevelopment costs capitalized of $239,000 and $307,000 in the three monthsended April 30, 2004 and 2003, respectively. Amortization expense is recorded as a component of cost of software licensefees in the accompanying consolidated statement of operations.

 

InOctober 2003, the Company purchased an anti-money laundering software solutiondesigned to help banks protect both their customers and their corporatereputations from the growing risk of financial fraud and to comply with agrowing number of laws and regulations. The $1.5 million purchase price was recorded in acquired developedtechnology in the accompanying consolidated balance sheets and is beingamortized over a 3-year period.

 

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

 

9

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Acquired developed technology with a useful life of3-6 years is amortized on a straight-line basis, resulting in amortizationexpense of $1.2 million and $1.0 million in the three months ended April 30,2004 and 2003, respectively. Amortization expense is recorded as a component of cost of softwarelicense fees in the accompanying consolidated statements of operations.

 

The following table sets forth the estimatedamortization expense of capitalized software costs and acquired developedtechnology for the nine months remaining in fiscal year ended January 31, 2005and for the remaining future fiscal years ending January 31 (in thousands):

 
| **Period**                           |   | **Capitalized  Software Costs** |   | **Acquired  Developed  Technology** |   |
|--------------------------------------|--------|---------------------------------|--------|-------------------------------------|--------|
| May 1, 2004 –  January 31, 2005 |   | $                               | 597    |                                | $      | 3,465 |   |
| Fiscal year  ended January 31, 2006  |   | 148                             |   | 4,620                               |   |
| Fiscal year  ended January 31, 2007  |   | —                          |   | 4,107                               |   |
| Fiscal year  ended January 31, 2008  |   | —                          |   | 1,200                               |   |
|                                      |        |                                 |        |                                     |        |  |  |

 

The table does not include the estimated amortizationexpense for $2.0 million of capitalized software products that are currentlybeing developed, and for which amortization has not commenced.

 

10

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**Revenue Recognition**

 

The Company’s revenue recognition policies are inaccordance with Statement of Position (“SOP”) 97-2, *“Software Revenue Recognition,”*as amended by SOP 98-9, “*Modification of SOP 97-2,**SoftwareRevenue Recognition with Respect to Certain Transactions,”* StaffAccounting Bulletin (“SAB”) No. 104,*RevenueRecognition and Emerging Issues Task Force (“EITF”) No. 00-21, “RevenueArrangements with Multiple Deliverables.”* In the case of software arrangements that require significantproduction, modification, or customization of software, or the licenseagreement requires the Company to provide implementation services that aredetermined to be essential to other elements of the arrangement, the Companyfollows the guidance in SOP 81-1, *“Accounting for Performance of Construction – Typeand Certain Production – Type Contracts.”*

 

*Consulting Fees.*  The Company employs three primary pricing methods in connectionwith its delivery of consulting services. First, the Company may price itsdelivery 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, the Company is generally paid fees andrelated amounts on a monthly basis, and the Company recognizes revenues as theservices are performed. Second, the Company may deliver consulting services ona fixed-price basis. In this case, the Company is paid on a monthly basis orpursuant to an agreed upon payment schedule, and the Company recognizesrevenues on a percentage-of-completion basis. The Company believes that this method is appropriate because of itsability to determine performance milestones and determine dependable estimatesof its costs applicable to each phase of a contract.  Because financial reporting of these contracts depends onestimates, which are assessed continually during the term of the contract,costs are subject to revisions as the contract progresses.  Anticipated losses on fixed-price contractsare recognized when estimatable.  Third,the Company may deliver consulting services pursuant to a value-priced contractwith the customer. In this case, the Company is paid, on an agreed upon basiswith the customer, either a specified percentage of (1) the projectedincreased revenues and/or decreased costs that are expected to be derived bythe customer generally over a period of up to twelve months followingimplementation of its solution or (2) the actual increased revenues and/ordecreased costs experienced by the customer generally over a period of up totwelve months following implementation of its solution, subject in either caseto a maximum, if any is agreed to, on the total amount of payments to be madeto the Company.  The Company must firstcommit time and resources to develop projections associated with value-pricingcontracts before a customer will commit to purchase its solutions, and theCompany therefore assumes the risk of making these commitments with noassurance that the customer will purchase the solution.  Costs associated with these value-pricingcontracts are expensed as incurred. These contracts typically include payments to be made to the Companypursuant to an agreed upon schedule ranging from one to twelve months inlength.  The Company recognizes revenuesgenerated from consulting services in connection with value-priced contractsbased upon projected results only upon completion of all services and agreementupon the actual fee to be paid (even though billings for these services may bedelayed by mutual agreement for periods not to exceed twelve months). In aneffort to allow customers to more closely match expected benefits from serviceswith payments to the Company, the Company on occasion, may offer payment termswhich extend beyond 12 months.  When theCompany enters into an agreement which has a significant component of the totalamount payable under the agreement due beyond 12 months or if it is determinedpayments are not fixed and determinable at the date the agreement was enteredinto, revenue under the arrangement will be recognized as payments become dueand payable.  When fees are to be paidbased on a percentage of actual revenues and/or savings to customers, theCompany recognizes revenues only upon completion of all services and as theamounts of actual revenues or savings are confirmed by the customer with a fixedpayment date.

 

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

 

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

 

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

 

*Software License Fees.*  A software license is sold either togetherwith implementation services or on a stand-alone basis.  The Company is usually paid software licensefees in one or more installments, as provided in the customer’s contract butnot to exceed twelve months.  TheCompany recognizes software license revenue upon execution of a contract anddelivery of the software, provided that the license fee is fixed anddeterminable, no significant production, modification or customization of thesoftware is required and collection is considered probable by management.  When the software license arrangementrequires the Company to provide implementation services that are essential tothe functionality of the software or significant production, customization ormodification of the software is required, both the product license revenue andimplementation fees are recognized as services are performed.

 

11

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In certain instances, especially with recentlydeveloped software, the Company defers software revenue recognition until theservices are completed and the project is accepted by the customer.

 

Software licenses are often sold as part of a multipleelement arrangement that may include maintenance, implementation orconsulting.  The Company determineswhether there is vendor specific objective evidence of fair value (“VSOEFV”)for each element identified in the arrangement to determine whether the totalarrangement fees can be allocated to each element.  If VSOEFV exists for each element, the total arrangement fee isallocated 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 defers revenuerecognition of the software license fees. However, if VSOEFV is determinable for all of the undelivered elements,and assuming the undelivered elements are not essential to the deliveredelements, the Company will defer recognition of the full fair value related tothe undelivered elements and recognize the remaining portion of the arrangementvalue through application of the residual method.  Where VSOEFV has not been established for certain undeliveredelements, revenue for all elements is deferred until those elements have beendelivered or their fair values have been determined.  Evidence of VSOEFV is determined for software products based onactual sales prices for the product sold to a similar class of customer andbased on pricing 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 relatedservices.  The Company establishesVSOEFV for maintenance agreements using the percentage method such that VSOEFVfor maintenance is a percentage of the license fee charged annually for aspecific software product, which in most instances is 20% of the portion ofarrangement fees allocated to the software license element.

 

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

 

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

 

*Software Implementation Fees.*  In connection with the sale of a software license,a customer may elect to purchase software implementation services, includingsoftware enhancements and other software services. Most of the customers thatpurchase software licenses from the Company also purchase softwareimplementation services.  The Companyprices its implementation services on a time-and-materials or on a fixed-pricebasis, and the Company recognizes the related revenues as services areperformed.  Costs associated with theseengagements are expensed as incurred.

 

The Company’s contracts typically do not include rightof return clauses, and as a result, the Company does not record a provision forreturns.

 

**Royalties**

 

In connection with software license and maintenanceagreements entered into with certain banks and purchase agreements with vendorsunder which the Company acquired software technology used in products sold toits customers, the Company is required to pay royalties on sales of certainsoftware products.  Under thesearrangements, the Company accrues royalty expense when the associated revenueis recognized.  For current productofferings, the royalty percentages generally range from 20% to 30% of theassociated revenues.  Approximately$256,000 and $435,000 of royalty expense was recorded under these agreements inthe three months ended April 30, 2004 and 2003, respectively.  Royalty expense is included as a componentof the cost of software license fees and cost of software maintenance fees inthe accompanying condensed consolidated statements of operations.

 

12

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**Deferred Revenue**

 

Deferred revenue represents amounts paid by customersunder terms specified in consulting, software licensing, and maintenancecontracts for which completion of contractual terms or delivery of the softwarehas not occurred.

 

Deferred revenue and advance payments from customersconsist of the following (in thousands):

 
|                                               |   | **April 30,  2004** |   | **January  31,  2004** |   |
|----------------------------------------------------|--------|---------------------|--------|------------------------|--------|
| Current:                                           |   |                |   |                   |   |
| Deferred  software maintenance fees                |   | $                   | 37,680 |                   | $      | 44,117 |   |
| Deferred  software implementation and license fees |   | 19,077              |   | 22,960                 |   |
|                                               |   | 56,757              |   | 67,077                 |   |
| Less related  accounts receivable                  |   | (28,282             | )      | (41,846                | )      |
|                                               |   | $                   | 28,475 |                   | $      | 25,231 |   |

 

**Research and Development Costs**

 

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

 

**Other income**

 

Other income is comprised of the following:

 
|                                                                |   | **Three  Months Ended  April 30,** |   |
|---------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                |   | **2004**                           |   | **2003** |   |
|                                                                |   |                               |   |   |   |
| Gain on sale of  Cash Services Australia Pty. Limited.              |   | $                                  | 539    |   | $ | — |   |
| Equity in  earnings (loss) of Cash Services Australia Pty. Limited. |   | (17                                | )      | 72 |   |
| Minority share of net loss of Carretek LLC                          |   | 86                                 |   | — |   |
| Foreign exchange losses                                             |   | (129                               | )      | (81 | ) |
| Other                                                               |   | 5                                  |   | 25 |   |
| Total                                                               |   | $                                  | 484    |   | $ | 16 |   |

 

In April 2004, the Company sold its 25% interest inCash Services Australia Pty. Limited. The carrying value of this investment was approximately $383,000 and theCompany received $922,000 in proceeds collected in May 2004.  As a result of this transaction, the Companyrecorded a $539,000 gain.

 

**IncomeTaxes**

 

The Company accounts for income taxes using theliability method, whereby deferred tax assets and liabilities are determinedbased on differences between financial reporting and tax basis of assets andliabilities measured using enacted tax rates and laws that will be in effectwhen the differences are expected to reverse. The measurement of deferred tax assets is adjusted by a valuationallowance, if necessary, to recognize the extent to which, based on availableevidence, it is more likely than not that the future tax benefits will not berealized.

 

13

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**Earnings Per Share**

 

Basicearnings per share is computed using the weighted average number of shares ofcommon stock outstanding during each period. Diluted earnings per share iscomputed using the weighted average number of shares of common stockoutstanding during each period and common equivalent shares consisting of stockoptions (using the treasury stock method), if such stock options have adilutive effect in the aggregate.

 

**Stock-Based Compensation**

 

The Company has elected to follow Accounting PrinciplesBoard (“APB”), Opinion No. 25, “*Accountingfor Stock Issued to Employees*,” in accounting for its employees anddirector stock options.  Under APB 25,if the exercise price of a stock option equals or exceeds the market price ofthe underlying stock on the date of grant, no compensation expense isrecognized.  The Company accounts forstock-based compensation for non-employees under the fair value methodprescribed by SFAS 123, “*Accounting forStock-Based Compensation”* (“SFAS 123”).  Through April 30, 2004, there have been no significant grants tonon-employees.

 

In December 2002, the FASB issued SFAS 148, *“Accounting for Stock-Based Compensation — Transitionand Disclosure, an Amendment of FASB Statement No. 123,”* whichprovides alternative methods of transition for an entity that voluntarilychanges to the fair value based method of accounting for stock-based employeecompensation.  SFAS 148 requiresprominent disclosure about the effects on reported net income of an entity’saccounting policy decisions with respect to stock-based employee compensationand amends APB Opinion 28, *“InterimFinancial Reporting,”* to require disclosure about those effects ininterim financial information.  Thesedisclosure requirements became effective for the Company in the three monthsended April 30, 2003.

 

OnJune 20, 2003, the Company issued 245,000 shares of restricted common stock toseveral employees.  The market price ofthe stock was $4.35.  The stock vestsone-third on June 20, 2006, one-third on June 20, 2007 and one-third on June20, 2008.  The Company is amortizing theresulting compensation expense on a straight-line basis from the date ofissuance through June 20, 2008, and any forfeitures will be accounted for inthe period the forfeiture takes place. The Company recorded $35,000 of compensation expense, during the threemonths ended April 30, 2004, and 215,000 restricted common shares remainoutstanding at April 30, 2004.

 

On May 3, 2004, the Company issued 149,990 shares ofrestricted common stock to its employees. The market price of the stock was $7.22.  The stock vests 20% on each of the next five anniversaries fromthe date of issuance.  The Company willamortize the resulting compensation expense on a straight-line basis from thedate of issuance through May 3, 2009, and any forfeitures will be accounted forin the period the forfeiture takes place. The estimated future quarterly compensation expense will beapproximately $54,100.

 

AlthoughSFAS 123 allows APB 25 guidelines to be applied in accounting for stockoptions, the Company is required to disclose pro forma net income (loss) andnet income (loss) per share as if they had adopted SFAS 123.  The following table sets forth the pro formainformation as if the provisions of SFAS 123 had been applied to account forstock based compensation (in thousands, except per share data):

 

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|                                                                       |   | **Three  Months Ended  April 30,** |   |
|----------------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                       |   | **2004**                           |   | **2003** |   |
|                                                                       |   |                               |   |   |   |
| Net loss, as  reported                                                     |   | $                                  | (812   | ) | $ | (2,967 | ) |
| Stock  compensation expense recorded under the intrinsic value method      |   | 35                                 |   | — |   |
| Pro forma stock  compensation expense computed under the fair value method |   | (951                               | )      | (1,068 | ) |
| Pro forma net  loss                                                        |   | $                                  | (1,728 | ) | $ | (4,035 | ) |
|                                                                       |   |                               |   |   |   |
| Basic and  diluted loss per common share, as reported                      |   | $                                  | (0.03  | ) | $ | (0.13 | ) |
| Pro forma basic  and diluted loss per common share                         |   | $                                  | (0.07  | ) | $ | (0.17 | ) |

 

Inputsused for the fair value method of the Company’s employee stock options are asfollows:

** **
|                                            |   | **Three  Months Ended  April 30,** |   |
|-------------------------------------------------|--------|------------------------------------|--------|
|                                            |   | **2004**                           |   | **2003** |   |
|                                            |   |                               |   |   |   |
| Volatility                                      |   | .887                               |   | .951 |   |
| Weighted-average  expected lives                |   | 4.50                               |   | 4.50 |   |
| Expected  dividend yields                       |   | —                             |   | — |   |
| Weighted-average  risk-free interest rates      |   | 2.79                               | %      | 2.10 | % |
| Weighted-average  fair value of options granted |   | $                                  | 6.20   |   | $ | 1.62 |   |
|                                                 |        |                                    |        |  |  |  |  |

 

**Risks and Uncertainties**

 

The Company’s future results of operations andfinancial condition could be impacted by the following factors, among others:dependence on the banking industry, decline in check volumes, fluctuations inoperating results, lack of long-term agreements, dependence on key personnel,product liability, rapid technological change and dependence on new products,focus on providing business process outsourcing with significant offshorecomponent, ability to attract and retain qualified personnel, customerconcentration, competition, potential strategic alliances and acquisitions,proprietary rights, infringement claims, dependence on third parties fortechnology licenses, liability claims, pending lawsuits, stock pricefluctuations, international operations, use of independent contractors,changing government and tax regulations, anti-takeover provisions in ourcharter and impairment of goodwill or intangible assets.

 

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**RecentlyIssued Accounting Standards**

 

In November 2002, the FASB issued Interpretation No. 45 (“FIN 45”), *“Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others.”*  FIN 45 requires that a guarantor recognize,at the inception of a guarantee, a liability for the fair value of theobligation undertaken in issuing the guarantee or indemnification.  FIN 45 also requires additional disclosureby a guarantor in its interim and annual consolidated financial statementsabout its 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 termsof the majority of the Company’s software license agreements with itscustomers, the Company agrees that in the event the software sold infringesupon any patent, copyright, trademark, or any other proprietary right of athird party, it will indemnify its customer license, against any loss, expense,or liability from any damages that may be awarded against its customer.  The Company includes this infringementindemnification in all of its software license agreements.  In the event the customer cannot use thesoftware or service due to infringement and the Company cannot obtain the rightto use, replace or modify the license or service in a commercially feasiblemanner so that it no longer infringes, then the Company may terminate thelicense and provide the customer a pro-rata refund of the fees paid by thecustomer for the infringing license or service.  The Company has recorded no liability associated with 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 propertyindemnification clauses is minimal.

 

•                  The Company hasagreed to indemnify members of the board of directors, as well as officers ofthe Company, if they are made a party or are threatened to be made a party toany proceeding (other than an action by or in the right of the Company) byreason of the fact that they are acting in their capacities on behalf of theCompany, or by reason of anything done or not done by them in any suchcapacities.  The indemnity is for anyand all expenses and liabilities of any type whatsoever (including but notlimited to, judgments, fines and amounts paid in settlement) actually andreasonably incurred by the directors or officers in connection with theinvestigation, defense, settlement or appeal of such proceeding, provided theyacted in good faith.  The Companymaintains insurance coverage for directors and officers liability (“D&Oinsurance”).  No maximum liability isstipulated in these agreements that include indemnifications of members or theboard of directors and officers of the Company.  The Company has recorded no liability associated with theseindemnifications as it is not aware of any pending or threatened actions orclaims against its members of board of directors or officers that are probablelosses in excess of amounts covered by its D&O insurance.  As a result of the insurance policycoverage, the Company believes the estimated fair value of theseindemnification agreements is minimal.

 

In January 2003, the Financial Accounting StandardsBoard issued Statement of Financial Accounting Standards Board InterpretationNo. 46, *“Consolidation of Variable InterestEntities, an Interpretation of ARB No. 41 (FIN 46).”*  In December 2003, the FASB modified FIN 46to make certain technical corrections and address certain implementation issuesthat had arisen.  FIN 46 provides a newframework for identifying variable interest entities (VIEs) and determiningwhen a company should include these assets, liabilities, non-controllinginterests and results of activities of a VIE in its consolidated financialstatements.

 

In general, a VIE is a corporation, partnership,limited liability corporation, trust or any other legal structure used toconduct activities or hold assets that either (1) has an insufficient amount ofequity to carry out its principal activities without additional subordinatedfinancial support, (2) has a group of equity owners that are unable to makesignificant decisions about its activities, or (3) has a group of equity ownersthat do not have the obligation to absorb losses or the right to receivereturns generated by its operations.

 

The Company adopted the provisions of FIN 46 as ofApril 30, 2004.  The effect of adoptingthe provisions of FIN 46 was not material to the Company’s financial position.

 

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

 

The Company adopted SFAS No. 142, *“Goodwill and Other Intangible Assets,”*effective February 1, 2002.  Under SFAS142, goodwill and intangible assets deemed to have indefinite lives are nolonger amortized but are subject to annual impairment tests in accordance withthis statement.  Other intangible assetswhich include acquired developed technology and customer relationships willcontinue to be amortized over their useful lives.

 

Upon adoption of SFAS 142, assembled work forceintangible with a remaining net book value of $5.0 million at February 1, 2002was reclassified to goodwill and the remaining goodwill will no longer beamortized.  The Company performed aninitial assessment of impairment on February 1, 2002, the date SFAS 142 wasadopted.  No impairment resulted fromthis initial assessment.

 

Customerrelationships with definite useful lives are amortized on a straight-linebasis, which resulted in amortization expense of $350,000 for the three monthsended April 30, 2004 and 2003.

 

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

 
| **Period**                          |   | **Amount** |   |
|-------------------------------------|--------|------------|--------|
|                                |   |       |   |
| May 1, 2004 -  January 31, 2005     |   | $          | 1,050  |   |
| Fiscal year  ended January 31, 2006 |   | 1,400      |   |
| Fiscal year  ended January 31, 2007 |   | 1,400      |   |
| Fiscal year  ended January 31, 2008 |   | 467        |   |
|                                     |        |            |        |  |

 

Certain accrued liabilities were recorded during theacquisition of Check Solutions Company in June 2001.  During the three months ended April 30, 2004, these estimateswere revised and $388,000 of these accrued liabilities were reversed andrecorded as an adjustment to Goodwill.

 

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

 

OnJune 6, 2001, the Company entered into a three-year revolving credit agreementwith a group of banks in an amount not to exceed $60.0 million to fund theacquisition of Check Solutions.  On July31, 2003, the revolving credit agreement was amended to reduce the commitmentamount to $30.0 million, and to extend the maturity date of outstandingborrowings to July 31, 2006.  Borrowingsunder the credit agreement, as amended, currently bear interest equal to eitherthe greater of prime or federal funds rate plus a margin ranging from 1.25% to2.25% depending on the Company’s ratio of funded debt to Earnings beforeInterest, Taxes, Depreciation and Amortization (“EBITDA”), or LIBOR plus amargin equal to 2.75% to 3.75% depending on the Company’s ratio of funded debtto EBITDA.  Interest payments are duequarterly.  The Company is required topay a commitment fee equal to 0.50% on the unused amount of the revolvingcredit agreement.  The revolving creditagreement contains customary affirmative and negative covenants, includingfinancial covenants requiring the maintenance of specified interest coverage,ratio of EBITDA to funded debt, and ratio of 80% of accounts receivable, cashand short-term investments to funded debt. Additionally, the payment of dividends is precluded except upon approvalof the banks.  Substantially all of theCompany’s assets collateralize the revolving credit agreement.  As of April 30, 2004, the Company is incompliance with the covenants of the revolving credit agreement, as amended.

 

TheCompany did not have any borrowings outstanding under our revolving creditagreement at April 30, 2004.  Becausethe interest on the debt is variable, the carrying value approximates the fairvalue.  Interest expense, exclusive ofthe amortization of deferred loan costs, on the credit agreement was $40,000and $310,000 for the three months ended April 30, 2004 and 2003, respectively.

 

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

 

The Company has established a valuation allowance toreserve its net deferred tax assets at April 30, 2004 because the more likelythan not criteria for future realization of the Company’s net deferred taxassets specified in Statements of Financial Accounting Standards No. 109, “*Accounting for Income Taxes,”* (“SFAS No.109”) were not met.

 

Thenet tax provision was zero for the three months ended April 30, 2004.  The net tax provision of $94,000 for thethree months ended April 30, 2003 consists of a provision for state and foreigntaxes.  No tax benefit was recorded dueto the uncertainty regarding the Company’s ability to generate taxable income,and resulting uncertainty relative to the recoverability of deferred taxassets.

 

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

 

**Profit Sharing Plan**

 

TheCompany has adopted a profit sharing plan pursuant to Section 401(k) of theInternal Revenue Code (the Code) whereby participants may contribute apercentage of compensation not in excess of the maximum allowed under the Code.The plan provides for a matching contribution by the Company.  Employer matching contributions amounted to$165,000 and $0 for the three months ended April 30, 2004 and 2003,respectively. The Company may make additional contributions at the discretionof the Board of Directors.  No discretionarycontributions were made during the three months ended April 30, 2004 and 2003.

 

**Incentive Compensation Plans**

 

EffectiveMay 3, 2004, the variable compensation plan was terminated.  The Company did not record expense underthis plan for the three months ended April 30, 2004 and 2003.

 

The Carreker Incentive Bonus Plan (“CIBP”) awardsemployees based on the Company’s and the applicable business unit’s operatingresults.  Substantially, all employeesare eligible to receive cash awards under the CIBP.  Awards from this plan are paid to employees subsequent to the endof the fiscal year.  In the three monthsended April 30, 2004 and 2003, the Company recorded expense under this plan ofapproximately $106,000 and $0, respectively. Payments under this Plan are anticipated to be made to employees inApril 2005.

 

TheCompany pays discretionary bonuses to key employees based primarily on Companyprofitability and the extent to which individuals meet agreed-upon objectivesfor the year. The Company recorded discretionary bonus expense of approximately$101,000 and $187,000 for the three months ended April 30, 2004 and 2003,respectively.

 

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

 

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

 
|                                                   |   | **Three  Months Ended  April 30,** |   |
|--------------------------------------------------------|--------|------------------------------------|--------|
|                                                   |   | **2004**                           |   | **2003** |   |
|                                                   |   |                               |   |   |   |
| Basic loss per  share:                                 |   |                               |   |   |   |
| Net loss                                               |   | $                                  | (812   | ) | $ | (2,967 | ) |
|                                                   |   |                               |   |   |   |
| Weighted average  shares outstanding                   |   | 24,376                             |   | 23,547 |   |
|                                                   |   |                               |   |   |   |
| Basic loss per  share                                  |   | $                                  | (0.03  | ) | $ | (0.13 | ) |
|                                                   |   |                               |   |   |   |
| Diluted loss per  share:                               |   |                               |   |   |   |
| Net loss                                               |   | $                                  | (812   | ) | $ | (2,967 | ) |
|                                                   |   |                               |   |   |   |
| Weighted average  shares outstanding                   |   | 24,376                             |   | 23,547 |   |
| Assumed  conversion of employee stock options          |   | —                             |   | — |   |
| Shares used in  diluted earnings per share calculation |   | 24,376                             |   | 23,547 |   |
|                                                   |   |                               |   |   |   |
| Diluted loss per  share                                |   | $                                  | (0.03  | ) | $ | (0.13 | ) |

 

Options totaling 2,219,882 and 4,473,624, in the threemonths ended April 30, 2004 and 2003, respectively, have been excluded from thediluted earnings per share computation as the options were anti-dilutive.

 

19

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**8.****              Contingencies**

 

On February 12, 2004, in the Court of Chancery of theState of Delaware in and for New Castle County (Civil Action No. 251-N),Barbara I. Smith brought a shareholders’ derivative action for the benefit ofNominal Defendant Carreker Corporation against John D. Carreker, Jr., James D.Carreker, Richard R. Lee, Jr., James L. Fischer, Donald L. House, David K.Sias, Terry L. Gage, James R. Erwin, Ronald G. Steinhart and Ernst & Young,seeking to remedy their individual breaches of fiduciary duty and to remedyErnst & Young’s accounting malpractice/negligence in connection with itsannual audits of the Company. The plaintiff seeks redress (the form of, 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.

 

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

 

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 against the Company, John D.Carreker Jr. and Terry L. Gage into a Consolidated Action styled In re CarrekerCorporation Securities Litigation, Civil Action No. 303CV0250-M.  Also, on March 3, 2003, Claude Alton Coulterfiled a purported class action lawsuit (Civil Action No. 503-CV-5-Q) againstthe Company, John D. Carreker Jr. and Terry L. Gage in the United StatesDistrict Court for the Eastern District of Texas, Texarkana Division.  These complaints, filed on behalf ofpurchasers of the Company’s common stock between May 20, 1998 and December 10,2002, inclusive, allege violations of Section 10(b) of the Securities ExchangeAct of 1934 and Rule 10b-5 against all defendants and violations of Section20(a) of the Exchange Act against the individual defendants.  These complaints also allege, among otherthings, that defendants artificially inflated the value of the Company’s stockby knowingly or recklessly misrepresenting the Company’s financial resultsduring the purported class period.  Theplaintiffs are seeking unspecified amounts of compensatory damages, interestsand costs, including legal fees.

 

EarningsPerformance Group (“EPG”) filed a complaint on or about September 16, 1998 inthe Superior Court of New Jersey, Law Division, Essex County seeking to enjoinand restrain the Company from using any EPG confidential or proprietaryinformation or trade secrets and from employing any former EPG employee in sucha manner that disclosure or use of an EPG confidential or proprietaryinformation or trade secret would be likely. EPG also seeks (a) an accounting of any profits realized from orattributable to the use of any EPG confidential or proprietary information ortrade secret, (b) compensatory and exemplary damages, plus interest and (c)attorneys’ fees and costs of suit.  OnOctober 14, 1998, the Company removed the case to the United States DistrictCourt for the District of New Jersey. The Company answered the complaint on November 4, 1998, essentiallydenying the allegations and setting forth various affirmative defenses.  On November 20, 1998, the Company filed anAmended Answer, Separate Defenses and Counterclaim.  In the Counterclaim the Company asserts claims for (a) restraintof trade, (b) tortuous interference with contractual relationships, (c) unfaircompetition and (d) interference with prospective economic advantage.  In May 2004, the jury in this litigationreturned a verdict in favor of EPG on one claim and in favor of the Company onthree claims. The jury also awarded EPG compensatory damages of $1,686,000, anddid not award EPG punitive damages.  Thejury award is subject to judicial review and the court has not issued a rulingon EPG’s request for injunctive relief.

 

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

 

20

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**9.****              BusinessSegments and 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.  Certain prior year amounts have beenreclassified to conform with the current year business segmentpresentation.  Our customer projects aresold on a solution basis, so it is necessary to break them down by segment andallocate accordingly.  Included in“Corporate Unallocated” are costs related to selling and marketing, unallocatedcorporate overhead expense and general software management.  Business segment results include costs forresearch and development as well as product royalty expense, the amortizationand impairment of goodwill and intangible assets, the write-off of capitalizedsoftware costs and merger and restructuring charges, were as follows (inthousands):

 
|                                                                                                              |   | **Three  Months ended April 30, 2004** |   |
|-------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|
|                                                                                                              |   | **Revenue  Enhancement**               |   | **Global  Payments  Technologies** |   | **Global  Payments  Consulting** |   | **Corporate  Unallocated** |   | **Total** |   |
| Revenues:                                                                                                         |   |                                   |   |   |   |   |   |   |   |   |   |
| Consulting fees                                                                                                   |   | $                                      | 8,487  |   | $ | 36 |   | $ | 534 |   | $ | — |   | $ | 9,057 |   |
| Software license  fees                                                                                            |   | 179                                    |   | 5,644 |   | 33 |   | — |   | 5,856 |   |
| Software  maintenance fees                                                                                        |   | 169                                    |   | 10,688 |   | 227 |   | — |   | 11,084 |   |
| Software  implementation fees                                                                                     |   | 156                                    |   | 2,557 |   | 166 |   | — |   | 2,879 |   |
| Out-of-pocket  expense reimbursements                                                                             |   | 490                                    |   | 300 |   | 100 |   | — |   | 890 |   |
| Total revenues                                                                                                    |   | $                                      | 9,481  |   | $ | 19,225 |   | $ | 1,060 |   | $ | — |   | $ | 29,766 |   |
|                                                                                                              |   |                                   |   |   |   |   |   |   |   |   |   |
| Income (loss)  from operations before amortization of customer relationships and  restructuring and other charges |   | $                                      | 4,615  |   | $ | 4,445 |   | $ | (566 | ) | $ | (7,327 | ) | $ | 1,167 |   |
|                                                                                                              |   |                                   |   |   |   |   |   |   |   |   |   |
| Amortization of  customer relationships                                                                           |   | —                                 |   | 350 |   | — |   | — |   | 350 |   |
| Litigation loss  provision                                                                                        |   | 1,686                                  |   | — |   | — |   | — |   | 1,686 |   |
| Restructuring  and other charges                                                                                  |   | 33                                     |   | 212 |   | — |   | 122 |   | 367 |   |
| Income (loss)  from operations                                                                                    |   | $                                      | 2,896  |   | $ | 3,883 |   | $ | (566 | ) | $ | (7,449 | ) | $ | (1,236 | ) |

 

21

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|                                                                  |   | **Three  Months ended April 30, 2003** |   |
|-----------------------------------------------------------------------|--------|----------------------------------------|--------|
|                                                                  |   | **Revenue  Enhancement**               |   | **Global  Payments  Technologies** |   | **Global  Payments  Consulting** |   | **Corporate  Unallocated** |   | **Total** |   |
| Revenues:                                                             |   |                                   |   |   |   |   |   |   |   |   |   |
| Consulting fees                                                       |   | $                                      | 6,078  |   | $ | 115 |   | $ | 558 |   | $ | — |   | $ | 6,751 |   |
| Software license  fees                                                |   | 907                                    |   | 5,671 |   | — |   | — |   | 6,578 |   |
| Software  maintenance fees                                            |   | 234                                    |   | 8,242 |   | 234 |   | — |   | 8,710 |   |
| Software  implementation fees                                         |   | 230                                    |   | 4,464 |   | 200 |   | — |   | 4,894 |   |
| Out-of-pocket  expense reimbursements                                 |   | 609                                    |   | 574 |   | 140 |   | — |   | 1,323 |   |
| Intercompany  revenue                                                 |   | —                                 |   | (20 | ) | 20 |   | — |   | — |   |
| Total revenues                                                        |   | $                                      | 8,058  |   | $ | 19,046 |   | $ | 1,152 |   | $ | — |   | $ | 28,256 |   |
|                                                                  |   |                                   |   |   |   |   |   |   |   |   |   |
| Income (loss)  from operations before restructuring and other charges |   | $                                      | 3,363  |   | $ | 3,876 |   | $ | (1,078 | ) | $ | (7,678 | ) | $ | (1,517 | ) |
|                                                                  |   |                                   |   |   |   |   |   |   |   |   |   |
| Amortization of  customer relationships                               |   | —                                 |   | 350 |   | — |   | — |   | 350 |   |
| Restructuring  and other charges                                      |   | —                                 |   | 11 |   | 147 |   | 526 |   | 684 |   |
| Income (loss)  from operations                                        |   | $                                      | 3,363  |   | $ | 3,515 |   | $ | (1,225 | ) | $ | (8,204 | ) | $ | (2,551 | ) |

 

During the three months ended July 31, 2003, the Company formedCarretek LLC (Carretek), a 51% jointly owned company to offer financialinstitutions offshore-centric outsourcing of their business processes and ITservices needs.  As this outsourcingbusiness is in the development phase and its operations immaterial, thefinancial results for the three months ended April 30, 2004 are contained inthe Corporate-Unallocated business segment in the tables above.

 

SinceCarretek’s inception, the Company and its partner funded Carretek with anaggregate amount of $500,000 from both partners.  $100,000 was in equity and another $400,000 in the form of a notepayable.  The $196,000 minority interestin the note payable is reflected as a long-term liability in the accompanyingcondensed consolidated balance sheets.

 

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

 
|               |   | **Three  Months Ended  April 30,** |   |
|--------------------|--------|------------------------------------|--------|
|               |   | **2004**                           |   | **2003** |   |
|               |   |                               |   |   |   |
| Single customer    |   | 11                                 | %      | 12 | % |
| Top five customers |   | 36                                 | %      | 38 | % |

 

22

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The Company markets itssolutions in several foreign countries. Revenues, exclusive of out-of-pocket expense reimbursements, for thethree months ended attributed to countries based on the location of thecustomers was as follows (in thousands):

 
|           |   | **Three Months Ended  April 30,  2004** |   | **Three Months Ended  April 30,  2003** |   |
|----------------|--------|-----------------------------------------|--------|-----------------------------------------|--------|
|           |   | **Amount**                              |   | **Percent  of total  revenues**         |   | **Amount** |   | **Percent  of total  revenues** |   |
| United States  |   | $                                       | 22,194 |                                    | 77     | % | $ | 21,494 |   | 80 | % |
| Europe         |   | 2,375                                   |   | 8                                       |   | 1,867 |   | 7 |   |
| Canada         |   | 1,525                                   |   | 5                                       |   | 1,996 |   | 7 |   |
| Asia Pacific   |   | 1,356                                   |   | 5                                       |   | 1,154 |   | 4 |   |
| South Africa   |   | 1,208                                   |   | 4                                       |   | 276 |   | 1 |   |
| Other          |   | 218                                     |   | 1                                       |   | 146 |   | 1 |   |
| Total revenues |   | $                                       | 28,876 |                                    | 100    | % | $ | 26,933 |   | 100 | % |

 

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

 

**The Company recorded various merger, restructuringand other charges during the three months ended April 30, 2004 and 2003 asfollows (in thousands):**

** **
|                                |   | **Workforce  Reductions** |   | **Charges  relating to  CheckFlow  Suite** |   | **Facility  Closures** |   | **Other** |   | **Total** |   |
|-------------------------------------|--------|---------------------------|--------|--------------------------------------------|--------|------------------------|--------|-----------|--------|-----------|--------|
|                                |   |                      |   |                                       |   |                   |   |      |   |      |   |
| Total quarter  ended April 30, 2003 |   | $                         | 545    |                                       | $      | —                 |   | $         | — |      | $      | 139 |   | $ | 684 |   |
|                                |   |                      |   |                                       |   |                   |   |      |   |      |   |
| Total quarter  ended April 30, 2004 |   | $                         | 308    |                                       | $      | —                 |   | $         | — |      | $      | 59 |   | $ | 367 |   |

 

Quarter Ended April 30, 2003

 

The Company recorded $545,000 in restructuring and other charges duringthe three month period ended April 30, 2003, principally associated with theseparation of 17 employees, within both the Corporate and Global PaymentsConsulting (“GPC”) business segments.  Duringthe quarterly period ended April 30, 2003, the Company recorded a charge of$139,000 relating to legal and professional fees relating to the Company’srestatement efforts and the shareholder legal actions described in Note 8.

 

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.  During the quarterly period ended April 30, 2004, the Companyrecorded a charge of $59,000 relating to legal and professional fees relatingto the Company’s shareholder legal actions described in Note 8.

 

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The activity related to the accrued merger andrestructuring costs reserve during the three months ended April 30, 2004 is asfollows (in thousands):

 
|                                 |   | **Workforce  Reductions** |   | **Charges  relating to  CheckFlow  Suite** |   | **Facility  Closures** |   | **Other** |   | **Total** |   |
|--------------------------------------|--------|---------------------------|--------|--------------------------------------------|--------|------------------------|--------|-----------|--------|-----------|--------|
|                                 |   |                      |   |                                       |   |                   |   |      |   |      |   |
| Reserve balance  at January 31, 2004 |   | $                         | 500    |                                       | $      | 1,296                  |   | $         | 5      |      | $      | 97 |   | $ | 1,898 |   |
|                                 |   |                      |   |                                       |   |                   |   |      |   |      |   |
| Additions to  reserve balance:       |   |                      |   |                                       |   |                   |   |      |   |      |   |
| Severance  charges                   |   | 308                       |   | —                                     |   | —                 |   | —    |   | 308       |   |
| Reductions to  reserve balances:     |   |                      |   |                                       |   |                   |   |      |   |      |   |
| Cash paid                            |   | (412                      | )      | (29                                        | )      | —                 |   | (5        | )      | (446      | )      |
| Reserve Balance  at April 30, 2004   |   | $                         | 396    |                                       | $      | 1,267                  |   | $         | 5      |      | $      | 92 |   | $ | 1,760 |   |

 

**Item 2.****Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

All statements other than statements of historical factcontained in this report, including statements in this “Management’s Discussionand Analysis of Financial Condition and Results of Operations” concerning ourfinancial position and liquidity, results of operations, prospects for futuregrowth, and other matters, are forward-looking statements.  Although we believe that the expectationsreflected in such forward-looking statements are reasonable, no assurance canbe given that such expectations will prove correct.  Factors that could cause our results to differ materially fromthe results discussed in, or contemplated by, such forward-looking statementsinclude the risks described under “Business – Forward Looking Statements andRisk Factors” contained in our Form 10-K for the year ended January 31, 2004, asfiled with the Securities and Exchange Commission (SEC).  Such risks include, without limitation:dependence on the banking industry, decline in check volumes, fluctuations inoperating results, lack of long-term agreements, dependence on key personnel,product liability, rapid technological change and dependence on new products,focus on providing business process outsourcing with significant offshorecomponent, ability to attract and retain qualified personnel, customerconcentration, competition, potential strategic alliances and acquisitions,proprietary rights, infringement claims, dependence on third parties fortechnology licenses, liability claims, pending lawsuits, stock pricefluctuations, international operations, use of independent contractors,changing government and tax regulations, anti-takeover provisions in ourcharter and impairment of goodwill or intangible assets.  All forward-looking statements in thisreport are expressly qualified in their entirety by the cautionary statementsin this paragraph, in the “risk factors” included in our SEC filings andelsewhere in this report.

 

**Overview**

 

We provide payments-related software and consultingsolutions to financial institutions and financial service providers.  We serve all of the top 20 and 75 of thenext largest 100 commercial banks in the United States.  We also consider other geographic regions tobe important elements of our market opportunity.  Our products and services traverse a broad spectrum of paymentactivities and are designed to improve operational efficiency in how paymentsare processed; enhance revenue and profitability from payments-orientedproducts and services; reduce losses associated with fraudulent paymenttransactions; and/or improve the alignment of product offerings with ourcustomer needs, hence maximizing their customer income streams.

 

We are organized into three primary operatingdivisions: Global Payments Technologies (“GPT”), Revenue Enhancement (“RevE”)and Global Payments Consulting (“GPC”). These three divisions bring together the capabilities essential toproviding the innovation and delivery engines for our products and services.

 

24

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*Global Payments Technologies Solutions.*  Carreker’s technology solutions helpfinancial institutions address the needs of some critical payment services anddelivery functions that impact overall operating costs and riskmanagement.  These functions includepresentment of checks in paper and electronic form, identification andmitigation of fraudulent payments, handling irregular items such as checksreturned unpaid (exceptions), maintaining a record of past transactions(archiving), responding to related customer inquiries (research), andcorrecting any errors that are discovered (adjustments).  The Global Payments Technologies (“GPT”)solutions suite addresses these key functions in the context of improvingoperational efficiency and a gradual transition from paper to electronic-based paymentsystems.  In addition, we offer technologysolutions that optimize the inventory management of a bank’s cash stock levels,including managing how much is needed, when it is needed and where it isneeded.  Our solutions reduce the amountof cash banks need to hold in reserve accounts and as cash-on-hand, whileensuring a high level of customer service through timely replenishment of ATMcash supplies.

 

Specific solutions in the GPT group include:

 
| **Solution**                    |   | **Description**                                                                                                                                                                                                                                                                              |   | **Products  Offered**                                                                                                                                                                    |
|---------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                            |   |                                                                                                                                                                                                                                                                                         |   |                                                                                                                                                                                     |
| Fraud Mitigation                |   | Automated fraud  detection and prevention solutions that reduce incidents of check fraud,  deposit fraud, check kiting, and electronic fraud. Scalable solutions are  offered for community banks.                                                                                           |   | FraudLink On-Us,  FraudLink Deposit, FraudLink Kite, FraudLink Positive Pay, FraudLink eTracker,  FraudLink PC, CORE, FraudLink ACHeCK, eFraudLink.com, Fraud Solutions  Consulting      |
|                            |   |                                                                                                                                                                                                                                                                                         |   |                                                                                                                                                                                     |
| Back Office Processing          |   | Products that bring new  efficiencies to back-office operations through leading-edge image, workflow,  and RECO (character recognition) technologies.                                                                                                                                        |   | Adjustments/Express,  Exceptions/Express, Input/Express, Inbound Returns/Express, Image Bulk-File,  All Transactions File and Fine Sort                                                  |
|                            |   |                                                                                                                                                                                                                                                                                         |   |                                                                                                                                                                                     |
| Remittance Processing           |   | Both host and  client/server-based platforms for improved productivity in processing retail  and wholesale remittance transactions.                                                                                                                                                          |   | 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, LTA (Large Table Access)                    |
|                            |   |                                                                                                                                                                                                                                                                                         |   |                                                                                                                                                                                     |
| Check Image Capture             |   | Products and services  related to the capture, 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 |
|                            |   |                                                                                                                                                                                                                                                                                         |   |                                                                                                                                                                                     |
| 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,  NeXGen Remittance, + CDRom Delivery, Input/Express, Express Capture, Payee  Name Verification, 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                                                                                                                                                                           |

 

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| **Solution**                  |   | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   | **Products  Offered**                                                        |
|-------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------|
|                          |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |   |                                                                         |
| 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 |   | Enables banks to  transition from paper-based to electronic payment systems by automating key  elements of the processing stream, as well as improving a bank’s yield from  float management. 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.                                                |   | CheckLink, CheckLink  PC, Deposit Manager, Branch Truncation Manager, Cnotes |
|                          |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |   |                                                                         |
| ATM Solutions                 |   | Advanced ATM monitoring  and management, improving ATM availability and ensuring service levels are  met. These solutions include an automated ATM monitoring and dispatching  system for maximizing network availability; an Internet-based cash  forecasting and inventory management desktop system for reducing cash needs  by 20-40% across the enterprise; and a real-time Internet-based system for  efficient handling of ATM service requests and responses. |   | eiManager, eiGateway,  iCom                                                  |
|                          |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |   |                                                                         |
| Cash Solutions                |   | A product suite, now  optimized through Web-based software solutions, that dramatically reduces the  amount of cash banks, financial institutions and companies need to hold as  cash-on-hand throughout vault, branch and ATM networks. These solutions also  automate and standardize the cash ordering process.  Consulting solutions can drive further efficiency and  automation in vault, branch and ATM operations.                                       |   | iCom, ReserveLink,  ReserveLink Plus, Cash Supply Chain Consulting           |

 

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*Revenue Enhancement Solutions.*  The Revenue Enhancement division includestwo business units:  RevE and EnAct.RevE is a highly specialized division that provides consulting services focusedon tactical methods of increasing banks’ fee income. The scope and depth ofthis practice has expanded throughout its 13 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.

 

Anothercomponent of our Revenue Enhancement Division is our business providing EnActsoftware and proprietary sales management methodology. Our EnAct solutionsassist financial institutions in leveraging central intelligence with localinsight. This enables our clients to recognize those customers and prospectsrepresenting the greatest value or potential. Our approach is unique andcomplimentary to many CRM investments that banks have made in recent years andis designed to focus their activities such that they can actually attainincreased returns on these CRM investments.

 

*Global Payments Consulting.*  Carreker helps financial institutionspro-actively plan, prepare and optimize for the regulatory, competitive andtechnological impacts affecting the financial payments environment.

 

OurGlobal Payments Consulting (GPC) division provides strategic planning andimplementation advisory services for financial institutions and otherclients.  These planning andimplementation services include:

 

•                  Enterprisepayment strategy

•                  Paymentresearch services

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

•                  Image-enabledpayment infrastructure planning

•                  Transportation,float and funds availability optimization

•                  Organizationaldesign

•                  Consolidationand merger/integration planning

•                  ProgramManagement

•                  Check 21readiness

 

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

 

The GPC division alsocontains the consulting license, maintenance and service revenue of our FloatManagement software products.  TheseFloat Management products provide solutions that manage a bank’s float throughfloat analysis and pricing to improve profitability, reporting, workflow andcheck clearing operations.  Theseproducts also provide critical activity summaries, aid in creating multipleavailability and pricing schedules, and pinpoint the cost/profitability oftransactions or relationships.  Theproducts offered consist of Float Analysis System and Float Pricing System.

 

*Outsourcing.*  Carretek is a jointly owned company withMajesco Software Inc., the US subsidiary of Mastek Limited, a leading Indianoutsourcing company with global operations. Carretek was formed in fiscal 2003. As this business is still in the developmental phase, and has notderived any revenue, its operations are contained in the Corporate-Unallocatedbusiness segment.  Carretek’s goal is toenable financial institutions and their processors to realize the benefits oftransformational offshore-centric outsourcing (offshoring) of their businessprocesses and IT services needs.  Thesebenefits could include reduction in operating costs, improvements inproductivity, and enhancement of quality.

 

Initially, Carretek isfocused on offshoring payments-related business processes.  Within this area of expertise, the Carretekoffering includes a flexible array of offshore outsourcing services tofinancial institutions, which include: global sourcing strategy development(consulting, methodology, and tools) to help banks understand their offshoringopportunities and optimize their decisions in this regard; and outsourcing ofselected payment processes to India through a range of business models suitedto each bank’s needs.

 

Carretek draws onCarreker’s expertise in payments systems and associated business processes tohelp banks rationalize the business case for transitioning some of theseprocesses to cost-efficient offshore locations and improving banks’ return oninvestments in payments technologies. Carreker’s image-related technologies, already in place at many largeU.S. banks, enable such transitioning and leverage the banks’ previousinvestment in these systems.

 

27

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*Costof Revenues and Gross Margins.*  We strive to control our cost of revenues and thereby maintain orimprove our gross margins.  The majoritems impacting cost of consulting, cost of software maintenance and cost ofsoftware implementation are driven by personnel, overhead and related expenses.  The major items impacting cost of softwarelicenses are amortization of both capitalized and acquired software and alsosoftware royalties for software from third parties.  While the amortization expense is relatively fixed, the thirdparty royalty expense can vary significantly based 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 andoffice services expenses.

 

*Liquidityand Cash Flows.*  Cashand cash equivalents at April 30, 2004 and January 31, 2004 totaled $31.5million and $28.6 million, respectively. During Q1 2004, we generated $9.8 million in cash from operatingactivities, used $1.1 million of cash for investing activities and used $5.7million for financing activities.  Ourprimary utilization of cash in Q1 2004 was to reduce our debt to zero under ourrevolving credit agreement.

 

**Results of Operations**

 

***Comparison of Quarter Ended April 30, 2004 (Q1 2004) toQuarter Ended April 30, 2003 (Q1 2003)***

 

***Revenues ($ in thousands):***

 
|                          |   | **Three  Months Ended  April 30,** |   | **Variance** |       |
|-------------------------------|--------|------------------------------------|--------|--------------|------------|
|                          |   | **2004**                           |   | **2003**     | ** ** | **$** |   | **%** | ** ** |
|                          |   |                               |   |         |       |   |   |   |   |
| Revenue Enhancement           |   | $                                  | 9,481  |         | $          | 8,058 |   | $ | 1,423 |   | 17.7 | % |
| Global Payments  Technologies |   | 19,225                             |   | 19,046       |       | 179 |   | 0.9 |   |
| Global Payments  Consulting   |   | 1,060                              |   | 1,152        |       | (92 | ) | (8.0 | ) |
|                          |   |                               |   |         |       |   |   |   |   |
| Total Revenues                |   | $                                  | 29,766 |         | $          | 28,256 |   | $ | 1,510 |   | 5.3 | % |

 

The increase in revenuewithin the Revenue Enhancement (“RevE”) segment in Q1 2004, compared to Q12003, was primarily attributable to a $2.4 million increase in RevE consultingrevenue in several international markets. This increase in consulting revenue was offset by a decline in softwarelicense and implementation services revenue from our EnAct software offering asthe demand for this offering, both domestically and internationally, hasdeclined.

 

Revenue in the GlobalPayments Technologies (“GPT”) segment remained relatively flat at $19.2 millionfor Q1 2004, as compared to $19.0 million in Q1 2003.  Maintenance revenue in this segment improved $2.4 million in Q12004 from Q1 2003 due to improved collections of maintenance billings.  However, this segment experienced a declinein software implementation revenues due primarily to delays in technologyinvestments by our customers and the availability of our new product offeringsrelating to Check 21 legislation and our other new Cash and Risk solutionsproducts.

 

The slight decline inrevenues within the Global Payments Consulting (“GPC”) segment in Q1 2004, ascompared to Q1 2003, reflects the transition of this segment in moving toaddress enterprise-wide payment strategies and image enablement planning andintegration.

 

Overall, as we lookacross our three business segments, we believe that we are well positioned andhave a competitive advantage to capitalize on the significant changes broughtabout by the Check 21 legislation, USA Patriot Act and Basel II due to our subjectmatter expertise in the impacted areas. We believe the revenue growth that will be derived from these regulatorychanges will result in modest revenue growth in late 2004 with more attractivegrowth rates in fiscal 2005.

 

28

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*ConsultingFees ($ in thousands):*

 
|            |   | **Three  Months Ended  April 30,** |   | **Variance** |   |
|-----------------|--------|------------------------------------|--------|--------------|--------|
|            |   | **2004**                           |   | **2003**     |   | **$** |   | **%** |   |
|            |   |                               |   |         |   |   |   |   |   |
| Consulting Fees |   | $                                  | 9,057  |         | $      | 6,751 |   | $ | 2,306 |   | 34.2 | % |
|                 |        |                                    |        |              |        |  |  |  |  |  |  |  |

 

Consulting revenue in theRevE segment increased $2.4 million, or 40%, to $8.5 million in Q1 2004 from$6.1 million in Q1 2003.  Domestically,consulting revenue for RevE was flat at $6.0 million.  International RevE consulting revenue increased $2.5 millionin Q1 2004, as compared to Q1 2003.

 

Consulting revenue in ourGPC segment declined 4%, to $534,000, in Q1 2004 from $558,000 in Q1 2003.  We experienced improvement in our FloatConsulting, which was offset by declines in both the Image and PaymentStrategies area.  While we have seensome momentum from our redefined GPC segment, we continue to be cautiouslyoptimistic about the future prospects of the GPC segment.

 

*SoftwareLicense Fees ($ in thousands):*

 
|                   |   | **Three  Months Ended  April 30,** |   | **Variance** |   |
|------------------------|--------|------------------------------------|--------|--------------|--------|
|                   |   | **2004**                           |   | **2003**     |   | **$** |   | **%** |   |
|                   |   |                               |   |         |   |   |   |   |   |
| Software License  Fees |   | $                                  | 5,856  |         | $      | 6,578 |   | $ | (722 | ) | (11.0 | )% |
|                        |        |                                    |        |              |        |  |  |  |  |  |  |  |

 

The great majority of oursoftware license fees are derived from our GPT business segment.  GPT software license revenue of $5.6 millionin Q1 2004 was basically flat, as compared to Q1 2003.  In Q1 2004, $2.9 million, or 51%, ofsoftware license revenue in the GPT business segment was the result of alicense sale to a single customer in our Archive area, which did not requireimplementation services.  In Q1 2003,the software license revenue was more evenly distributed over our customerbase.  We anticipate that in futureperiods the software license revenue will be more evenly distributed over ourcustomer base.

 

The software revenuederived from our EnAct product offering, contained in our RevE businesssegment, declined $728,000, or 80%, to $179,000 in Q1 2004 from $907,000 in Q12003.

 

Beginning in the latterhalf of fiscal 2002, and continuing into fiscal 2003 and Q1 2004, the numberand dollar amount of software license and related services arrangements beganto decline.  This trend resulted from anatural decline in software revenue derived from our existing products as theyreached a state of maturity in their product life cycle.

 

During the latter half offiscal 2003 and continuing in Q1 2004, several new product initiatives werelaunched.  These initiatives include:

 

•                  ExchgLink:  an application designed to send and receivecheck images.  This product is beinginstalled at our functional partner site, along with an additional beta site.  All license revenues continue to be deferredsince the product is not generally available.

 

•                  SourceCapture:  an application that enablescustomers to capture check images at corporate sites, bank branches and ATM’s.

 

•                  COREAML:  an anti-money launderingapplication.

 

•                  ExpressResearch:  an image-enabled back officeapplication.

 

We anticipate market clarity emerging in the industry, especially as itrelates to software solutions surrounding Check 21, which gives us confidencein customer buying decisions during fiscal 2004.

 

29

----

 

*SoftwareMaintenance Fees ($ in thousands):*

 
|                      |   | **Three  Months Ended  April 30,** |   | **Variance** |   |
|---------------------------|--------|------------------------------------|--------|--------------|--------|
|                      |   | **2004**                           |   | **2003**     |   | **$** |   | **%** |   |
|                      |   |                               |   |         |   |   |   |   |   |
| Software Maintenance Fees |   | $                                  | 11,084 |         | $      | 8,710 |   | $ | 2,374 |   | 27.3 | % |
|                           |        |                                    |        |              |        |  |  |  |  |  |  |  |

 

Software maintenancerevenue increased $2.4 million, or 27%, in Q1 2004 to $11.1 million from $8.7million in Q1 2003.  The great majorityof 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 we recognized this maintenance revenueratably over the term of the related contract. If the annual maintenance fee is not paid at the beginning of themaintenance period, we defer revenue recognition until the time that themaintenance fee is paid by the customer. When the payment is received, maintenance revenue is recognized for theperiod that maintenance revenue was previously deferred.  The increase in Q1 2004 compared to Q1 2003reflects more timely payment by our customer base for their maintenanceagreements.  Maintenance contractsusually carry annual maintenance fee escalation clauses typically based on anindex, such as the consumer price index. Increases for maintenance revenue in 2004 due to this escalation will beoffset by the fact that a major customer has recently given notice of theirintent to not renew their maintenance contract for 2004.  Given this cancellation and the historicaldecline in new software license fees discussed above, maintenance fees areprojected to decline in fiscal 2004, as compared to fiscal 2003.

 

 

*SoftwareImplementation Fees ($ in thousands):*

 
|                          |   | **Three  Months Ended  April 30,** |   | **Variance** |   |
|-------------------------------|--------|------------------------------------|--------|--------------|--------|
|                          |   | **2004**                           |   | **2003**     |   | **$** |   | **%** |   |
|                          |   |                               |   |         |   |   |   |   |   |
| Software  Implementation Fees |   | $                                  | 2,879  |         | $      | 4,894 |   | $ | (2,015 | ) | (41.2 | )% |
|                               |        |                                    |        |              |        |  |  |  |  |  |  |  |

 

The great majority ofour software implementation fees are derived from our GPT businesssegment.  In that segment, softwareimplementation fees declined $1.9 million, or 43%, in Q1 2004 to $2.6 millionfrom $4.5 million in Q1 2003.  In themajority of our customer arrangements, installation services are provided tothe customer when a license is purchased. However, the decline in installation services in Q1 2004 was greaterthan the decline in license revenue for Q1 2004, compared to Q1 2003 primarilydue to the large software license arrangement discussed above that did notrequire any installation services.  Thisdecline reflects the completion of several major projects during fiscal 2003that were not replaced during the latter half of fiscal 2003 nor Q1 2004.

 

The future softwareimplementation fee revenue will be dependent on the sales levels of our newsoftware solutions responding to Check 21 and other opportunities.

 

30

----

 

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

 
|                                  |   | **Three  Months Ended  April 30,** |   | **Variance** |   |
|---------------------------------------|--------|------------------------------------|--------|--------------|--------|
|                                  |   | **2004**                           |   | **2003**     |   | **$** |   | **%** |   |
|                                  |   |                               |   |         |   |   |   |   |   |
| Out-of-Pocket  Expense Reimbursements |   | $                                  | 890    |         | $      | 1,323 |   | $ | (433 | ) | (32.7 | )% |
|                                       |        |                                    |        |              |        |  |  |  |  |  |  |  |

 

The decrease in thesereimbursements occurred across the three revenue generating business segments(GPT, GPC and RevE.)  Most of thesoftware services and consulting engagements require our employees to be at thecustomer location for extended periods of time, which gives rise toout-of-pocket expense reimbursements.

 

***Cost of Revenues ($ in thousands):***

 
|                          |   | **Three  Months Ended  April 30,** |   | **Variance** |   |
|-------------------------------|--------|------------------------------------|--------|--------------|--------|
|                          |   | **2004**                           |   | **2003**     |   | **$** |   | **%** |   |
|                          |   |                               |   |         |   |   |   |   |   |
| Revenue  Enhancement          |   | $                                  | 4,376  |         | $      | 4,455 |   | $ | (79 | ) | (1.8 | )% |
| % of revenue                  |   | 46.2                               | %      | 55.3         | %      |   |   |   |   |
|                          |   |                               |   |         |   |   |   |   |   |
| Global Payments  Technologies |   | $                                  | 8,518  |         | $      | 9,593 |   | $ | (1,075 | ) | (11.2 | )% |
| % of revenue                  |   | 44.3                               | %      | 50.4         | %      |   |   |   |   |
|                          |   |                               |   |         |   |   |   |   |   |
| Global Payments  Consulting   |   | $                                  | 1,343  |         | $      | 1,926 |   | $ | (583 | ) | (30.3 | )% |
| % of revenue                  |   | 126.7                              | %      | 167.2        | %      |   |   |   |   |
|                          |   |                               |   |         |   |   |   |   |   |
| Total Cost of  Revenues       |   | $                                  | 14,237 |         | $      | 15,974 |   | $ | (1,737 | ) | (10.9 | )% |
| % of revenue                  |   | 47.8                               | %      | 56.5         | %      |   |   |   |   |

 

Costs of revenue inabsolute dollars declined in all segments in Q1 2004 and were also lower as apercentage of revenues for each category of revenue as well as in total. TheGPT business segment had a decline in total cost of revenues of $1.1 million or11% reflecting some personnel reductions as well as some redeployment ofpersonnel to work on R&D projects as the number of software implementationservices declined.  In the GPC segment,which experienced a decline of $583,000 or 30%, actions had been taken infiscal 2003 to reduce the headcount in this segment to bring it in line withexpected revenues.  Likewise, the RevEsegment experienced a slight decline of $79,000 or 2% related primarily toredeployment of personnel working on the EnAct product to the software salesefforts for this product.

 

31

----

 

*Costof Consulting ($ in thousands):*

 
|                     |   | **Three  Months Ended  April 30,** |   | **Variance** |   |
|--------------------------|--------|------------------------------------|--------|--------------|--------|
|                     |   | **2004**                           |   | **2003**     |   | **$** |   | **%** |   |
|                     |   |                               |   |         |   |   |   |   |   |
| Cost of  Consulting      |   | $                                  | 4,529  |         | $      | 4,969 |   | $ | (440 | ) | (8.9 | )% |
| % of consulting  revenue |   | 50.0                               | %      | 73.6         | %      |   |   |   |   |
|                          |        |                                    |        |              |        |  |  |  |  |  |  |  |

 

The cost of consultingconsists primarily of personnel costs related to our consulting engagementswithin our RevE and GPC segments.  Thedecline in absolute dollars of $440,000 along with the decline in consulting costsas a percentage of consulting revenue in Q1 2004 compared to Q1 2003 primarilyreflects our efforts to lower the cost of the GPC segment to bring it in linewith expected near-term revenues.  Thisreduction, of approximately $530,000, is in personnel costs and contract laborin the GPC business segment.  However,the RevE segment experienced an increase in consulting costs of $200,000 or 6%related to an increase in personnel costs and consulting expenses.

 

*Costof Software Licenses ($ in thousands):*

 
|                           |   | **Three Months  Ended  April 30,** |   | **Variance** |   |
|--------------------------------|--------|------------------------------------|--------|--------------|--------|
|                           |   | **2004**                           |   | **2003**     |   | **$** |   | **%** |   |
|                           |   |                               |   |         |   |   |   |   |   |
| Cost of Software  Licenses     |   | $                                  | 1,598  |         | $      | 1,721 |   | $ | (123 | ) | (7.1 | )% |
| % of software  license revenue |   | 27.3                               | %      | 26.2         | %      |   |   |   |   |
|                                |        |                                    |        |              |        |  |  |  |  |  |  |  |

 

The cost of softwarelicenses consists primarily of amortization of capitalized and acquiredsoftware costs along with royalties payable to third parties.  The decline in costs of software licensefees of $123,000 or 7% is due primarily to lower royalty costs.

 

In connection withsoftware license and maintenance agreements entered into with certain banks andpurchase agreements with vendors under which we acquired software technologyused in products sold to our customers, we are required to pay royalties onsales of certain software products. Under these arrangements, we accrue royalty expense when the associatedrevenue is recognized.  The royaltypercentages generally range from 20% to 30% of the associated revenue.  In Q1 2004 we recorded $256,000 of royaltyexpense compared to $435,000 of royalty expense recorded in Q1 2003.  Depending on our future product mix, ourmargins from software license fees may be negatively impacted by increasedsoftware royalty expense.

 

*Costof Software Maintenance ($ in thousands):*

 
|                               |   | **Three  Months Ended  April 30,** |   | **Variance** |   |
|------------------------------------|--------|------------------------------------|--------|--------------|--------|
|                               |   | **2004**                           |   | **2003**     |   | **$** |   | **%** |   |
|                               |   |                               |   |         |   |   |   |   |   |
| Cost of Software  Maintenance      |   | $                                  | 3,798  |         | $      | 3,176 |   | $ | 622 |   | 19.6 | % |
| % of software  maintenance revenue |   | 34.3                               | %      | 36.5         | %      |   |   |   |   |
|                                    |        |                                    |        |              |        |  |  |  |  |  |  |  |

 

Cost of softwaremaintenance consists primarily of personnel and facility costs to providetelephone support, products defect support and other enhancements to ourexisting products, which are not significant enough to extend the product’slife cycle or substantially increase its marketability. The increase of$622,000, or 20%, in Q1 2004 compared to Q1 2003, occurred in both our GPT andRevE business segments.  This increaseis personnel related and reflects increased emphasis in supporting andenhancing our current product mix.  Thisincrease was not attributable to additional overall headcount; rather, thiscost increase represents redeployment of our technical staff from the softwareservices area to the maintenance area.

 

32

----

 

As discussed above, theannual maintenance fee is generally paid by the customer at the beginning ofthe maintenance period and we recognize this maintenance revenue ratably overthe term of the related contract.  Ifthe annual maintenance fee is not paid at the beginning of the maintenanceperiod, we defer the revenue recognition until the time that the maintenancefee is paid by the customer.  When thepayment is received, maintenance revenue is recognized for the period thatmaintenance revenue was previously deferred. As a result, our cost of software maintenance as a percentage of relatedmaintenance revenue may fluctuate.

 

*Costof Software Implementation ($ in thousands):*

 
|                                  |   | **Three  Months Ended  April 30,** |   | **Variance** |   |
|---------------------------------------|--------|------------------------------------|--------|--------------|--------|
|                                  |   | **2004**                           |   | **2003**     |   | **$** |   | **%** |   |
|                                  |   |                               |   |         |   |   |   |   |   |
| Cost of Software  Implementation      |   | $                                  | 3,369  |         | $      | 4,855 |   | $ | (1,486 | ) | (30.6 | )% |
| % of software  implementation revenue |   | 117.0                              | %      | 99.2         | %      |   |   |   |   |
|                                       |        |                                    |        |              |        |  |  |  |  |  |  |  |

 

Costs of softwareimplementation consist primarily of personnel and facility costs to providesoftware implementation and project management support to customer softwareimplementations within our GPT business segment and our RevE segment.  The decline in costs of softwareimplementation of $1.5 million in Q1 2004 to $3.4 million, from $4.9 million,in Q1 2003 is due to a decline in new software license and implementation projects,in both the GPT segment and the RevE segment, as well as the completion ofseveral major projects in the GPT segment that were in progress during Q1 2003,and completed in the latter half of fiscal 2003.  The increase in the percentage of software implementation costsas a percentage of software implementation revenue is the result of the declinein software implementation revenue experienced in Q1 2004.  As discussed within software implementationfee revenue, improvements in our software implementation margins will bedependent on our sales levels of the new software solutions responding to Check21 and other opportunities.

 

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

 
|                                       |   | **Three  Months Ended  April 30,** |   | **Variance** |   |
|--------------------------------------------|--------|------------------------------------|--------|--------------|--------|
|                                       |   | **2004**                           |   | **2003**     |   | **$** |   | **%** |   |
|                                       |   |                               |   |         |   |   |   |   |   |
| Cost of  Out-of-Pocket Expenses            |   | $                                  | 943    |         | $      | 1,253 |   | $ | (310 | ) | (24.7 | )% |
| % of  out-of-pocket expense reimbursements |   | 106.0                              | %      | 94.7         | %      |   |   |   |   |
|                                            |        |                                    |        |              |        |  |  |  |  |  |  |  |

 

These costs representtravel, meals and other sundry expenses incurred by our employees.  These costs are invoiced to the customer,without mark-up, usually on a monthly basis. The absolute costs have declined $310,000 in Q1 2004, as compared to Q12003, due to fewer software implementation engagements as discussed above.  In addition, certain customer contractscontain expense maximums, so in certain cases not all expenses incurred can bepassed along to the customer.

 

33

----

 

***Operating Costs and Expenses ($ in thousands):***

 

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

 
|                                          |   | **Three  Months Ended  April 30,** |   | **Variance** |   |
|-----------------------------------------------|--------|------------------------------------|--------|--------------|--------|
|                                          |   | **2004**                           |   | **2003**     |   | **$** |   | **%** |   |
|                                          |   |                               |   |         |   |   |   |   |   |
| Selling, General  and Administrative Expenses |   | $                                  | 12,654 |         | $      | 11,933 |   | $ | 721 |   | 6.0 | % |
| % of total  revenue                           |   | 42.5                               | %      | 42.2         | %      |   |   |   |   |
|                                               |        |                                    |        |              |        |  |  |  |  |  |  |  |

 

Selling, general andadministrative expenses generally consist of personnel costs such as salaries,commissions and other incentive compensation along with travel associated withselling, marketing, general management and software management. Additionally,the provision for doubtful accounts, insurance, including directors andofficers insurance, as well as professional services such as legal andaccounting expense and other related costs are classified within selling,general and administrative expense.  Weexperienced an increase in these costs of $721,000 in Q1 2004 to $12.6 millionfrom $11.9 million in Q1 2003.

 

While we have madeprogress in reducing costs in this area by reducing personnel costs, thesereductions have been more than offset by increases in non-personnel expenses,such as legal fees associated with our litigation.  In Q1 2004, we incurred approximately $462,000 in EPG legalcosts.  Additionally, we have incurredincreased insurance costs for our directors and officers, travel costsassociated with sales efforts and our professional fees associated with ourSarbanes-Oxley compliance.

 

In addition, in thesecond quarter of 2003, we formed Carretek LLC, a jointly owned company tooffer financial institutions offshore-centric outsourcing of their businessprocesses and IT needs.  Carretek LLCincreased selling, general and administrative costs by approximately $174,000in Q1 2004.

 

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

 
|                               |   | **Three  Months Ended  April 30,** |   | **Variance** |   |
|------------------------------------|--------|------------------------------------|--------|--------------|--------|
|                               |   | **2004**                           |   | **2003**     |   | **$** |   | **%** |   |
|                               |   |                               |   |         |   |   |   |   |   |
| Research and  Development Expenses |   | $                                  | 1,708  |         | $      | 1,866 |   | $ | (158 | ) | (8.5 | )% |
| % of total  revenue                |   | 5.7                                | %      | 6.6          | %      |   |   |   |   |
|                                    |        |                                    |        |              |        |  |  |  |  |  |  |  |

 

Research anddevelopment expenses consist primarily of personnel, contract labor, travel andfacilities expenses incurred by our research and development organization.  In Q1 2004, research and development costshave decreased as compared to Q1 2003, as a result of increased capitalizationof research and development costs. Research and development costs are typically limited to development ofnew software products, or enhancements to existing software products, which extendthe product’s life cycle and/or substantially increase its marketability.

 

In accordance withSFAS No. 86, “*Accounting for Costs ofComputer Equipment**to be Sold,Leased or Otherwise Marketed,”* we capitalized $910,000 for the threemonths ended April 30, 2004, as compared to $0 for the three months ended April30, 2003.  In Q1 2004, $467,000 of ourcapitalization is related to our first version of ExchgLink, our productoffering to send and receive check images. We expect this product to become generally available in the second orthird quarter of fiscal 2004.  We haveseveral other development initiatives underway in fiscal 2004 such as thesecond version of ExchgLink; Express Research, an image-enabled back officeapplication; Source Capture, an application which enables customers to capturecheck images at corporate sites, bank branches and ATM’s; and an anti-moneylaundering application.  Consideringthese initiatives, we expect the total amount of research and development coststo remain at approximately the same levels during the remainder of fiscal 2004.

 

Software developmentcosts of a product are capitalized from the time technological feasibility isreached until the general release of the product.  We establish technological feasibility through the process ofcreating a detailed program design and reviewing the detailed program designfor any high risk development issues. Capitalization only occurs if we believe costs capitalized arerecoverable through future sales of the software product under development.

 

34

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*Amortizationof Goodwill and Intangible Assets:*

 

Amortization ofgoodwill and intangible assets was $350,000 in each of the three months endedApril 30, 2004 and 2003.  Theamortization results from the periodic recognition of amortization expense ofintangible customer relationships acquired in the Check Solutions acquisition.

 

*Litigationloss provision**($ in thousands):*

 
|                       |   | **Three  Months Ended  April 30,** |   | **Variance** |   |
|----------------------------|--------|------------------------------------|--------|--------------|--------|
|                       |   | **2004**                           |   | **2003**     |   | **$** |   | **%** |   |
|                       |   |                               |   |         |   |   |   |   |   |
| Litigation loss  provision |   | $                                  | 1,686  |         | $      | — |   | $ | 1,686 |   | 100 | % |
|                            |        |                                    |        |              |        |  |  |  |  |  |  |  |

 

The jury in thislitigation returned a verdict in favor of EPG on one claim and in favor ofCarreker on three claims. The jury also awarded EPG compensatory damages of$1,686,000.  The jury award is subjectto judicial review.

 

Based on the facts andcircumstances, we accrued the amount of the jury verdict as of April 30,2004.  Any subsequent changes in thisamount will be accounted for in the period when they are deemed probable and canbe estimated.

 

***Restructuringand Other Charges:***  We recorded variousrestructuring and other charges during the three months ended April 30, 2004and 2003 as follows ($ in thousands):

** **
|                                |   | **Workforce  Reductions** |   | **Charges  relating to  CheckFlow  Suite** |   | **Facility  Closures** |   | **Other** |   | **Total** |   |
|-------------------------------------|--------|---------------------------|--------|--------------------------------------------|--------|------------------------|--------|-----------|--------|-----------|--------|
|                                |   |                      |   |                                       |   |                   |   |      |   |      |   |
| Total quarter  ended April 30, 2003 |   | $                         | 545    |                                       | $      | —                 |   | $         | — |      | $      | 139 |   | $ | 684 |   |
|                                |   |                      |   |                                       |   |                   |   |      |   |      |   |
| Total quarter  ended April 30, 2004 |   | $                         | 308    |                                       | $      | —                 |   | $         | — |      | $      | 59 |   | $ | 367 |   |
|                                     |        |                           |        |                                            |        |                        |        |           |        |           |        |  |  |  |  |  |  |

 

Quarter Ended April 30,2003:

 

We recorded $545,000 inrestructuring and other charges during the three month period ended April 30,2003, principally associated with the separation of 17 employees, within boththe Corporate and Global Payments Consulting (“GPC”) business segments.  During the quarterly period ended April 30,2003, we recorded a charge of $139,000 relating to legal and professional feesrelating to our restatement efforts and the shareholder legal actions describedin Note 8 of the Condensed Consolidated Unaudited Financial Statements.

 

Quarter Ended April 30,2004:

 

We recorded $308,000 inrestructuring and other charges during the three month period ended April 30,2004, principally associated with the separation of 10 employees.  During the quarterly period ended April 30,2004, we recorded a charge of $59,000 relating to legal and professional feesrelating to our shareholder legal actions described in Note 8 of the CondensedConsolidated Unaudited Financial Statements.

 

35

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The activity related tothe accrued merger and restructuring costs reserve during the three monthsended April 30, 2004 is as follows ($ in thousands):

 
|                                 |   | **Workforce  Reductions** |   | **Charges  relating to  CheckFlow  Suite** |   | **Facility  Closures** |   | **Other** |   | **Total** |   |
|--------------------------------------|--------|---------------------------|--------|--------------------------------------------|--------|------------------------|--------|-----------|--------|-----------|--------|
|                                 |   |                      |   |                                       |   |                   |   |      |   |      |   |
| Reserve balance  at January 31, 2004 |   | $                         | 500    |                                       | $      | 1,296                  |   | $         | 5      |      | $      | 97 |   | $ | 1,898 |   |
|                                 |   |                      |   |                                       |   |                   |   |      |   |      |   |
| Additions to  reserve balance:       |   |                      |   |                                       |   |                   |   |      |   |      |   |
| Severance  charges                   |   | 308                       |   | —                                     |   | —                 |   | —    |   | 308       |   |
| Reductions to  reserve balances:     |   |                      |   |                                       |   |                   |   |      |   |      |   |
| Cash paid                            |   | (412                      | )      | (29                                        | )      | —                 |   | (5        | )      | (446      | )      |
| Reserve Balance  at April 30, 2004   |   | $                         | 396    |                                       | $      | 1,267                  |   | $         | 5      |      | $      | 92 |   | $ | 1,760 |   |

 

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

 

*InterestIncome ($ in thousands)*:

 
|            |   | **Three  Months Ended  April 30,** |   | **Variance** |   |
|-----------------|--------|------------------------------------|--------|--------------|--------|
|            |   | **2004**                           |   | **2003**     |   | **$** |   | **%** |   |
|            |   |                               |   |         |   |   |   |   |   |
| Interest Income |   | $                                  | 48     |         | $      | 80 |   | $ | (32 | ) | (40.0 | )% |
|                 |        |                                    |        |              |        |  |  |  |  |  |  |  |

 

Interest income consistsof interest earned on cash and cash equivalents.  Interest income decreased 40%, to $48,000, in Q1 2004, ascompared to $80,000 in Q1 2003.  Thedecrease is primarily the result of lower interest rates.

 

*InterestExpense ($ in thousands)*:

 
|             |   | **Three  Months Ended  April 30,** |   | **Variance** |   |
|------------------|--------|------------------------------------|--------|--------------|--------|
|             |   | **2004**                           |   | **2003**     |   | **$** |   | **%** |   |
|             |   |                               |   |         |   |   |   |   |   |
| Interest Expense |   | $                                  | (108   | )            | $      | (418 | ) | $ | (310 | ) | (74.2 | )% |
|                  |        |                                    |        |              |        |  |  |  |  |  |  |  |

 

Interest expense isprimarily the result of borrowings under our $30.0 million revolving creditagreement.  Additionally, theamortization of the deferred loan costs are also included in interestexpense.  Interest expense decreased74%, to $108,000, in Q1 2004, as compared to $418,000 in Q1 2003.  The decline is attributable to lessoutstanding borrowings under the revolving credit agreement in Q1 2004, ascompared to Q1 2003.

 

*Otherincome ($ in thousands)*:

 
|                                                         |   | **Three  Months Ended  April 30,** |   | **Variance** |   |
|--------------------------------------------------------------|--------|------------------------------------|--------|--------------|--------|
|                                                         |   | **2004**                           |   | **2003**     |   | **$** |   | **%** |   |
|                                                         |   |                               |   |         |   |   |   |   |   |
| Gain on sale of  Cash Services Australia Pty. Limited        |   | $                                  | 539    |         | $      | — |   | $ | 539 |   | 100.0 | % |
| Equity in  earnings of Cash Services Australia Pty. Limited. |   | (17                                | )      | 72           |   | (89 | ) | (123.6 | ) |
| Minority share of net loss of Carretek LLC                   |   | 86                                 |   | —       |   | 86 |   | 100.0 |   |
| Foreign exchange losses                                      |   | (129                               | )      | (81          | )      | (48 | ) | (59.3 | ) |
| Other                                                        |   | 5                                  |   | 25           |   | (20 | ) | (80.0 | ) |
| Total other  income                                          |   | $                                  | 484    |         | 16     |   | $ | 468 |   |   |   |
|                                                              |        |                                    |        |              |        |  |  |  |  |  |  |  |

 

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In April 2004, we soldour 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 May2004.  As a result of this transaction,we recorded a $539,000 gain.

 

During Q2 2003, we formedCarretek LLC (“Carretek”), a 51% jointly owned company to offer financialinstitutions off-shore centric outsourcing of their business processes and ITservices needs.  To date, Carretek hasnot generated any revenue and accordingly, the 49% share, or $86,000 of theminority interest in this loss was recorded in other income (expense.)

 

*Provision for Income Taxes:*

 

The Company hasestablished a valuation allowance to reserve its net deferred tax assets atApril 30, 2004 because the more likely than not criteria for future realizationof the Company’s net deferred tax assets specified in Statements of FinancialAccounting Standards No. 109, “*Accountingfor Income Taxes,”* (“SFAS No. 109”) were not met.

 

The net tax provisionwas zero for the three months ended April 30, 2004.  The net tax provision of $94,000 for the three months ended April30, 2003 consists of a provision for state taxes.  No tax benefit was recorded at April 30, 2004 due to theuncertainty regarding the Company’s ability to generate taxable income, andresulting uncertainty relative to the recoverability of deferred tax assets.

 

In May 2004, the federaltax law changed to allow software license revenue to be deferred for taxpurposes similar to the percent-complete revenue recognition model we use forfinancial statement purposes.  Theimpact of this change in the tax law will most likely increase the amount ofthe net operating loss carryforwards and thereby further reduce our effectivetax rate at such time as we begin to generate taxable income.

 

**Liquidity and Capital Resources**

 

Historically, we havefunded our operations and cash expenditures primarily with cash generated fromoperating activities.  At April 30,2004, we had working capital of $7.5 million compared to $11.7 million atJanuary 31, 2004.  We had $31.5 millionin cash and cash equivalents at April 30, 2004, an increase of $2.9 millionfrom $28.6 million in cash and cash equivalents at January 31, 2004.  At April 30, 2004, we had no long-term debtcompared to $6.3 million at January 31, 2004. We expect that existing cash and cash generated from operatingactivities will be sufficient to meet our presently anticipated requirementsfor the foreseeable future.

 

Cash provided byoperating activities was $9.8 million in the three months ended April 30, 2004compared to cash provided by operating activities of $12.2 million in the threemonths ended April 30, 2003.  Operatingcash flows decreased during the three months ended April 30, 2004, as comparedto the three months ended April 30, 2003, primarily as a result of lower amountof deferred revenue related to both software license and softwareimplementation fees.

 

Average days’ salesoutstanding fluctuate for a variety of reasons, including the timing ofbillings specified by contractual agreement, and receivables for expensereimbursements.  The following tablecontains the quarterly days’ sales outstanding (DSO):

 
| **Quarter ended** |   | **DSO** |   |
|-------------------|--------|---------|--------|
| April 30, 2004    |   | 46      |   |
| January 31, 2004  |   | 59      |   |
| October 31, 2003  |   | 56      |   |
| July 31, 2003     |   | 43      |   |
| April 30, 2003    |   | 51      |   |

 

Cash used in investingactivities during the three months ended April 30, 2004 was $1.1 million, andwas primarily related to $231,000 of routine purchases of property andequipment along with $910,000 of capitalized software costs.  Cash used in investing activities during thethree months ended April 30, 2003 was $311,000, and was related to thepurchases of property and equipment.  Weexpect purchases of property and equipment to increase in future quarters infiscal 2004 as we replace certain developmental hardware and software withinour technology group based in Charlotte, NC. We expect these expenditures to approximate between $1.0 million and$1.5 million primarily during the next two quarters.  We believe that capitalized software development costs willcontinue at approximately the same trend over the future quarters in fiscal2004.

 

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Financing activities usedcash of $5.7 million in the three months ended April 30, 2004, and used cash of$10.0 million in the three months ended April 30, 2003.  The cash used in financing activities in thethree months ended April 30, 2004 was comprised of $6.3 million of payments onour revolving credit agreement offset by $375,000 of stock option exerciseproceeds.  In addition, $147,000 wasreceived related to the minority interest and shareholder loan for CarretekLLC.  The cash used in financingactivities during the three months ended April 30, 2003 was comprised of $10.0million of payments on our revolving credit agreement.

 

On June 6, 2001, weentered into a three-year revolving credit agreement with a group of banks inan amount not to exceed $60.0 million to fund the acquisition of CheckSolutions.  On July 31, 2003, therevolving credit agreement was amended to reduce the commitment amount to $30.0million, and to extend the maturity date of the outstanding borrowings to July31, 2006.  At April 30, 2004, theCompany did not have any borrowings outstanding.  At April 30, 2003, we had outstanding borrowings of $15.0 millionunder the credit agreement.  Borrowingsunder the credit agreement currently bear interest equal to either the greaterof prime or federal funds rate plus a margin ranging from 1.25% to 2.25%depending on our ratio of funded debt to Earnings Before Interest, Taxes,Depreciation and Amortization (“EBITDA”); or London Interbank Offered Rate(“LIBOR”) plus a margin equal to 2.75% to 3.75% depending on our ratio offunded debt to EBITDA.  Interestpayments are due quarterly.  We arerequired to pay a commitment fee equal to 0.50% on the unused amount of therevolving credit agreement.  Therevolving credit agreement contains customary affirmative and negativecovenants, some of which have been amended, 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 subject to theapproval of the banks.  Substantiallyall of our assets collateralize this revolving credit agreement.  As of April 30, 2004, we are in compliancewith the covenants of the revolving credit agreement, as amended.

 

The following summarizesour contractual obligations at April 30, 2004 and the effect these contractualobligations are expected to have on our liquidity and cash flows in futureperiods (in thousands):

 
|             |   | **Payments  Due by Period** |   |
|------------------|--------|-----------------------------|--------|
|             |   | **Total**                   |   | **1 Year  or Less** |   | **Years 2-3** |   | **Years 4-5** |   | **After  5 Years** |   |
|             |   |                        |   |   |   |   |   |   |   |   |   |
| Operating leases |   | $                           | 16.7   |   | $ | 4.1 |   | $ | 6.1 |   | $ | 4.7 |   | $ | 1.8 |   |
|             |   | $                           | 16.7   |   | $ | 4.1 |   | $ | 6.1 |   | $ | 4.7 |   | $ | 1.8 |   |

 

We believe that currentcash balances and expected future cash flows will be sufficient to meet ouranticipated cash needs for working capital, capital expenditures and otheractivities during fiscal 2004.  However,if current sources are not sufficient to meet our needs, we may seek additionalequity or debt financing.  There can beno assurance that additional financing would be available on acceptable terms,if at all.  We are presently involved ina number of lawsuits, including several class action lawsuits.  In May 2004, the jury in the EPG litigationreturned a verdict against us and awarded approximately $1.7 million incompensatory damages to the plaintiff. We are currently evaluating other legal actions that could possiblyreduce this verdict.  The final outcomesor resolutions of the lawsuits are unknown, but could include judgments againstus, or settlements that could require additional substantial payments by us.  See Note 8 in our Notes to CondensedConsolidated Unaudited Financial Statements. The timing of the final resolution of these matters is uncertain.  We believe that a material adverse outcomeor outcomes with respect to the lawsuits could have a material adverse effecton our financial results, our business or our management including but notlimited to, significantly impacting our liquidity in a negative manner as wellas causing 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 could 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.

 

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**Critical Accounting Policies**

 

In preparing ourcondensed consolidated financial statements in conformity with accountingprinciples generally accepted in the United States, we use certain estimatesand assumptions that affect the reported amounts and related disclosures andour estimates 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 webelieve that our estimates and assumptions are reasonable, actual results maydiffer, and such differences could be significant to our financial results.

 

Revenue Recognition

 

Our revenue recognitionpolicies are in accordance with Statement of Position (“SOP”) 97-2, *“SoftwareRevenue Recognition,”* as amended by SOP 98-9, “*Modification of SOP 97-2, SoftwareRevenue Recognition with Respect to Certain Transactions,”* and StaffAccounting Bulletin (“SAB”) No. 101, *“Revenue Recognition in Financial Statements,”*SAB No. 104,**Revenue Recognition and Emerging Issues TaskForce (“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 us to provide implementation services that aredetermined to be essential to other elements of the arrangement, we follow theguidance in SOP 81-1, *“Accounting for Performance of Construction – Typeand Certain Production – Type Contracts.”*

 

*Consulting Fees.*  We employ three primary pricing methods inconnection with our delivery of consulting services. First, we may price ourdelivery of consulting services on the basis of time and materials, in whichcase the customer is charged agreed-upon daily rates for services performed andout-of-pocket expenses. In this case, we are generally paid fees and relatedamounts on a monthly basis, and we recognize revenues as the services areperformed. Second, we may deliver consulting services on a fixed-price basis.In this case, we are generally paid on a monthly basis or pursuant to an agreedupon payment schedule, and we recognize revenues on a percentage-of-completion basis.We believe that this method is appropriate because of our ability to determineperformance milestones and determine dependable estimates of our costsapplicable to each phase of a contract. Because financial reporting of these contracts depends on estimates,which are assessed continually during the term of the contract, costs aresubject to revisions as the contract progresses.  Anticipated losses on fixed-priced contracts are recognized whenestimable.  Third, we may deliverconsulting services pursuant to a value-priced contract with the customer. Inthis case, we are 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 our 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 our solution, subject in either case to a maximum, if any isagreed to, on the total amount of payments to be made to us.  We must first commit time and resources todevelop projections associated with value-pricing contracts before a bank willcommit to purchase our solutions, and we therefore assume the risk of makingthese commitments with no assurance that the customer will purchase thesolution.  Costs associated with thesevalue-pricing contracts are expensed as incurred**.**  These contractstypically include payments to be made to us pursuant to an agreed upon scheduleranging from one to twelve months in length. We recognize revenues generatedfrom consulting services in connection with value-priced contracts based uponprojected results only upon completion of all services and agreement upon theactual fee to be paid (even though billings for these services may be delayedby mutual agreement for periods not to exceed twelve months). In an effort toallow customers to more closely match expected benefits from our services withpayments to us, we may on occasion, offer payment terms which extend beyond 12months.  When we enter into an agreementthat has a significant component of the total amount payable under theagreement due beyond 12 months or if it is determined payments are not fixedand determinable at the date the agreement is entered into, revenue under thearrangement 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 our customers, we recognizerevenues only upon completion of all services and as the amounts of actualrevenues or savings are confirmed by the customer with a fixed payment date.

 

Costs associated withtime and materials, fixed-priced and value-priced consulting fee arrangementsare expensed as incurred and are included as a component of the cost ofconsulting fees.

 

We expect thatvalue-priced contracts will continue to account for a significant portion ofour 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.

 

Regardless of the pricingmethod employed by us in a given contract, we are typically reimbursed on amonthly basis for out-of-pocket expenses incurred on behalf of our customers.

 

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

 

In certain instances,especially with recently developed software, we defer software revenuerecognition until the services are completed and the project is accepted by thecustomer.

 

Software licenses areoften sold as part of a multiple element arrangement that may includemaintenance, implementation or consulting. We determine 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, we defer revenue recognition of thesoftware license fees.  However, if VSOEFVis determinable for all of the undelivered elements, and assuming theundelivered elements are not essential to the delivered elements, we will deferrecognition of the full fair value related to the undelivered elements andrecognize the remaining portion of the arrangement value through application ofthe residual method.  Where VSOEFV hasnot been established for certain undelivered elements, revenue for all elementsis deferred until those elements have been delivered or their fair values havebeen determined.  Evidence of VSOEFV isdetermined for software products based on actual sales prices for the productsold to a similar class of customer and based on pricing strategies set forthin our price book.  Evidence of VSOEFVfor services (installation, implementation and consulting) is based uponstandard billing rates and the estimated level of effort for individualsexpected to perform the related services. We establish VSOEFV for maintenance agreements using the percentagemethod such that VSOEFV for maintenance is a percentage of the license feecharged annually for specific software product, which in most instances is 20%of the portion of arrangement fees allocated to the software license element.

 

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

 

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

 

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

 

Our contracts typicallydo not include right of return clauses, and as a result, we do not record aprovision for returns.

 

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Royalties

 

In connection withsoftware license and maintenance agreements entered into with certain banks andpurchase agreements with vendors under which we acquired software technologyused in products sold to its customers, we are required to pay royalties onsales of certain software products. Under these arrangements, we accrue royalty expense when the associatedrevenue is recognized.  For current productofferings, the royalty percentages generally range from 20%-30% of theassociated revenues.  Royalty expense isincluded as a component of the cost of software license fees and cost ofsoftware maintenance fees in the accompanying condensed consolidated statementof operations.

 

Allowance for DoubtfulAccounts

 

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

 

Software CostsCapitalized, Goodwill, Other Intangible Assets and Other Long-Lived Assets

 

Software costscapitalized include developed technology acquired in acquisitions and costsincurred by us in developing our products that qualify for capitalization.  We capitalize our software developmentcosts, other than costs for internal-use software, in accordance with Statementof Financial Accounting Standards No. 86, “*Accountingfor Costs of Computer Software to be Sold, Leased or Otherwise Marketed”*(“SFAS 86”).  Our policy is tocapitalize software development costs incurred in developing a product oncetechnological feasibility of the product has been established.  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 remaining economic life of the product (generallythree to six years).

 

Goodwill and intangibleswith indefinite lives are assessed on an annual basis for impairment at the reportingunit level by applying a fair value based test.  We performed the initial impairment test of goodwill andintangibles with indefinite lives assets at February 1, 2002 and a follow uptest at November 1, 2002 to determine if an impairment charge should berecognized under SFAS 142.  The initialimpairment analysis did not result in any write-down of capitalized costs.  We perform an annual impairment assessmenton November 1st of each year or when factors indicate that otherlong-lived assets should be evaluated for possible impairment.  We use an estimate of undiscounted futurenet cash flows over the remaining life of the asset to determine if impairmenthas occurred.  Assets are grouped at thelowest level for which there are identifiable cash flows that are largelyindependent from other asset groups.  Animpairment in the carrying value of an asset is assessed when the undiscounted,expected future operating cash flows derived from the asset are less than itscarrying value.  Management believes thatassumptions used to determine cash flows are reasonable, but actual future cashflows may differ from those estimated. If we determine an asset has been impaired, the impairment is recordedbased on the estimated fair value of the impaired asset.  During the fourth quarter of the year endedJanuary 31, 2004, we performed our annual evaluation for goodwill impairmentand determined that the carrying amount of goodwill was not impaired and havenot noted any factors subsequent that would indicate impairment.  Goodwill at April 30, 2004 totaled $20.8million.  Any deterioration in marketconditions, increases in interest rates and changes in our projections withrespect to the Global Payments Technologies reporting unit to which goodwill isallocated would result in additional impairment charges in the future.

 

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Restructuring and Other Charges

 

Duringfiscal year 2001, we recorded reserves in connection with our acquisition ofCheck Solutions and subsequent operational restructurings.  Additional reserves were recorded duringfiscal 2002, 2003 and Q1 2004.  Thesereserves contain significant estimates pertaining to work force reductions, andthe settlement of contractual obligations resulting from our actions.  Although we do not anticipate anysignificant changes, the actual costs may differ from these estimates.

 

Contingencies

 

We are subject to proceedings, lawsuits and otherclaims.  We are required to assess thelikelihood of any adverse judgments of outcomes to these matters as well aspotential ranges of probable losses.  Adetermination of the amount or reserves required, if any, for thesecontingencies is made after careful analysis of each individual issue.  The required reserves may change in the futuredue to new developments in each matter or changes in insurance coverage orapproach such as change in settlement strategy.

 

Income Taxes

 

We recognize deferred taxassets or liabilities for the expected future tax consequences of temporarydifferences between the book and tax basis of assets and liabilities.  We review our deferred tax assets forrecoverability and establish a valuation allowance based on historical taxableincome, projected future taxable income and the expected timing of the reversalsof existing temporary differences.  As aresult of our cumulative net losses we have provided a full valuation allowanceagainst our net deferred tax assets.  Inaddition, we expect to provide a full valuation allowance of any future taxbenefits until we can sustain a level of profitability that demonstrates ourability to utilize these assets.

 

RecentlyIssued Accounting Standards

 

See “Recently IssuedAccounting Standards” in Note 2 of the Condensed Consolidated UnauditedFinancial Statements.

 

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**Item3.  Quantitative and QualitativeDisclosures About Market Risk**

 

**Interest Rate Risk**

 

We invest our cash in avariety of financial instruments.  Theseinvestments are denominated in U.S. dollars and maintained with nationallyrecognized financial institutions, and mutual fund companies.

 

We account for ourinvestment instruments in accordance with Statement of Financial AccountingStandards No. 115, *“Accounting for CertainInvestments in Debt and Equity Securities”* (“SFAS 115”).  We treat all of our cash equivalents andshort-term investments as available-for-sale under SFAS 115.

 

Investments in bothfixed rate and floating rate interest earning instruments carry a degree ofinterest rate risk.  Fixed rate securitiesmay have their fair market value adversely impacted due to a rise in interestrates, while floating rate securities may produce less income than expected ifinterest rates fall.  Due in part tothese factors, our future investment income may fall short of expectations dueto changes in interest rates, or we may suffer losses in principal if forced tosell securities which have seen a decline in market value due to changes ininterest rates.  Our investment securitiesare held for purposes other than trading. At April 30, 2004, we did not hold any fixed-rate investments.

 

We had no outstandingborrowings under our revolving credit agreement at April 30, 2004.  As described in Note 4 of our Notes toCondensed Consolidated Unaudited Financial Statements, the interest rate underthe revolving credit agreement is variable.

 

**Foreign Currency Risk**

 

We currently have salesand marketing operations in several international locations including Canada,United Kingdom, South Africa and Australia. As a result, we have assets and liabilities outside the United Statesthat are subject to fluctuations in foreign currency exchange rates.  Due to the nature of these operations, wecurrently utilize the U.S. Dollar as the functional currency for allinternational operations.

 

An insignificant portionof our accounts receivable balance at April 30, 2004, was denominated in aforeign currency.  Our exposure toadverse movements to foreign exchange rates is not significant.  Therefore, we do not currently hedge ourforeign currency exposure; however, we do try to limit our foreign currencyexposure by negotiating these foreign contracts in U.S. Dollars.  We will continue to evaluate the need toadopt a hedge strategy in the future and may implement a formal strategy if ourbusiness transacted in foreign currencies increases.

 

Foreign exchange losseswere $129,000 and $81,000 in the three months ended April 30, 2004 and 2003,respectively.

 

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**Item4.  Controls and Procedures**

 

*DisclosureControls*

 

We maintain disclosurecontrols and procedures designed to ensure that we are able to collect theinformation we are required to disclose in the reports we file with the SEC,and to process, summarize and disclose this information within the time periodsspecified in the rules of the SEC.

 

Our management, under thesupervision and with the participation of our Chief Executive and ChiefFinancial Officers, is responsible for evaluating the effectiveness of ourdisclosure controls and procedures.  Asof April 30, 2004, they carried out an evaluation of our disclosure controlsand procedures, and the Chief Executive and Chief Financial Officers believethat these controls and procedures are effective to ensure that we are able tocollect, process and disclose the information we are required to disclose inthe reports we file with the SEC within the required time periods.

 

In designing andevaluating the disclosure controls and procedures, management recognized thatany controls and procedures, no matter how well designed and operated, canprovide only reasonable assurance of achieving the desired control objectives,and management necessarily was required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures.

 

*InternalControls*

 

There have been nochanges in our internal control over financial reporting during our mostrecently completed fiscal quarter that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

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**PART II:   OTHER INFORMATION**

 

**ITEM 1.**                             LEGAL PROCEEDINGS

 

Except as noted below,the information contained in Part I, Item 3. Legal Proceedings in our Form 10-Kfor the period ended January 31, 2004 is hereby incorporated by reference.

 

Earnings PerformanceGroup (“EPG”) filed a complaint on or about September 16, 1998 in the SuperiorCourt of New Jersey, Law Division, Essex County seeking to enjoin and restrainus from using any EPG confidential or proprietary information or trade secretsand from employing any former EPG employee in such a manner that disclosure oruse of an EPG confidential or proprietary information or trade secret would belikely.  EPG also seeks (a) an accountingof any profits realized from or attributable to the use of any EPG confidentialor proprietary information or trade secret, (b) compensatory and exemplarydamages, plus interest and (c) attorneys’ fees and costs of suit.  On October 14, 1998, we removed the case tothe United States District Court for the District of New Jersey.  We answered the complaint on November 4,1998, essentially denying the allegations and setting forth various affirmativedefenses.  On November 20, 1998, wefiled an Amended Answer, Separate Defenses and Counterclaim.  In the Counterclaim we asserted claims for(a) restraint of trade, (b) tortuous interference with contractualrelationships, (c) unfair competition and (d) interference with prospectiveeconomic advantage.  In May 2004, thejury in this litigation returned a verdict in favor of EPG on one claim and infavor of us on three claims. The jury also awarded EPG compensatory damages of$1,686,000, and did not award EPG punitive damages.  The jury award is subject to judicial review and the court hasnot issued a ruling on EPG’s request for injunctive relief.

 

**ITEM 2.**                             CHANGES INSECURITIES AND USE OF PROCEEDS

 

None.

 

**ITEM 3.**                             DEFAULTSUPON SENIOR SECURITIES

 

None.

 

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

 

None.

 

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

 

None.

 

**ITEM 6.**                             EXHIBITS AND REPORTS ON FORM 8-K.

 

(a)          Exhibits

 
| **Number** |   | **Exhibit  Description**                                                                                                 |
|------------|--------|--------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                     |
| 31.1       |   | Certification Pursuant  to Section 302(a) of the Sarbanes-Oxley Act of 2002                                              |
|       |   |                                                                                                                     |
| 31.2       |   | Certification Pursuant  to Section 302(a) of the Sarbanes-Oxley Act of 2002                                              |
|       |   |                                                                                                                     |
| 32.1       |   | Certification Pursuant  to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
|       |   |                                                                                                                     |
| 32.2       |   | Certification Pursuant  to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |

 

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(b)         Reports on Form 8-K

 

We filed the followingCurrent Reports on Form 8-K with the Securities and Exchange Commission duringthe quarterly period April 30, 2004:

 

(i)                                                             OnMarch 16, 2004, we furnished a current report on Form 8-K to announce our 4Q2003 quarterly and annual fiscal 2003 financial condition and results ofoperations (Item 12).

 

(ii)                                                          OnApril 21, 2004, we filed a current report on Form 8-K to announce the SEC’stermination of its investigation of the Company (Item 5).

 

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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.

 

 

CARREKERCORPORATION

 

 
| By:    | /s/ John D.  Carreker, Jr. |   | Date: | June 9, 2004 |   |
|--------|----------------------------|--------|-------|--------------|--------|
|   | John D. Carreker, Jr.      |   |
|   | Chairman of the Board  and |   |
|   | Chief Executive Officer    |   |
|   |                       |   |
|   |                       |   |
| By:    | /s/ Lisa K.  Peterson      |   | Date: | June 9, 2004 |   |
|   | Lisa K. Peterson           |   |
|   | Chief Financial Officer    |   |
|        |                            |        |       |              |        |  |

 

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