**United StatesSecurities and Exchange Commission**

**Washington, D.C.  20549**

 

**FORM 10-Q**

 

**ý****Quarterly Report Pursuant to Section 13 or 15(d) of the SecuritiesExchange Act of 1934 for the Period Ended July 31, 2005.**

 

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

 

**Commissionfile number  0-24201**

 

**Carreker Corporation**

(Exact name of registrant as specified in its charter)

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

 

**(972) 458-1981**

(Registrant’s telephone number, including area code)

 

 

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

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter periods that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes  ý  No  o

 

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

Yes  ý  No  o

 

Indicate bycheck mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).  

Yes  o  No  ý

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practical date.

 

Common Stock,$.01 par value — 24,654,242 shares as of August 31, 2005.

 

 

----

 

**CARREKER CORPORATION**

 

**Index**

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

 

2

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**PART I:  FINANCIAL INFORMATION**

 

**Item 1.****  FinancialStatements**

 

**CARREKER CORPORATION**

**Condensed ConsolidatedBalance Sheets**

**(Unaudited)**

**(In thousands)**

 

**ASSETS**

 
| ** **                                                                                                                                              | ** ** | **July 31,  2005** | ** ** | **January 31,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
|                                                                                                                                                    |       |                    |       |                       |       |
| Current assets                                                                                                                                          |       |                    |       |                       |       |
| Cash and cash equivalents                                                                                                                               |       | $                       | 21,749     |                       | $          | 34,516 |   |
| Marketable securities                                                                                                                                   |       | 4,600                   |       | —                     |       |
| Accounts receivable, net of allowance of  $447 and $529 at July 31, 2005 and January 31, 2005, respectively                                   |       | 16,390                  |       | 11,144                     |       |
| Prepaid expenses and other current assets                                                                                                               |       | 2,876                   |       | 2,595                      |       |
| Total current assets                                                                                                                                    |       | 45,615                  |       | 48,255                     |       |
|                                                                                                                                                    |       |                    |       |                       |       |
| Property and equipment, net of  accumulated depreciation of $21,521 and $20,194 at July 31, 2005 and January 31, 2005, respectively |       | 6,292                   |       | 6,604                      |       |
| Capitalized software costs, net of  accumulated amortization of $12,893 and $12,426 at July 31, 2005 and January 31,  2005, respectively      |       | 3,486                   |       | 3,245                      |       |
| Acquired developed technology, net of  accumulated amortization of $18,083 and $15,773 at July 31, 2005 and January 31,  2005, respectively   |       | 7,617                   |       | 9,927                      |       |
| Goodwill, net of accumulated amortization  of $3,405 at July 31, 2005 and January 31, 2005                                                    |       | 20,765                  |       | 20,765                     |       |
| Customer relationships, net of  accumulated amortization of $5,833 and $5,133 at July 31, 2005 and January 31,  2005, respectively       |       | 2,567                   |       | 3,267                      |       |
| Deferred loan costs, net of accumulated  amortization of $1,435 and $1,300 at July 31, 2005 and January 31,  2005, respectively               |       | 272                     |       | 407                        |       |
| Other assets                                                                                                                                            |       | 823                     |       | 835                        |       |
| Total assets                                                                                                                                            |       | $                       | 87,437     |                       | $          | 93,305 |   |
|                                                                                                                                                    |       |                    |       |                       |       |
| Current liabilities                                                                                                                                     |       |                    |       |                       |       |
| Accounts payable                                                                                                                                        |       | $                       | 946        |                       | $          | 992 |   |
| Accrued compensation and benefits                                                                                                                       |       | 5,968                   |       | 7,818                      |       |
| Other accrued expenses                                                                                                                                  |       | 3,596                   |       | 3,609                      |       |
| Income tax payable                                                                                                                                      |       | 75                      |       | 339                        |       |
| Deferred revenue                                                                                                                                        |       | 20,361                  |       | 22,181                     |       |
| Accrued merger and restructuring costs                                                                                                                  |       | 275                     |       | 1,004                      |       |
| Total current liabilities                                                                                                                               |       | 31,221                  |       | 35,943                     |       |
|                                                                                                                                                    |       |                    |       |                       |       |
| Commitments and Contingencies                                                                                                                           |       |                    |       |                       |       |
|                                                                                                                                                    |       |                    |       |                       |       |
| Stockholders’ equity                                                                                                                               |       |                    |       |                       |       |
| Preferred stock, $.01 par value:                                                                                                                        |       |                    |       |                       |       |
| 2,000 shares authorized; no shares issued  or outstanding                                                                                               |       | —                  |       | —                     |       |
| Common stock, $.01 par value:                                                                                                                           |       |                    |       |                       |       |
| 100,000 shares authorized; 25,294 and  24,852 shares issued at July 31, 2005 and January 31, 2005,  respectively                              |       | 253                     |       | 249                        |       |
| Additional paid-in capital                                                                                                                              |       | 111,512                 |       | 110,992                    |       |
| Accumulated deficit                                                                                                                                     |       | (52,324                 | )          | (53,876                    | )          |
| Less treasury stock, at cost                                                                                                                            |       | (3,225                  | )          | (3                         | )          |
| Total stockholders’ equity                                                                                                                         |       | 56,216                  |       | 57,362                     |       |
| Total liabilities and stockholders’  equity                                                                                                        |       | $                       | 87,437     |                       | $          | 93,305 |   |

 

See accompanying notes.

 

3

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**CARREKER CORPORATION**

**Condensed ConsolidatedStatements of Operations**

**(Unaudited)**

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

 
| ** **                                                  | ** ** | **Three Months Ended  July 31,** | ** ** | **Six Months Ended  July 31,** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                  | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                        |       |                                  |       |                                |       |   |   |   |   |
| **Revenues:**                                               | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Consulting                                                  |       | $                                     | 9,502      |                                | $          | 10,514 |   | $ | 17,820 |   | $ | 19,571 |   |
| Software license                                            |       | 3,782                                 |       | 4,577                               |       | 7,141 |   | 10,433 |   |
| Software maintenance                                        |       | 10,576                                |       | 10,232                              |       | 21,888 |   | 21,316 |   |
| Software implementation and other  services                 |       | 4,892                                 |       | 3,642                               |       | 9,026 |   | 6,521 |   |
| Outsourcing service                                         |       | 241                                   |       | 10                                  |       | 498 |   | 10 |   |
| Out-of-pocket expense reimbursements                        |       | 927                                   |       | 662                                 |       | 1,745 |   | 1,552 |   |
| Total revenues                                              |       | 29,920                                |       | 29,637                              |       | 58,118 |   | 59,403 |   |
|                                                        |       |                                  |       |                                |       |   |   |   |   |
| **Cost of revenues:**                                       |       |                                  |       |                                |       |   |   |   |   |
| Consulting                                                  |       | 4,277                                 |       | 5,082                               |       | 8,518 |   | 9,611 |   |
| Software license                                            |       | 1,828                                 |       | 1,670                               |       | 3,364 |   | 3,268 |   |
| Software maintenance                                        |       | 3,436                                 |       | 3,386                               |       | 7,411 |   | 7,184 |   |
| Software implementation and other  services                 |       | 3,682                                 |       | 3,810                               |       | 6,655 |   | 7,179 |   |
| Outsourcing service                                         |       | 434                                   |       | 14                                  |       | 1,013 |   | 14 |   |
| Out-of-pocket expenses                                      |       | 808                                   |       | 652                                 |       | 1,598 |   | 1,595 |   |
| Total cost of revenues                                      |       | 14,465                                |       | 14,614                              |       | 28,559 |   | 28,851 |   |
| Gross profit                                                |       | 15,455                                |       | 15,023                              |       | 29,559 |   | 30,552 |   |
|                                                        |       |                                  |       |                                |       |   |   |   |   |
| **Operating costs and expenses:**                           | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Selling, general and administrative                         |       | 11,593                                |       | 11,971                              |       | 22,497 |   | 24,163 |   |
| Research and development                                    |       | 2,516                                 |       | 1,874                               |       | 5,037 |   | 3,582 |   |
| Amortization of customer relationships                      |       | 350                                   |       | 350                                 |       | 700 |   | 700 |   |
| Restructuring and other charges                             |       | 28                                    |       | 197                                 |       | 123 |   | 2,712 |   |
| Total operating costs and expenses                          |       | 14,487                                |       | 14,392                              |       | 28,357 |   | 31,157 |   |
| Income (loss) from operations                               |       | 968                                   |       | 631                                 |       | 1,202 |   | (605 | ) |
|                                                        |       |                                  |       |                                |       |   |   |   |   |
| **Other income (expense):**                                 | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest income                                             |       | 166                                   |       | 66                                  |       | 310 |   | 115 |   |
| Interest expense                                            |       | (107                                  | )          | (121                                | )          | (212 | ) | (230 | ) |
| Other income (expense)                                      |       | 129                                   |       | (27                                 | )          | 435 |   | 457 |   |
| Total other income (expense), net                           |       | 188                                   |       | (82                                 | )          | 533 |   | 342 |   |
| Income (loss) before provision for income  taxes            |       | 1,156                                 |       | 549                                 |       | 1,735 |   | (263 | ) |
| Provision for income taxes                                  |       | 102                                   |       | 350                                 |       | 183 |   | 350 |   |
| Net income (loss)                                           |       | $                                     | 1,054      |                                | $          | 199 |   | $ | 1,552 |   | $ | (613 | ) |
| Basic earnings (loss) per share                             |       | $                                     | 0.04       |                                | $          | 0.01 |   | $ | 0.06 |   | $ | (0.03 | ) |
| Diluted earnings (loss) per share                           |       | $                                     | 0.04       |                                | $          | 0.01 |   | $ | 0.06 |   | $ | (0.03 | ) |
| Shares used in computing basic earnings  (loss) per share   |       | 24,127                                |       | 24,671                              |       | 24,326 |   | 24,524 |   |
| Shares used in computing diluted earnings  (loss) per share |       | 24,421                                |       | 25,481                              |       | 24,703 |   | 24,524 |   |

 

See accompanying notes.

 

4

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**CARREKER CORPORATION**

**Condensed ConsolidatedStatements of Stockholders’ Equity**

**(Unaudited)**

**(In thousands)**

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

 

See accompanying notes.

 

5

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**CARREKER CORPORATION**

**Condensed Consolidated Statements of Cash Flows**

**(Unaudited)**

**(In thousands)**

 
| ** **                                                                                | ** ** | **Three Months Ended  July 31,** | ** ** | **Six Months Ended  July 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Operating Activities:**                                                                 |       |                                  |       |                                |       |   |   |   |   |
| Net income (loss)                                                                         |       | $                                     | 1,054      |                                | $          | 199 |   | 1,552 |   | (613 | ) |
| Adjustments to reconcile net income  (loss) to net cash provided by operating activities: |       |                                  |       |                                |       |   |   |   |   |
| Depreciation and amortization of property  and equipment                                  |       | 805                                   |       | 835                                 |       | 1,598 |   | 1,657 |   |
| Amortization of capitalized software  costs and acquired developed technology             |       | 1,356                                 |       | 1,394                               |       | 2,777 |   | 2,789 |   |
| Amortization of customer relationships                                                    |       | 350                                   |       | 350                                 |       | 700 |   | 700 |   |
| Amortization of deferred loan costs                                                       |       | 68                                    |       | 69                                  |       | 135 |   | 136 |   |
| Compensation earned under restricted  stock plan                                          |       | 130                                   |       | 141                                 |       | 258 |   | 176 |   |
| Minority share of loss in Carretek LLC                                                    |       | (213                                  | )          | (134                                | )          | (531 | ) | (220 | ) |
| Non-cash charge for merger costs                                                          |       | —                                |       | (1,215                              | )          | (32 | ) | (1,215 | ) |
| EPG Litigation settlement                                                                 |       | —                                |       | 14                                  |       | — |   | 1,700 |   |
| Payment of EPG Litigation settlement                                                      |       | —                                |       | (1,700                              | )          | — |   | (1,700 | ) |
| Allowance for doubtful accounts                                                           |       | (48                                   | )          | (212                                | )          | (41 | ) | (392 | ) |
| Gain on sale of Cash Services Australia  Pty. Limited                                     |       | —                                |       | —                              |       | — |   | (539 | ) |
| Changes in operating assets and  liabilities:                                             |       |                                  |       |                                |       |   |   |   |   |
| Accounts receivable                                                                       |       | (5,606                                | )          | 124                                 |       | (5,205 | ) | 6,897 |   |
| Prepaid expenses and other assets                                                         |       | 363                                   |       | 636                                 |       | (289 | ) | 937 |   |
| Accounts payable and accrued expenses                                                     |       | (242                                  | )          | 995                                 |       | (2,606 | ) | (2,278 | ) |
| Income taxes payable/receivable                                                           |       | (275                                  | )          | (13                                 | )          | (264 | ) | (46 | ) |
| Deferred revenue                                                                          |       | (3,620                                | )          | (3,750                              | )          | (1,820 | ) | (506 | ) |
| Net cash provided by (used in) operating  activities                                      |       | (5,878                                | )          | (2,267                              | )          | (3,768 | ) | 7,483 |   |
|                                                                                      |       |                                  |       |                                |       |   |   |   |   |
| **Investing Activities:**                                                                 | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Purchases of property and equipment                                                       |       | (588                                  | )          | (1,134                              | )          | (1,286 | ) | (1,365 | ) |
| Purchases of marketable securities                                                        |       | (4,600                                | )          | —                              |       | (4,600 | ) | — |   |
| Computer software costs capitalized                                                       |       | (271                                  | )          | (698                                | )          | (708 | ) | (1,608 | ) |
| Net cash used in investing activities                                                     |       | (5,459                                | )          | (1,832                              | )          | (6,594 | ) | (2,973 | ) |
|                                                                                      |       |                                  |       |                                |       |   |   |   |   |
| **Financing Activities:**                                                                 | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Payments on long-term debt                                                                |       | —                                |       | —                              |       | — |   | (6,250 | ) |
| Proceeds from exercises of stock options                                                  |       | 214                                   |       | 949                                 |       | 266 |   | 1,324 |   |
| Purchase of treasury stock                                                                |       | (2,873                                | )          | —                              |       | (3,222 | ) | — |   |
| Proceeds from minority shareholder equity  contributions to Carretek LLC                  |       | —                                |       | 113                                 |       | 551 |   | 260 |   |
| Net cash provided by (used in) financing  activities                                      |       | (2,659                                | )          | 1,062                               |       | (2,405 | ) | (4,666 | ) |
| Net decrease in cash and cash equivalents                                                 |       | (13,996                               | )          | (3,037                              | )          | (12,767 | ) | (156 | ) |
| Cash and cash equivalents at beginning of  period                                         |       | 35,745                                |       | 31,486                              |       | 34,516 |   | 28,605 |   |
| Cash and cash equivalents at end of  period                                               |       | $                                     | 21,749     |                                | $          | 28,449 |   | 21,749 |   | 28,449 |   |
|                                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Supplemental disclosures of cash flow  information:                                       |       |                                  |       |                                |       |   |   |   |   |
| Cash paid for interest                                                                    |       | $                                     | 38         |                                | $          | 38 |   | 76 |   | 109 |   |
| Cash paid for income taxes, net                                                           |       | $                                     | 351        |                                | $          | 349 |   | 427 |   | 382 |   |

 

See accompanying notes.

 

6

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**Carreker Corporation**

**Notes to Condensed Consolidated UnauditedFinancial StatementsFor the Three and Six Months Ended July 31, 2005and 2004**

 

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

 

Carreker Corporation (“the Company,” “Carreker,” “our,” “we”) providespayments-related software, consulting and business process outsourcingsolutions to financial institutions and financial service providers.  These solutions help the Company’s customersset winning strategies in their payments 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 product offeringswith customer needs.  

 

**2.****                                      Summary of Significant Accounting Procedures**

 

**Principlesof Consolidation and Presentation**

 

The condensed consolidated unaudited financial statements include theaccounts of the Company and its wholly owned subsidiaries. All significantintercompany balances and transactions have been eliminated in consolidation. 

 

The consolidated financial statements also reflect the operations ofCarretek LLC, which is a 51% owned subsidiary. The minority interest and minority interest in income (loss) of CarretekLLC represent the 49% minority stockholder’s investment and share of the lossof this consolidated subsidiary.

 

The accompanying condensed consolidated unaudited financial statementsand notes have been prepared in accordance with the rules and regulationsof the Securities and Exchange Commission for Form 10-Q and include all ofthe information and disclosures required by generally accepted accountingprinciples for interim financial reporting. The accompanying financial statements reflect all adjustments(consisting of normal recurring entries) which in the opinion of management arenecessary for a fair presentation of the results for the interim periodspresented.  The results of operations forthe three and six months ended July 31, 2005 are not necessarilyindicative of full-year results.

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States requires the use ofestimates and assumptions that affect the amounts reported in the financialstatements and accompanying notes.  Asdiscussed below, the Company makes significant estimates and assumptions in theareas of accounts receivable, impairment of intangibles and revenue recognition.  Although the Company believes that theestimates and assumptions are reasonable, actual results may differ, and suchdifferences could be significant to the Company’s financial results.

 

**Cashand Cash Equivalents**

 

The Company considers all highly liquid investments with original maturitiesof three months or less when purchased to be cash equivalents.  Cash and cash equivalents consist primarilyof demand deposit accounts and demand money market accounts with nationallyrecognized financial institutions, along with domestic commercial paper. 

 

**MarketableSecurities**

 

We classify our investments in marketable securities as “available-for-sale”in accordance with the provisions of Statement of Financial AccountingStandards No. 115, *“Accounting for CertainInvestments in Debt and Equity Securities”* (“SFAS 115”).  We currently have no investments that weintend to hold for more than one year and therefore all investments areclassified as short term investments.

 

Available-for-sale securities are carried at fair value with theunrealized gain or loss, net of tax, reported in other comprehensiveincome.  Held-to-maturity securities arerecorded at amortized cost.  Unrealizedlosses considered to be “other-than-temporary” are recognized currently inearnings.  The cost of securities sold isbased on the specific identification method. The fair value of most investment securities is determined by currentlyavailable market prices.  Where quotedmarket prices are not available, we use the market price of similar types ofsecurities that are traded in the market to estimate fair value.

 

7

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The cost, gross unrealized gains (losses) and fair value of ouravailable-for-sale securities by major security type at July 31, 2005 isas follows (in thousands):

 
| ** **                                      | ** ** | **Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|-------------------------------------------------|------------|----------|------------|------------------------------|------------|-------------------------------|------------|----------------|------------|
|                                            |       |     |       |                         |       |                          |       |           |       |
| Available for sale:                             |       |     |       |                         |       |                          |       |           |       |
| Corporate debt securities                       |       | $        | 700        |                         | $          | —                        |       | $              | —     |   | $ | 700 |   |
| Guaranteed student loan backed debt  securities |       | 3,900    |       | —                       |       | —                        |       | 3,900          |       |
|                                            |       |     |       |                         |       |                          |       |           |       |
| Total available for sale                        |       | $        | 4,600      |                         | $          | —                        |       | $              | —     |   | $ | 4,600 |   |

 

Currently all original maturities of debt securities classified asavailable for sale at July 31, 2005 were due after 10 years.  All the debt securities are auction ratenotes and the interest rate for these investments will adjust to current marketrates at each interest reset date, which is typically on at least a monthlybasis.

 

**ComprehensiveIncome**

 

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

 

**ForeignCurrency Translation**

 

The Company considers the U.S. Dollar to be the functional currency forits international subsidiaries.  Allremeasurement adjustments are recorded in the consolidated statements ofoperations.

 

**AccountsReceivable****andConcentration of Credit Risk**

 

Financial instruments which potentially subject the Company toconcentration of credit risk consist principally of temporary cash investmentssuch as short term commercial paper and marketable debt securities along withaccounts receivable.  The Company placestemporary cash investments with major banks and limits its exposure with anyone financial institution, or commercial or municipal issuer.  The Company has not experienced any materialcredit losses on these investments.

 

A significant portion of the Company’s business consists of providingconsulting services and licensing software to major domestic and internationalbanks, which gives rise to a concentration of credit risk in receivables.  Because the Company’s accounts receivable aretypically unsecured, the Company periodically evaluates the collectibility ofits accounts based on a combination of factors, including a particular customer’sability to pay as well as the age of receivables.  In cases where the evidence suggests acustomer may not be able to satisfy its obligation to the Company or if thecollection of the receivable becomes doubtful due to a dispute that arisessubsequent to the delivery of the Company’s products and services, the Companysets up a reserve in an amount determined appropriate for the perceivedrisk.  Most of the Company’s contractsinclude multiple payment milestones, some of which occur in advance of revenuerecognition, which mitigates the risk both in terms of collectibility andadjustments to recorded revenue. Write-offs of receivables during the three months ended July 31,2005 and 2004 were $9,000 and $135,000, respectively.  Write-offs of receivables during the sixmonths ended July 31, 2005 and 2004 were $42,000 and $134,000,respectively.

 

The fair value of accounts receivable approximates the carrying amountof accounts receivable.

 

8

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

 
| ** **                           | ** ** | **July 31,** | ** ** | **January 31,** | ** ** |
|--------------------------------------|------------|-------------------|------------|----------------------|------------|
| ** **                           | ** ** | **2005**          | ** ** | **2005**             | ** ** |
|                                 |       |              |       |                 |       |
| Gross accounts receivable            |       | $                 | 42,812     |                 | $          | 47,000 |   |
| Less related deferred revenue        |       | (25,975           | )          | (35,327              | )          |
| Less allowance for doubtful accounts |       | (447              | )          | (529                 | )          |
| Net accounts receivable              |       | $                 | 16,390     |                 | $          | 11,144 |   |

 

**Propertyand Equipment**

 

Property and equipment are stated at cost. Depreciation is calculatedusing the straight-line method over the estimated useful lives of therespective assets, generally from two to five years. Leasehold improvements areamortized using the straight-line method over the shorter of the terms of therelated leases or the respective useful lives of the assets.  

 

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

 

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

 
| ** **                                      | ** ** | **July 31,** | ** ** | **January 31,** | ** ** |
|-------------------------------------------------|------------|-------------------|------------|----------------------|------------|
| ** **                                      | ** ** | **2005**          | ** ** | **2005**             | ** ** |
|                                            |       |              |       |                 |       |
| Furniture                                       |       | $                 | 5,071      |                 | $          | 5,069 |   |
| Equipment and software                          |       | 21,458            |       | 20,446               |       |
| Leasehold improvements                          |       | 1,284             |       | 1,283                |       |
| Total cost                                      |       | 27,813            |       | 26,798               |       |
|                                            |       |              |       |                 |       |
| Less accumulated depreciation and  amortization |       | (21,521           | )          | (20,194              | )          |
| Net property and equipment                      |       | $                 | 6,292      |                 | $          | 6,604 |   |

 

**Long Lived Assets**

 

The Company accounts for goodwill and other intangibleassets in accordance with Statement of Financial Accounting Standards No. 142,*“Goodwill and Other Intangible Assets,”*(“SFAS 142”).  Under the provisions of SFAS 142, an annualassessment of goodwill impairment is performed. This assessment involves the use of estimates related to fair marketvalues of the Company’s reporting units with which the goodwill isassociated.  The assessment of goodwillimpairment in the future will be impacted if future operating cash flows of theCompany’s reporting units decline significantly, whichcould result 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. 

 

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

 

9

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**DeferredLoan Costs**

 

Deferred loan costs consist of loan closing costs and otheradministrative expenses associated with the Revolving Credit Agreement.  These costs are being amortized to interestexpense over the 36 month life of the Revolving Credit Agreement.

 

**CapitalizedSoftware Costs and Acquired Developed Technology**

 

The Company capitalizes the development costs of software, other thaninternal-use software, in accordance with Statement of Financial AccountingStandards No. 86, *“Accounting for Costsof Computer Software to be Sold, Leased or Otherwise Marketed”* (“SFAS86”).  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 capitalizedsoftware development costs 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 theestimated remaining economic life of the product (generally three to fiveyears). The Company capitalized $271,000 and $698,000 in the three months endedJuly 31, 2005 and 2004, respectively. The Company capitalized $708,000 and $1.6 million in the six monthsended July 31, 2005 and 2004, respectively.  The Company developed software for sendingand receiving check images, and has developed software for distributed captureof checks and check images and extending the functionality of its anti-moneylaundering software and other Risk solutions. The Company has also begun development of a product to verify cashlogistic invoices with automated precision and an internet-based track andtrace system that streamlines the cash delivery management process.

 

The Company recorded amortization relating to software developmentcosts capitalized of $201,000 and $239,000 in the three months ended July 31,2005 and 2004, respectively.  The Companyrecorded amortization relating to software development costs capitalized of$468,000 and $479,000 in the six months ended July 31, 2005 and 2004,respectively.  Amortization expense isrecorded as a component of cost of software license fees in the accompanyingconsolidated statements of operations.

 

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

 

Acquired developed technology with a useful life of 3-6 years isamortized on a straight-line basis, resulting in amortization expense of $1.2million for the three months ended July 31, 2005 and 2004, respectively,and $2.3 million for the six months ended July 31, 2005 and 2004.  Amortization expense is recorded as acomponent of cost of software license fees in the accompanying consolidatedstatements of operations.

 

The following table sets forth the estimated amortization expense ofcapitalized software costs and acquired developed technology for the indicatedfiscal years ending January 31 (in thousands):

 
| **Year**          | ** ** | **Capitalized  Software  Costs** | ** ** | **Acquired  Developed  Technology** | ** ** |
|-------------------|------------|----------------------------------|------------|-------------------------------------|------------|
| Remainder of 2006 |       | $                                | 499        |                                | $          | 2,310 |   |
| 2007              |       | 997                              |       | 4,107                               |       |
| 2008              |       | 812                              |       | 1,200                               |       |
| 2009              |       | 177                              |       | —                              |       |
|                   |            |                                  |            |                                     |            |  |  |

 

The table does not include the estimated amortization expense for $1.0million of capitalized software products that are currently being developed,and for which amortization has not commenced.

 

10

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The Company continually monitors the net realizable value of softwarecapitalized and acquired developed technology for factors that would indicateimpairment such as a decline in demand or a loss of a significantcustomer.  During the quarterly periodended January 31, 2005, the Company performed its annual formal evaluationfor impairment and determined that the carrying amount of these assets was notimpaired and has subsequently noted no factors that would indicate impairment.

 

**RevenueRecognition**  

 

The Company’s revenue recognition policies are in accordance withStatement of Position (“SOP”) 97-2, *“Software RevenueRecognition,”* as amended by SOP 98-9, “*Modificationof SOP 97-2,**Software RevenueRecognition with Respect to Certain Transactions,”* Staff AccountingBulletin (“SAB”) No. 104,*“Revenue Recognition,”* and Emerging Issues Task Force (“EITF”) No. 00-21,*“Revenue Arrangements with Multiple Deliverables.”* In the case of software arrangements thatrequire significant production, modification, or customization of software, orthe license agreement requires the Company to provide implementation servicesthat are determined to be essential to other elementsof the arrangement, the Company follows the guidance in SOP 81-1, *“Accounting for Performance of Construction–Type and CertainProduction–Type Contracts.”*  

 

In the case of non-software arrangements, we apply EITF No. 00-21and revenues related to arrangements with multiple elements are allocated toeach element based on the element’s relative fair value.  Revenue allocated to separate elements isrecognized for each element in accordance with our accounting policiesdescribed below.  If we cannot accountfor items included in a multiple-element arrangement as separate units ofaccounting, they are combined and accounted for as a single unit of accountingand generally recognized as the undelivered items or services are provided tothe customer.

 

*Consulting.*  The Company employs threeprimary pricing methods in connection with its delivery of consulting services.First, the Company may price its delivery of consulting services on the basisof time and materials, in which case the customer is charged agreed-upon dailyrates for services performed and out-of-pocket expenses. In this case, theCompany is generally paid fees and related amounts usually on a monthly basis,and the Company recognizes revenues as the services are performed. Second, theCompany may deliver consulting services on a fixed-price basis. In this case,the Company is paid on a monthly basis or pursuant to an agreed upon payment schedule, and the Company recognizes revenues on aproportionate performance basis.  TheCompany believes that this method is appropriate because of its ability todetermine performance milestones and determine dependable estimates of itscosts applicable to each phase of a contract. Because financial reporting of these contracts depends on estimates,which are assessed continually during the term of the contract, costs aresubject to revisions as the contract progresses.  Anticipated losses on fixed-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 first committime 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 afixed payment date.  

 

Costs associated with time and materials, fixed-priced and value-pricedconsulting fee arrangements are expensed as incurred and are included as acomponent of the cost of consulting fees. 

 

11

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The Company expects that value-pricing contracts will continue toaccount for a significant portion of its revenues in the future. As aconsequence 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 the Company in a givencontract, the Company is typically reimbursed on a monthly basis forout-of-pocket expenses incurred on behalf of its customers.  

 

*Software License.*  A perpetual software licenseis sold either together with implementation services or on a stand-alonebasis.  The Company is usually paidsoftware license fees in one or more installments, as provided in the customer’scontract but not to exceed twelve months. The Company recognizes software license revenue upon execution of acontract and delivery of the software, provided that the license fee is fixedand determinable, no significant production, modification or customization ofthe software 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 theproduct license revenue and implementation fees are recognized as services areperformed.  A term software license issold either together with implementation services and/or with maintenanceservices.  These term licenses areusually paid in annual installments over the term of the license.  If the term software license is sold withoutessential implementation services, the revenue is recognized ratably over thenon-cancelable license term.  If the termlicense is sold with essential implementation services, the license revenue isrecognized as the lesser of the amount of license revenue recognized asservices are performed or on a ratable basis. 

 

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

 

Software licenses are often sold as part of a multiple elementarrangement that may include maintenance, implementation or consulting.  The Company determines whether there isvendor specific objective evidence of fair value (“VSOEFV”) for each elementidentified in the arrangement to determine whether the total arrangement feescan be allocated to each element.  IfVSOEFV exists for each element, the total arrangement fee is allocated based onthe relative fair value of each element. In cases where there is not VSOEFV for each element,or if it is determined services are essential to the functionality of thesoftware being delivered, or if significant production, modification orcustomization of the software is required, the Company initially defers revenuerecognition of the software license fees until VSOEFV is established or theservices are performed.  However, ifVSOEFV is determinable for all of the undelivered elements, and assuming theundelivered elements are not essential to the delivered elements, the Companywill defer recognition of the full fair value related to the undeliveredelements and recognize the remaining portion of the arrangement value throughapplication of the residual method. Where VSOEFV has not been established for certain undelivered elements,revenue for all elements is deferred until those elements have been deliveredor their fair values have been determined. Evidence of VSOEFV is determined for software products based on actualsales prices for the product sold to a similar class of customer and based onpricing strategies set forth in the Company’s price book.  Evidence of VSOEFV for services(implementation and consulting) is based upon standard billing rates and theestimated level of effort for individuals expected to perform the relatedservices.  The Company establishes VSOEFVfor maintenance agreements using the percentage method such that VSOEFV formaintenance is a percentage of the license fee charged annually for a specificsoftware product, which in most instances is 20% of the portion of arrangementfees allocated to the software license element. 

 

Although substantially all of the Company’s current software licensesprovide for a fixed price license fee, some licenses instead provide for thecustomer to pay a monthly license fee based on actual use of the softwareproduct.  The level of license feesearned by the Company under these arrangements will vary based on the actualamount of use by the customer.  Revenueunder these arrangements is recognized on a monthly basis as the usage becomesdeterminable.

 

*Software Maintenance.*  In connection with the saleof a software license, a customer may elect to purchase software maintenanceservices. Most of the customers that purchase software licenses from theCompany also purchase software maintenance services, which typically arerenewed annually.  The Company charges anannual maintenance fee, which is typically a percentage of the initial softwarelicense fee. The annual maintenance fee generally is paid to the Company at thebeginning of the maintenance period, and the Company recognizes these revenuesratably over the term of the related contract. If the annual maintenance fee is not paid at the beginning of themaintenance period, the Company defers revenue recognition until the time thatthe maintenance fee is paid by the customer. The Company normally continues to provide maintenance service whileawaiting payment from customers.  Whenthe payment is received, revenue is recognized for the period that revenue waspreviously deferred.  This may result involatility in software maintenance revenue from period to period.

 

12

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*Software Implementation and Other Services.*  In connection with the saleof a software license, a customer may elect to purchase software implementationservices, including software enhancements and other software services. Most ofthe customers that purchase software licenses from the Company also purchasesoftware implementation services.  TheCompany prices its implementation services on atime-and-materials or on a fixed-price basis, and the Company recognizesthe related revenues as services are performed. Costs associated with these engagements are expensed as incurred.

 

*Outsourcing Services.*  While outsourcing revenuehas been minimal to date, we currently recognize revenue based on the number ofitems processed.  These services arecurrently billed on a monthly basis.

 

The Company’s contracts typically do not include right of returnclauses, and as a result, the Company does not record a provision for returns.

 

**Royalties**

 

In connection with software license, maintenance, and consulting agreements,entered into with certain banks and purchase agreements with vendors underwhich the Company acquired software technology used in products sold to itscustomers, the Company is required to pay royalties on sales of certainsoftware products.  Under thesearrangements, the Company recognizes royalty expense when the associatedrevenue is recognized.  For currentproduct offerings, the royalty percentages generally range from 20% to 50% ofthe associated revenues.  Approximately$535,000 and $433,000 of royalty expense was recorded under these agreements inthe three months ended July 31, 2005 and 2004, respectively, and $749,000and $688,000 of royalty expense was recorded under these agreements in the sixmonths ended July 31, 2005 and 2004. Royalty expense is included as a component of the cost of consultingfees, cost of software license fees and cost of software maintenance fees inthe accompanying consolidated statements of operations.

 

**DeferredRevenue**

 

Deferred revenue represents amounts paid by customers under termsspecified in consulting, software licensing, and maintenance contracts forwhich completion of contractual terms or delivery of the software has notoccurred.  

 

Deferred revenue consist of the following (inthousands):

 
| ** **                                         | ** ** | **July 31,** | ** ** | **January 31,** | ** ** |
|----------------------------------------------------|------------|-------------------|------------|----------------------|------------|
| ** **                                         | ** ** | **2005**          | ** ** | **2005**             | ** ** |
|                                               |       |              |       |                 |       |
| Deferred software maintenance fees                 |       | $                 | 25,733     |                 | $          | 33,850 |   |
| Deferred software implementation and  license fees |       | 20,603            |       | 23,658               |       |
|                                               |       | 46,336            |       | 57,508               |       |
| Less related accounts receivable                   |       | (25,975           | )          | (35,327              | )          |
| Net deferred revenue                               |       | $                 | 20,361     |                 | $          | 22,181 |   |

 

**Researchand Development Costs**

 

Research and development costs which are not subject to capitalizationunder Statement of Financial Accounting Standards No. 86, *“Accounting for the Cost of Computer Software to beSold, Leased, or Otherwise Marketed”* (“SFAS 86”), are expensed asincurred and relate mainly to the development of new products, newapplications, new features or enhancements for existing products orapplications.  Sustaining maintenanceactivities are expensed as incurred and charged to cost of revenues -- softwaremaintenance fees. 

 

13

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**Otherincome (expense)**

 

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

 
| ** **                                              | ** ** | **Three Months Ended  July 31,** | ** ** | **Six Months Ended  July 31,** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                              | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                    |       |                                  |       |                                |       |   |   |   |   |
| Gain on sale of Cash Services Australia  Pty. Limited   |       | $                                     | —     |                                | $          | — |   | $ | — |   | $ | 539 |   |
| Equity in loss of Cash Services Australia  Pty. Limited |       | —                                |       | —                              |       | — |   | (17 | ) |
| Minority  share of net loss of Carretek LLC             |       | 213                                   |       | 133                                 |       | 530 |   | 219 |   |
| Foreign  exchange losses                                |       | (84                                   | )          | (159                                | )          | (101 | ) | (288 | ) |
| Other                                                   |       | —                                |       | (1                                  | )          | 6 |   | 4 |   |
| Total                                                   |       | $                                     | 129        |                                | $          | (27 | ) | $ | 435 |   | $ | 457 |   |

 

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

 

The Company owns a 51% interest in Carretek LLC (“Carretek”), whichoffers financial institutions offshore-centric outsourcing of their businessprocesses.  The minority interest in thisloss was recorded in other income (expense) and was $213,000 and $133,000 forthe three months ended July 31, 2005 and 2004, respectively, and $530,000and $219,000 for the six months ended July 31, 2005 and 2004.

 

**Income Taxes**

 

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

 

**EarningsPer Share**

 

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

 

14

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**Stock-BasedCompensation**

 

The Company has elected to follow Accounting Principles Board (“APB”)Opinion No. 25, “*Accounting for StockIssued to Employees*,” in accounting for its employee and directorstock options.  Under APB 25, if theexercise price of a stock option equals or exceeds the market price of theunderlying stock on the date of grant, no compensation expense isrecognized.  In October 1995, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) 123, *“Accountingfor Stock-Based Compensation.”* SFAS 123 allows the Company to continue to follow the present APBOpinion 25 guidelines, but requires pro-forma disclosures of net income andearnings per share as if the Company had adopted the provisions of theStatement.  In December 2002, theFASB issued SFAS 148, *“Accounting for Stock-BasedCompensation – Transition and Disclosure – an Amendment of FASB StatementNo.123,”* which provides alternative methods of transition for anentity that voluntarily changes to the fair value based method of accountingfor stock-based employee compensation. The Company continues to account for stock-based compensation under theprovisions of APB Opinion 25 using the intrinsic value method.

 

The stock compensation expense recorded under the intrinsic valuemethod is primarily the result of restricted common stock issued to employeesand officers in fiscal years 2004 and 2003. The Company is amortizing the compensation expense on a straight linebasis over the period that the restrictions on the common stock lapse.

 

The Company recorded $130,000 and $141,000 of compensation expenseduring the three months ended July 31, 2005 and 2004, respectively, and$258,000 and $176,000 during the six months ended July 31, 2005 and 2004,respectively.  As of July 31, 2005,786,444 unvested restricted common shares remain outstanding.

 

Hadcompensation cost for stock-based compensation plans been determined based onthe fair value at the grant dates for awards under those plans in accordancewith the provisions of SFAS 123, net income (loss) and net income (loss) pershare would have been as follows (in thousands, except per share data): 

 
| ** **                                                                 | ** ** | **Three Months Ended  July 31,** | ** ** | **Six Months Ended  July 31,** | ** ** |
|----------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                 | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                       |       |                                  |       |                                |       |   |   |   |   |
| Net income (loss), as reported                                             |       | $                                     | 1,054      |                                | $          | 199 |   | $ | 1,552 |   | $ | (613 | ) |
| Stock compensation expense recorded under  the intrinsic value method      |       | 130                                   |       | 141                                 |       | 258 |   | 176 |   |
| Pro forma stock compensation expense  computed under the fair value method |       | (989                                  | )          | (861                                | )          | (1,743 | ) | (2,422 | ) |
| Pro forma net income (loss)                                                |       | $                                     | 195        |                                | $          | (521 | ) | $ | 67 |   | $ | (2,859 | ) |
|                                                                       |       |                                  |       |                                |       |   |   |   |   |
| Basic earnings (loss) per common share,  as reported                       |       | $                                     | 0.04       |                                | $          | 0.01 |   | $ | 0.06 |   | $ | (0.03 | ) |
| Diluted earnings (loss) per common share,  as reported                     |       | $                                     | 0.04       |                                | $          | 0.01 |   | $ | 0.06 |   | $ | (0.03 | ) |
| Pro forma basic earnings (loss) per  common share                          |       | $                                     | 0.01       |                                | $          | (0.02 | ) | $ | 0.00 |   | $ | (0.12 | ) |
| Pro forma diluted earnings (loss) per  common share                        |       | $                                     | 0.01       |                                | $          | (0.02 | ) | $ | 0.00 |   | $ | (0.12 | ) |

 

The Companycalculated the estimated fair value of each stock option using theBlack-Scholes option-pricing model and utilized the following assumptions:  

 
| ** **                                      | ** ** | **Three Months Ended  July 31,** | ** ** | **Six Months Ended  July 31,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                      | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                            |       |                                  |       |                                |       |   |   |   |   |
| Volatility                                      |       | 0.835                                 |       | 0.797                               |       | 0.837 |   | 0.800 |   |
| Weighted-average expected lives                 |       | 4.000                                 |       | 4.500                               |       | 4.000 |   | 4.500 |   |
| Expected dividend yields                        |       | —                                |       | —                              |       | — |   | — |   |
| Weighted-average risk-free interest rates       |       | 3.91                                  |       | 3.93                                |       | 3.91 |   | 3.90 |   |
| Weighted-average fair value of options  granted |       | $                                     | 3.61       |                                | $          | 5.96 |   | $ | 3.63 |   | $ | 5.97 |   |
|                                                 |            |                                       |            |                                     |            |  |  |  |  |  |  |  |  |

 

15

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**Risksand Uncertainties**

 

The Company’s future results of operations and financial conditioncould be impacted by the following factors, among others: dependence on thebanking industry, decline in check volumes, fluctuations in operating results,lack of long-term agreements, dependence on key personnel, rapid technologicalchange and dependence on new products, focus on providing business processoutsourcing with significant offshore component, ability to attract and retainqualified personnel, customer concentration, competition, proprietary rights,infringement claims, dependence on third parties for technology licenses,liability claims, our ability to protect our information technologyinfrastructure, international operations, changing government and taxregulations, stock price fluctuations, impairment of goodwill or intangibleassets, realization of revenue from contracted sales, potential sales andbacklog, changes in the accounting treatment of stock options and othershare-based compensation and pending class action and shareholder derivativelawsuits.  

 

**FinancialGuarantees **

 

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 guarantorrecognize, at the inception of a guarantee, a liability for the fair value ofthe obligation undertaken in issuing the guarantee or indemnification.  FIN 45 also requires additional disclosure bya guarantor in its interim and annual consolidated financial statements aboutits obligations under certain guarantees and indemnifications.  The following is a summary of the agreementsthat the Company has determined are within the scope of FIN 45:

 

Under the terms of the majority of the Company’s software licenseagreements with its customers, the Company agrees that in the event thesoftware sold infringes upon any patent, copyright, trademark, or any otherproprietary right of a third party, it will indemnify its customer licenseeagainst any loss, expense, or liability from any damages that may be awardedagainst its customer.  The Companyincludes this infringement indemnification in most of its software licenseagreements.  In the event the customercannot use the software or service due to infringement and the Company cannotobtain the right to use, replace or modify the license or service in acommercially feasible manner so that it no longer infringes, then the Companymay generally terminate the license and provide the customer a pro-rata refundof the fees paid by the customer for the infringing license or service.  The Company has recorded no liabilityassociated with this indemnification, as it is not aware of any pending orthreatened infringement actions that are probable losses.  The Company believes the estimated fair valueof these intellectual property indemnification clauses is minimal.

 

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

 

16

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**RecentlyIssued Accounting Standards **

 

On December 16, 2004, the Financial Accounting Standards Boardissued SFAS No. 123 (revised 2004), *“Share-Based Payment,”*which is a revision of SFAS No. 123. SFAS No. 123 (R) supersedes APB No. 25, and amends SFAS No. 95,*“Statement of Cash Flows.”*  Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123.  However, SFAS No. 123 (R) requires allshare-based payments to employees, including grants of employee stock options,to be recognized in the statement of operations based on their fairvalues.  Pro forma disclosure is nolonger an alternative.  The Companyexpects to adopt SFAS No. 123 (R) in the first quarter of fiscal2006.  SFAS No. 123 (R) permitscompanies to adopt its requirements using one of two methods:

 

•                  A “modified prospective” method in which compensation cost isrecognized beginning with the effective date (a) based on the requirementsof SFAS No. 123 (R) for all share-based payments granted after theeffective date and (b) based on the requirements of SFAS No. 123 forall awards granted to employees prior to the effective date of SFAS No. 123(R) that remain unvested on the effective date.

•                  A “modified retrospective” method which includes the requirements ofthe modified prospective method described above, but also permits entities torestate based on the amounts previously recognized under SFAS No. 123 forpurposes of pro forma disclosures either (a) all prior periods presentedor (b) prior interim periods of the year of adoption.

 

The Company is still assessing the appropriate transition method. 

 

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

 

**3.****                                      Goodwill and Intangible Assets**

 

Goodwill and intangible assets deemed to have indefinite lives are nolonger amortized but are subject to annual impairment tests.  Other intangible assets, which includeacquired developed technology and customer relationships, are amortized over theirestimated useful lives.

 

Customer relationshipswith definite useful lives are amortized on a straight-line basis, whichresulted in amortization expense of $350,000 during the three months ended July 31,2005 and 2004, respectively, and $700,000 during the six months ended July 31,2005 and 2004.  

 

The following table sets forth the estimated amortization expense ofcustomer relationships for the indicated fiscal years ending January 31(in thousands):

 
| **Year**          | ** ** | **Amount** | ** ** |
|-------------------|------------|------------|------------|
| Remainder of 2006 |       | $          | 700        |   |
| 2007              |       | 1,400      |       |
| 2008              |       | 467        |       |
|                   |            |            |            |  |

 

17

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

 

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

 

Interestexpense, including the commitment fee and exclusive of the amortization ofdeferred loan costs on the credit agreement was $38,000 and $53,000 for thethree months ended July 31, 2005 and 2004, respectively, and $75,000 and$94,000 for the six months ended July 31, 2005 and 2004.

 

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

 

The Company has established a valuation allowance to reserve its netdeferred tax assets at July 31, 2005 because the more likely than notcriteria for future realization of the Company’s net deferred tax assetsspecified in Statement of Financial Accounting Standards No. 109, “*Accounting for Income Taxes,”* (“SFAS No. 109”)were not met.  

 

The taxprovision was $102,000 and $350,000 for the three months ended July 31,2005 and 2004, respectively, and $183,000 and $350,000 for the six months endedJuly 31, 2005 and 2004.  Thisprovision is primarily related to a provision for foreign taxes; however, theCompany recorded $15,000 of U.S. Federal and State tax expense in the threemonths ended July 31, 2005 for alternative minimum tax purposes due to theavailability of net operating losses from prior years.  No U.S. Federal tax benefit was recordedduring the three months ended July 31, 2004 due to the uncertaintyregarding the Company’s ability to generate taxable income, and resultinguncertainty relative to the recoverability of deferred tax assets.

 

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

 

**401(k)Plan**

 

The Companyhas adopted a plan pursuant to Section 401(k) of the Internal Revenue Code(“the Code”) whereby participants may contribute a percentage of compensationnot in excess of the maximum allowed under the Code. The plan provides for amatching contribution by the Company which was reinstated as of January 31,2004.  Employer matching contributionsamounted to $267,000 and $165,000 for the three months ended July 31, 2005and 2004, respectively, and $605,000 and $330,000 for the six months ended July 31,2005 and 2004. The Company may make additional contributions at the discretionof the Board of Directors.  Nodiscretionary contributions were made during the three months ended July 31,2005 and 2004.

 

**IncentiveCompensation Plans**

 

The Carreker Incentive Bonus Plan (“CIBP”) awards employees bonusesbased on the Company’s or the applicable business unit’s operatingresults.  Substantially all employees areeligible to receive cash awards under the CIBP. Awards from this plan are paid to employees subsequent to the end of thefiscal year.  The Company’s CompensationCommittee of the Board of Directors has the authority to determine the finalamount of the bonus that is ultimately paid to the officers of theCompany.  In the three months ended July 31,2005 and 2004, the Company recorded expense under this plan of approximately$19,000 and $424,000, respectively.  Inthe six months ended July 31, 2005 and 2004, the Company recorded expenseunder this plan of approximately $263,000 and $529,000, respectively.  

 

The Companypays discretionary bonuses to key employees based primarily on the extent towhich individuals meet agreed-upon objectives for the year. The Company recordeddiscretionary bonus expense of approximately $459,000 and $314,000 for thethree months ended July 31, 2005 and 2004, respectively, and $724,000 and$403,000 for the six months ended July 31, 2005 and 2004.  

 

18

----

 

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

 

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

 
| ** **                                                                  | ** ** | **Three Months Ended  July 31,** | ** ** | **Six Months Ended  July 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                  | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                        |       |                                  |       |                                |       |   |   |   |   |
| Basic earnings (loss) per share:                                            |       |                                  |       |                                |       |   |   |   |   |
| Net income (loss)                                                           |       | $                                     | 1,054      |                                | $          | 199 |   | $ | 1,552 |   | $ | (613 | ) |
|                                                                        |       |                                  |       |                                |       |   |   |   |   |
| Weighted average shares outstanding                                         |       | 24,127                                |       | 24,671                              |       | 24,326 |   | 24,524 |   |
|                                                                        |       |                                  |       |                                |       |   |   |   |   |
| Basic earnings (loss) per share                                             |       | $                                     | 0.04       |                                | $          | 0.01 |   | $ | 0.06 |   | $ | (0.03 | ) |
|                                                                        |       |                                  |       |                                |       |   |   |   |   |
| Diluted earnings (loss) per share:                                          |       |                                  |       |                                |       |   |   |   |   |
| Net income (loss)                                                           |       | $                                     | 1,054      |                                | $          | 199 |   | $ | 1,552 |   | $ | (613 | ) |
|                                                                        |       |                                  |       |                                |       |   |   |   |   |
| Weighted average shares outstanding                                         |       | 24,127                                |       | 24,671                              |       | 24,326 |   | 24,524 |   |
| Assumed conversion of employee stock  options and unvested restricted stock |       | 294                                   |       | 810                                 |       | 377 |   | — |   |
| Shares used in diluted earnings per share  calculation                      |       | 24,421                                |       | 25,481                              |       | 24,703 |   | 24,524 |   |
|                                                                        |       |                                  |       |                                |       |   |   |   |   |
| Diluted earnings (loss) per share                                           |       | $                                     | 0.04       |                                | $          | 0.01 |   | $ | 0.06 |   | $ | (0.03 | ) |

 

Options totaling 2,609,894 and 2,024,866 for the three months ended July 31,2005 and 2004, respectively, and 2,666,520 and 1,361,509 for the six monthsended July 31, 2005 and 2004, respectively, have been excluded from thediluted earnings per share computation as the options were anti-dilutive.

 

**8.****                                      Contingencies**

 

On June 15, 2004, by mutual agreement between the parties, CivilAction No. 303CV1211-M was reinstated in the United States District Courtfor the Northern District of Texas, Dallas Division. This action was originallyfiled on May 29, 2003, in the United States District Court for theNorthern District of Texas, Dallas Division as Civil Action no. 303CV1211-D. OnJanuary 15, 2004, the Court, acting upon the joint motion of the parties,dismissed the action without prejudice. This action was brought as ashareholders’ derivative action pursuant to Rule 23.1, Fed.R.Civ.P. forthe benefit of Nominal Defendant Carreker Corporation against certain of itscurrent and former officers and directors, i.e., John D. Carreker, Jr.,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 RonaldAntinori, seeking to remedy their individual breaches of fiduciary duty,including their knowing violations of Generally Accepted Accounting Principles(“GAAP”), knowing violations of federal and state securities laws, acts of badfaith and other breaches of fiduciary duty. The plaintiff seeks redress (theform of, among others, unspecified amounts of compensatory damages, interestand costs, including legal fees) for injuries to the Company and itsshareholders caused by Defendants’ misfeasance and/or malfeasance during theperiod from May 20, 1998 through December 10, 2002.  The Company has filed a motion to dismiss andis awaiting a ruling from the judge.

 

On June 2,2003, in the District Court, Dallas County, Texas, Walter Evans brought ashareholders’ derivative action, for the benefit of Nominal Defendant Carreker Corporationagainst James D. Carreker, John D. Carreker, Jr., James R. Erwin, James L.Fischer, Michael D. Hansen, Donald L. House, Richard R. Lee, Jr., David K.Sias, Ronald J. Steinhart, and Ernst & Young, LLP and CarrekerCorporation, Nominal Defendant (Cause No. 0305505). The complaint allegesthat the director defendants breached their fiduciary duty to the company.  The complaint seeks unspecified amounts ofcompensatory damages, as well as interest and costs, including legal fees fromthe director defendants.  This action hasbeen voluntarily dismissed without prejudice.

 

19

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On April 16, 2003 the United States District Court for theNorthern District of Texas, Dallas Division, issued an order consolidating anumber of purported class action lawsuits into a Consolidated Action styled *In re Carreker Corporation Securities Litigation*, CivilAction No. 303CV0250-M. On October 14, 2003 the plaintiffs filedtheir Consolidated Class Action Complaint. The complaint, filed on behalfof purchasers of the Company’s common stock between May 20, 1998 and December 10,2002, inclusive, alleged violations of Section 10(b) of theSecurities Exchange Act of 1934 and Rule 10b-5 against all defendants (theCompany, John D. Carreker Jr., Ronald Antinori, Terry L. Gage and Ernst &Young, the Company’s auditors), violations of Section 20(a) of theExchange Act against the individual defendants, and violation of Section 20Aof the Securities Exchange Act against defendants John D. Carreker, Jr.and Ronald Antinori.  The complaint alsoalleges, among other things, that defendants artificially inflated the value ofCarreker stock by knowingly or recklessly misrepresenting the Company’sfinancial results during the purported class period.  On March 22, 2005 the Court dismissedthe action without prejudice and allowed the plaintiffs 60 days in which tofile an amended complaint. Also the Court dismissed, with prejudice, all claimsby shareholders relating to periods prior to July 31, 1999.  

 

On May 31, 2005, the plaintiffs filed an Amended Consolidated Class ActionComplaint on behalf of purchasers of the Company’s common stock between July 30,1999 and December 10, 2002, inclusive, which reiterates the allegations inthe first complaint, and alleges violations of Section 10(b) of theSecurities Exchange Act of 1934 and Rule 10b-5 against all defendants (theCompany, John D. Carreker Jr., Ronald Antinori and Terry L. Gage) except Ernst &Young LLP, violations of Section 20(a) of the Exchange Act againstthe individual defendants, and violations of Section 20A of the SecuritiesExchange Act against defendants John D. Carreker, Jr. and RonaldAntinori.  The plaintiffs are seekingunspecified amounts of compensatory damages, interest and costs, includinglegal fees.  

 

On July 29, 2005, the Company filed a motion to dismiss theAmended Consolidated Class Action Complaint, primarily based on variousprovisions of the Private Securities Litigation Reform Act of 1995.  The court has not yet ruled on thismotion.  

 

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

 

The Companyis periodically involved in various other legal actions and claims which arisein the normal course of business.  In theopinion of management, the final disposition of these mattersare not expected to have a material adverse effect on the Company’sfinancial position or results of operations. 

 

20

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**9.****                                      Business Segments and Revenue Concentration**

 

The tablesbelow show revenues and income (loss) from operations for the periods indicatedfor our three reportable business segments: Revenue Enhancement, GlobalPayments Technologies and Global Payments Consulting.  Certain prior year amounts have beenreclassified to conform with the current year businesssegment presentation.  Our customerprojects are sold on a solution basis, so it is necessary to break them down bysegment and allocate accordingly. Included in “Corporate Unallocated” are costs related to selling andmarketing, unallocated corporate overhead expense.  Business segment results, which include costsfor research and development as well as product royalty expense, theamortization and impairment of goodwill and intangible assets, the write-off ofcapitalized software costs and restructuring and other charges, were as follows(in thousands):  

 
| ** **                                                                                                       | ** ** | **Three Months ended July 31,  2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                       | ** ** | **Revenue  Enhancement**                   | ** ** | **Global Payments  Technologies** | ** ** | **Global Payments  Consulting** | ** ** | **Corporate  Unallocated** | ** ** | **Total** | ** ** |
| Revenues:                                                                                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| Consulting                                                                                                       |       | $                                          | 8,832      |   | $ | 2 |   | $ | 668 |   | $ | — |   | $ | 9,502 |   |
| Software license                                                                                                 |       | 252                                        |       | 3,415 |   | 115 |   | — |   | 3,782 |   |
| Software maintenance                                                                                             |       | 152                                        |       | 10,210 |   | 214 |   | — |   | 10,576 |   |
| Software implementation and other  services                                                                      |       | 1,176                                      |       | 3,523 |   | 193 |   | — |   | 4,892 |   |
| Outsourcing services                                                                                             |       | —                                     |       | — |   | — |   | 241 |   | 241 |   |
| Out-of-pocket expense reimbursements                                                                             |       | 485                                        |       | 331 |   | 111 |   | — |   | 927 |   |
| Total revenues                                                                                                   |       | $                                          | 10,897     |   | $ | 17,481 |   | $ | 1,301 |   | $ | 241 |   | $ | 29,920 |   |
|                                                                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| Income (loss) from operations before  amortization of customer relationships and restructuring and other charges |       | $                                          | 5,470      |   | $ | 2,063 |   | $ | 8 |   | $ | (6,195 | ) | $ | 1,346 |   |
|                                                                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| Amortization of customer relationships                                                                           |       | —                                     |       | 350 |   | — |   | — |   | 350 |   |
| Restructuring and other charges                                                                                  |       | —                                     |       | 23 |   | — |   | 5 |   | 28 |   |
| Income (loss) from operations                                                                                    |       | $                                          | 5,470      |   | $ | 1,690 |   | $ | 8 |   | $ | (6,200 | ) | $ | 968 |   |

 
| ** **                                                                                                       | ** ** | **Three Months ended July 31,  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                       | ** ** | **Revenue  Enhancement**                   | ** ** | **Global Payments  Technologies** | ** ** | **Global Payments  Consulting** | ** ** | **Corporate  Unallocated** | ** ** | **Total** | ** ** |
| Revenues:                                                                                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| Consulting                                                                                                       |       | $                                          | 9,351      |   | $ | 314 |   | $ | 849 |   | $ | — |   | $ | 10,514 |   |
| Software license                                                                                                 |       | 13                                         |       | 4,564 |   | — |   | — |   | 4,577 |   |
| Software maintenance                                                                                             |       | 215                                        |       | 9,782 |   | 235 |   | — |   | 10,232 |   |
| Software implementation and other  services                                                                      |       | 159                                        |       | 3,284 |   | 199 |   | — |   | 3,642 |   |
| Outsourcing services                                                                                             |       | —                                     |       | — |   | — |   | 10 |   | 10 |   |
| Out-of-pocket expense reimbursements                                                                             |       | 304                                        |       | 267 |   | 91 |   | — |   | 662 |   |
| Total revenues                                                                                                   |       | $                                          | 10,042     |   | $ | 18,211 |   | $ | 1,374 |   | $ | 10 |   | $ | 29,637 |   |
|                                                                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| Income (loss) from operations before  amortization of customer relationships and restructuring and other charges |       | $                                          | 4,994      |   | $ | 3,102 |   | $ | (263 | ) | $ | (6,655 | ) | $ | 1,178 |   |
|                                                                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| Amortization of customer relationships                                                                           |       | —                                     |       | 350 |   | — |   | — |   | 350 |   |
| Restructuring and other charges (credits)                                                                        |       | 28                                         |       | (852 | ) | — |   | 1,021 |   | 197 |   |
| Income (loss) from operations                                                                                    |       | $                                          | 4,966      |   | $ | 3,604 |   | $ | (263 | ) | $ | (7,676 | ) | $ | 631 |   |

 

21

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| ** **                                                                                                       | ** ** | **Six Months ended July 31,  2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                                       | ** ** | **Revenue  Enhancement**                 | ** ** | **Global Payments  Technologies** | ** ** | **Global Payments  Consulting** | ** ** | **Corporate  Unallocated** | ** ** | **Total** | ** ** |
| Revenues:                                                                                                        |       |                                     |       |   |   |   |   |   |   |   |   |
| Consulting                                                                                                       |       | $                                        | 16,554     |   | $ | 52 |   | $ | 1,214 |   | $ | — |   | $ | 17,820 |   |
| Software license                                                                                                 |       | 553                                      |       | 6,473 |   | 115 |   | — |   | 7,141 |   |
| Software maintenance                                                                                             |       | 265                                      |       | 21,180 |   | 443 |   | — |   | 21,888 |   |
| Software implementation and other  services                                                                      |       | 1,652                                    |       | 7,072 |   | 302 |   | — |   | 9,026 |   |
| Outsourcing services                                                                                             |       | —                                   |       | — |   | — |   | 498 |   | 498 |   |
| Out-of-pocket expense reimbursements                                                                             |       | 872                                      |       | 672 |   | 201 |   | — |   | 1,745 |   |
| Total revenues                                                                                                   |       | $                                        | 19,896     |   | $ | 35,449 |   | $ | 2,275 |   | $ | 498 |   | $ | 58,118 |   |
|                                                                                                             |       |                                     |       |   |   |   |   |   |   |   |   |
| Income (loss) from operations before  amortization of customer relationships and restructuring and other charges |       | $                                        | 9,408      |   | $ | 4,617 |   | $ | (316 | ) | $ | (11,684 | ) | $ | 2,025 |   |
|                                                                                                             |       |                                     |       |   |   |   |   |   |   |   |   |
| Amortization of customer relationships                                                                           |       | —                                   |       | 700 |   | — |   | — |   | 700 |   |
| Restructuring and other charges (credits)                                                                        |       | —                                   |       | 154 |   | (24 | ) | (7 | ) | 123 |   |
| Income (loss) from operations                                                                                    |       | $                                        | 9,408      |   | $ | 3,763 |   | $ | (292 | ) | $ | (11,677 | ) | $ | 1,202 |   |

 
| ** **                                                                                                       | ** ** | **Six Months ended July 31, 2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                                       | ** ** | **Revenue  Enhancement**                | ** ** | **Global Payments  Technologies** | ** ** | **Global Payments  Consulting** | ** ** | **Corporate  Unallocated** | ** ** | **Total** | ** ** |
| Revenues:                                                                                                        |       |                                    |       |   |   |   |   |   |   |   |   |
| Consulting                                                                                                       |       | $                                       | 17,838     |   | $ | 350 |   | $ | 1,383 |   | $ | — |   | $ | 19,571 |   |
| Software license                                                                                                 |       | 192                                     |       | 10,208 |   | 33 |   | — |   | 10,433 |   |
| Software maintenance                                                                                             |       | 384                                     |       | 20,470 |   | 462 |   | — |   | 21,316 |   |
| Software implementation and other  services                                                                      |       | 315                                     |       | 5,841 |   | 365 |   | — |   | 6,521 |   |
| Outsourcing services                                                                                             |       | —                                  |       | — |   | — |   | 10 |   | 10 |   |
| Out-of-pocket expense reimbursements                                                                             |       | 795                                     |       | 567 |   | 190 |   | — |   | 1,552 |   |
| Total revenues                                                                                                   |       | $                                       | 19,524     |   | $ | 37,436 |   | $ | 2,433 |   | $ | 10 |   | $ | 59,403 |   |
|                                                                                                             |       |                                    |       |   |   |   |   |   |   |   |   |
| Income (loss) from operations before  amortization of customer relationships and restructuring and other charges |       | $                                       | 9,609      |   | $ | 7,548 |   | $ | (829 | ) | $ | (13,521 | ) | $ | 2,807 |   |
|                                                                                                             |       |                                    |       |   |   |   |   |   |   |   |   |
| Amortization of customer relationships                                                                           |       | —                                  |       | 700 |   | — |   | — |   | 700 |   |
| Restructuring and other charges (credits)                                                                        |       | 1,747                                   |       | (639 | ) | — |   | 1,604 |   | 2,712 |   |
| Income (loss) from operations                                                                                    |       | $                                       | 7,862      |   | $ | 7,487 |   | $ | (829 | ) | $ | (15,125 | ) | $ | (605 | ) |

 

22

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During the three months ended July 31, 2003, the Company formedCarretek LLC (“Carretek”), in which the Company owns a 51% interest, to offerfinancial institutions offshore-centric outsourcing of their businessprocesses.  During July 2004,Carretek signed its first contract to perform outsourced services with acustomer.  As this outsourcing businesscontinues to be in the development phase and its operations are immaterial, thefinancial results for the three and six months ended July 31, 2005 and2004 are contained in the Corporate-Unallocated business segment in the tablesabove.

 

For the three months ended July 31, 2005, Carretek recorded$241,000 of revenue and recorded expense of $675,000.  For the three months ended July 31,2004, Carretek recorded $10,000 of revenue and recorded expense of$282,000.  For the six months ended July 31,2005, Carretek recorded $498,000 of revenue and recorded expense of $1.6million.  For the six months ended July 31,2004, Carretek recorded $10,000 of revenue and recorded expense of$456,000.  Accordingly, the 49% sharerelating to the minority interest in these losses, which was $213,000 and$133,000 for the three months ended July 31, 2005 and 2004, respectively,and $530,000 and $219,000 for the six months ended July 31, 2005 and 2004,respectively, was recorded in other income in the accompanying consolidatedstatements of operations.  The Companyand its partner have funded Carretek to date in the aggregate amount of $3.2million of equity.  

 

The following table summarizes revenues, exclusive of out-of-pocketexpense reimbursements, derived from the Company’s largest customer and topfive customers during the periods indicated. 

 
| ** **         | ** ** | **Three Months Ended  July 31,** | ** ** | **Six Months Ended  July 31,** | ** ** |
|--------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **         | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|               |       |                                  |       |                                |       |   |   |   |   |
| Single customer    |       | 15.0                                  | %          | 13.7                                | %          | 12.2 | % | 9.9 | % |
| Top five customers |       | 39.0                                  | %          | 39.2                                | %          | 38.3 | % | 34.3 | % |

 

National City Corporation accounted for approximately 15.0% of totalrevenues during the three months ended July 31, 2005, and Wells Fargoaccounted for approximately 12.2% of total revenues during the six months endedJuly 31, 2005.  Wells Fargoaccounted for approximately 13.7% of total revenues during the three monthsended July 31, 2004, and approximately 9.9% of total revenues during thesix months ended July 31, 2004.

 

23

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The Company markets its solutions in severalforeign countries.  Revenues, exclusiveof out-of-pocket expense reimbursements, for the periods indicated attributedto countries based on the location of the customers, were as follows (in thousands):  

 
| ** **     | ** ** | **Three Months Ended****July 31****,  2005** | ** ** | **Three Months Ended****July 31****,  2004** | ** ** |
|----------------|------------|---------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **     | ** ** | **Amount**                                        | ** ** | **Percent of  total  revenues**                   | ** ** | **Amount** | ** ** | **Percent of  total  revenues** | ** ** |
| United States  |       | $                                                 | 20,890     |                                              | 72.1       | % | $ | 21,330 |   | 73.7 | % |
| Europe         |       | 1,548                                             |       | 5.3                                               |       | 2,151 |   | 7.4 |   |
| Canada         |       | 1,562                                             |       | 5.4                                               |       | 1,517 |   | 5.2 |   |
| Asia Pacific   |       | 1,769                                             |       | 6.1                                               |       | 955 |   | 3.3 |   |
| South Africa   |       | 2,410                                             |       | 8.3                                               |       | 2,788 |   | 9.6 |   |
| Other          |       | 814                                               |       | 2.8                                               |       | 234 |   | 0.8 |   |
| Total revenues |       | $                                                 | 28,993     |                                              | 100        | % | $ | 28,975 |   | 100 | % |

 
| ** **     | ** ** | **Six Months Ended****July 31****,  2005** | ** ** | **Six Months Ended****July 31****,  2004** | ** ** |
|----------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **     | ** ** | **Amount**                                      | ** ** | **Percent of  total  revenues**                 | ** ** | **Amount** | ** ** | **Percent of  total  revenues** | ** ** |
| United States  |       | $                                               | 40,962     |                                            | 72.7       | % | $ | 43,523 |   | 75.2 | % |
| Europe         |       | 3,319                                           |       | 5.9                                             |       | 4,526 |   | 7.8 |   |
| Canada         |       | 3,422                                           |       | 6.1                                             |       | 3,042 |   | 5.3 |   |
| Asia Pacific   |       | 2,831                                           |       | 5.0                                             |       | 2,290 |   | 4.0 |   |
| South Africa   |       | 4,420                                           |       | 7.8                                             |       | 3,997 |   | 6.9 |   |
| Other          |       | 1,419                                           |       | 2.5                                             |       | 473 |   | 0.8 |   |
| Total revenues |       | $                                               | 56,373     |                                            | 100        | % | $ | 57,851 |   | 100 | % |

 

24

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

 

**The Company recorded variousrestructuring and other charges and (credits) during the three months ended July 31,2005 and 2004, respectively, as follows (in thousands):**

** **
| ** **                                 | ** ** | **Workforce  Reductions** | ** ** | **EPG  Litigation  Settlement** | ** ** | **Legal and  Professional  Fees** | ** ** | **Other**  | ** ** | **Total**  | ** ** |
|--------------------------------------------|------------|---------------------------|------------|---------------------------------|------------|-----------------------------------|------------|------------|------------|------------|------------|
|                                       |       |                      |       |                            |       |                              |       |       |       |       |       |
| **YTD 2004:**                              | ** ** | ** **                | ** ** | ** **                      | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Quarterly period ended April 30, 2004 |       | 308                       |       | 1,686                           |       | 521                               |       | —     |       | 2,515      |       |
| Quarterly period ended July 31, 2004  |       | 192                       |       | 14                              |       | 1,206                             |       | (1,215     | )          | 197        |       |
| Total YTD 2004                             |       | $                         | 500        |                            | $          | 1,700                             |       | $          | 1,727      |       | $          | (1,215 | ) | $ | 2,712 |   |
|                                       |       |                      |       |                            |       |                              |       |       |       |       |       |
| **YTD 2005:**                              | ** ** | ** **                | ** ** | ** **                      | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Quarterly period ended April 30, 2005 |       | 127                       |       | —                          |       | —                            |       | (32        | )          | 95         |       |
| Quarterly period ended July 31, 2005  |       | 28                        |       | —                          |       | —                            |       | —     |       | 28         |       |
| Total YTD 2005                             |       | $                         | 155        |                            | $          | —                            |       | $          | —     |       | $          | (32 | ) | 123 |   |
|                                            |            |                           |            |                                 |            |                                   |            |            |            |            |            |  |  |  |  |  |

** **

**QuarterEnded April 30, 2004**

** **

TheCompany recorded $308,000 in restructuring and other charges during the threemonth period ended April 30, 2004, principally associated with theseparation of 10 employees.  The Companyexpensed $1.686 million for compensatory damages to EPG after the jury returneda verdict in favor of EPG on one claim and Carreker on three claims.  This litigation ultimately settled in June 2004for $1.7 million.  The Company recorded acharge of $521,000 relating to legal and professional fees relating to theselegal actions.  

 

**QuarterEnded July 31, 2004**

** **

TheCompany recorded $192,000 in restructuring and other charges during the threemonth period ended July 31, 2004, principally associated with theseparation of 8 employees.  During thequarter ended July 31, 2004, the Company recorded a charge of $36,000relating to legal and professional fees relating to the Company’s shareholderlegal actions described in Note 8.

 

On July 8,2004, the Company settled with EPG for $1.7 million.  An additional $14,000 was expensed and thesettlement paid to the plaintiff. Additionally, the Company recorded a charge for the litigation costsrelated to this legal action totaling $1.2 million.  

 

Finally,the Company received a final payment of $455,000 from a customer in the finalsettlement with one of its original CheckFlow Suite customers.  This payment was recorded directly to thisreserve.  Concurrently, based on revisedcost estimates, the Company lowered its estimate of the cost to develop andinstall any additional software, or software modifications, with thesecustomers and reversed approximately $1.2 million of this reserve.

 

**QuarterEnded April 30, 2005**

** **

TheCompany recorded $127,000 in restructuring and other charges during the threemonth period ended April 30, 2005, principally associated with theseparation of 6 employees.  The Companyalso lowered its estimate by $32,000 for the costs associated with thediscontinuance of one of its software offerings originally recorded in January 2004.   

 

25

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**QuarterEnded July 31, 2005**

** **

TheCompany recorded $28,000 in restructuring and other charges during the threemonth period ended July 31, 2005, principally associated with the separationof 2 employees.  

 

The activity related tothe accrued merger and restructuring costs during the three and six monthsended July 31, 2005 is as follows (in thousands):

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

 

TheCompany anticipates the remaining reserve accruals at July 31, 2005 willbe paid or remaining customer obligations completed within the next 9 months.

 

**11.****                               SubsequentEvent**

 

On August 31,2005, we implemented staffing reductions primarily within our Global PaymentsTechnologies (“GPT”) business segment. This action was taken to realign this business to achieve improvedlong-term profitability and increased flexibility going forward.  We currently expect to recognize a charge ofapproximately $775,000 in our third quarter of fiscal 2005.  On an ongoing basis, annual benefits ofapproximately $2.4 million are expected to result from this action including approximately$400,000 and $600,000 which is expected to be realized beginning in the thirdand fourth quarters of fiscal 2005, respectively.

 

26

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**Item2.********Management’s Discussion and Analysis of Financial Condition and Resultsof Operations**

 

Allstatements other than statements of historical fact contained in this report,including statements in this “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” concerning our financial position andliquidity, results of operations, prospects for future growth, and othermatters, are forward-looking statements. Although we believe that the expectations reflected in such forward-lookingstatements are reasonable, no assurance can be given that such expectationswill prove correct.  Factors that couldcause our results to differ materially from the results discussed in, orcontemplated by, such forward-looking statements include the risks describedunder “Business – Forward Looking Statements and Risk Factors” contained in ourForm 10-K for the year ended January 31, 2005, as filed with theSecurities and Exchange Commission (“SEC”). Such risks include, without limitation: dependence on the bankingindustry, decline in check volumes, fluctuations in operating results, lack oflong-term agreements, dependence on key personnel, product liability, rapidtechnological change and dependence on new products, focus on providingbusiness process outsourcing with significant offshore components, ability toattract and retain qualified personnel, customer concentration, competition,proprietary rights, infringement claims, dependence on third parties fortechnology licenses, liability claims, our ability to protect our informationtechnology infrastructure, international operations, changing government andtax regulations, stock price fluctuations, impairment of goodwill or intangibleassets, realization of revenue from contracted sales, potential sales andbacklog, changes in accounting treatment of share-based compensation and theresolution of pending class action and shareholder derivative lawsuits.  All forward-looking statements in this reportare expressly qualified in their entirety by the cautionary statements in thisparagraph, in the “risk factors” included in our SEC filings and elsewhere inthis report.  

 

**Overview**

** **

Forthe last 27 years Carreker Corporation has designed, developed, sold anddelivered payments-related software and consulting solutions to financialinstitutions and financial service providers. Our products and services address a broad spectrum of payment activitiesand are designed to help our clients enhance the performance of their paymentsbusinesses; improve operational efficiency in payments processing; enhancerevenue and profitability from payments-oriented products and services; reducelosses associated with fraudulent payment transactions; facilitate compliancewith risk-related laws and regulations; and/or maximize clients’ customerincome streams by aligning their customer interactions and products withcustomer needs.

 

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

 

*Global Payments Technologies*.  This division is responsible for design,development, sales, and support of our technology solutions.   Revenue is primarily derived from licensefees, implementation fees and maintenance fees.

 

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

 

*Global Payments Consulting*.  The objective of this professional servicesdivision is to provide our clients with “applied thought leadership” related tothe business of payments.  Revenue in theGPC division is primarily derived through the delivery of consulting servicesoffered primarily on a time and materials basis to our clients, along with thelicense fees, maintenance fees and services fees associated with our FloatPricing System software offering and Payments Clearing Model product offering.  

 

Inaddition to these three divisions, in fiscal 2003 we formed Carretek LLC.  Carretek is a transformational businessoutsourcer for payment and transaction processing jointly owned by CarrekerCorporation and Majesco Software, Inc., the U.S. subsidiary of MastekLimited, a leading Indian outsourcing company with global operations.

 

27

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

 

*Operating Expenses.*  Operating expenses, including selling,general and administrative and research and development, are substantiallydriven by personnel and overhead expenses. Other significant operating expenses that we monitor includeprofessional fees, use of contractors, travel, insurance and office servicesexpenses.  Additionally in the first twoquarters of fiscal 2004, the settlement of the EPG legal action along withassociated legal fees was recorded on the Restructuring and Other Chargesfinancial statement caption on the Consolidated Statement of Operations.

 

Liquidity and Cash Flows.  Cash and cash equivalents at July 31,2005 and January 31, 2005 totaled $21.7 million and $34.5 million,respectively.  In addition to our growthin accounts receivable, our primary utilization of cash in fiscal 2005 was toinvest in $4.6 million of marketable debt securities and $3.2 million oftreasury stock purchases.

 

**Productsand Services**

 

Theproducts and services of our three primary operating divisions are describedbelow in this sequence: Global Payments Technologies (“GPT”), RevenueEnhancement (“RevE”) and Global Payments Consulting (“GPC”)

 

*Global Payments Technologies Solutions.*  Carreker’s technology solutions helpfinancial institutions address the needs of some critical payment services anddelivery functions that impact overall operating revenues and costs and riskmanagement.  These functions 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).  Global Payments Technologies (“GPT”)solutions address these and other key functions in the context of improvingoperational efficiency and a gradual transition from paper to electronic-basedpayment systems.  In addition, we offertechnology solutions that optimize the inventory management of a bank’s cash stocklevels and logistical service requirements, including managing how much isneeded, when it is needed and where it is needed.  Our solutions reduce the amount of cash banksneed to hold in reserve accounts and as cash-on-hand while ensuring a high levelof customer service through timely replenishment of ATM cash supplies atminimal logistical services cost.  

 

Specific solutions inthe GPT group include:  

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

 

28

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| **Solution**                                     | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | ** ** | **Products Offered**                                                                                                                                                                                                                                                                   |
|--------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Remittance and  Payments Processing              |       | Both host and  client/server-based platforms for improved productivity in processing retail  and wholesale remittance transactions for financial institutions and payments  processing for a wide variety of cross-industry applications.                                                                                                                                                                                                                                                  |       | NeXGen  Remittance                                                                                                                                                                                                                                                                     |
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                                                                                                                                                                   |
| Conventional  Check Capture                      |       | An extensive  array of enhancement products that add flexibility and usability to IBM’s  Check Processing Control System (CPCS) and the IBM 3890/XP series of Document  Processors.                                                                                                                                                                                                                                                                                                   |       | Conventional  Capture Products, CPCS Enhancements Products, XP/Productivity Tools, Platform  Emulation, NeXGen Settlement, NeXGen Balancing, and LTA (Large Table Access)                                                                                                              |
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                                                                                                                                                                   |
| Check Image  Capture                             |       | Products and  services related to the centralized and distributed capture, quality and  inspection assurance, storage and delivery of check images.                                                                                                                                                                                                                                                                                                                                        |       | ALS &  CIMS Products (MVS, AIX, Windows), NeXGen Image Processor, Image Enhancement  Products, Reject Repair, RECO Technology, Image POD, Image Delivery Products,  Delivery Express QAS Image Inspector, NeXGen Capture, Source Capture  Corporate and Source Capture Branch |
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                                                                                                                                                                   |
| Check Image Archive Management                   |       | Comprehensive array of check image archive  management products that may be tailored to a bank’s unique requirements  based on their operational environments and volumes. Carreker offers archive  technology for both in-house solutions and shared outsource providers.                                                                                                                                                                                                            |       | Check Image Archive-AIX, Check Image  Archive-MVS, Check Image Archive Load                                                                                                                                                                                                            |
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                                                                                                                                                                   |
| Other Check  Image Applications                  |       | An array of  solutions that address revenue enhancement, risk reduction, and expense  reduction issues through the application of image, workflow and RECO  technologies.                                                                                                                                                                                                                                                                                                                  |       | Image  Statements, CDRom Delivery, Input/Express, Express Capture, Payee Name  Verification, and Amount Encoding Verification                                                                                                                                                          |
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                                                                                                                                                                   |
| Global Tracking                                  |       | A complete bar  code tracking system eliminates manual log sheets, automates data gathering  and maximizes workflow by tracking accountable mail,  branch bags, item volumes, currency bags, incoming domestic and international  deposits, outgoing cash letters, exceptions and much more.                                                                                                                                                                                               |       | Receive Sentry                                                                                                                                                                                                                                                                         |
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                                                                                                                                                                   |
| eMetrics                                         |       | Performance-measurement  software suite that uses historical data to generate key performance  indicators, item processing volume data, productivity statistics and quality  control benchmarks.                                                                                                                                                                                                                                                                                           |       | Lumen, ProModel,  eiMICR, eiStats, eiQuality, eiPerform                                                                                                                                                                                                                                |
|                                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                                                                                                                                                                   |
| Electronic Check  Presentment and Image Exchange |       | Enables banks to  transition from paper-based to electronic payment systems by automating key  elements of the processing stream, creation of image replacement documents (“IRD”)  and image quality and usability checking.  Aided by Check 21 legislation, these solutions are designed to reduce and  eventually eliminate the movement of paper payments through the system,  improving productivity, reducing errors, increasing customer satisfaction and  reducing fraud. |       | ExchgLink , IRD  Create, IRD Author, Image Inspector, CheckLink, CheckLink PC, Deposit  Manager, Branch Truncation Manager and Cnotes                                                                                                                                                  |

 

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

 

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

 

Another component of ourRevenue Enhancement offering is our CVE solutions thatincludes EnAct software, proprietary sales management methodologies andsales training programs. Our CVE solutions assist financial institutions inleveraging central intelligence with local insight. This enables our clients torecognize those customers and prospects representing the greatest value orpotential. Our approach is unique and complementary to many CRM investmentsthat banks have made in recent years and is designed to focus their activitiessuch that they can actually attain increased returns on these CRMinvestments.  

 

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

 

•                  Enterprisepayment rationalization (strategy through performance optimization)

•                  Paymentresearch services

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

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

•                  Electronicpayment infrastructure planning (image enablement through converged paymentenvironments) 

•                  Consolidationand merger/integration planning

•                  EnterpriseRisk support for payments related functions

 

30

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TheGPC division also contains the license, maintenance and services revenue fortwo product areas:

 

•                  Float Management software products –Float Analysis System and Float Management System – for managing a bank’s floatthrough float analysis and pricing to improve profitability, reporting,workflow and check clearing operations. These products also provide critical activity summaries, aid in creatingmultiple availability and pricing schedules, andpinpoint the cost/profitability of transactions or relationships. 

 

•                  Payments Clearing Modeling product –Payments Financial Modeling application that allows a bank to create anenterprise virtual profit and loss statement for the payments business as wellas model business scenarios around product and service pricing andtransactional volume trends.

 

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

 

Carretek’smission is to enable financial institutions and their processors to realize thebenefits of transformational offshore-centric outsourcing (“offshoring”) oftheir business processes.  The benefitsto clients could include reduction in operating costs, improvements inproductivity, and enhancement of quality. 

 

Initially,Carretek is focused on offshoring payments-related business processes.  Through Carretek, financial institutions canleverage the global work force at this critical period when Check 21 and otherpayment electronification trends are pressuring financial institutions toreduce their payment per item costs beyond the power of traditional costmanagement practices.  Carretek has designed and built specificproduct offerings targeted at payment and transaction processing functions forthis express purpose.  Within thisarea of expertise, the Carretek offering includes a flexible array of offshoreoutsourcing services to financial institutions.

 

31

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**ExecutiveSummary**

 

In Q22005, we generated revenue of $29.9 million and net income of $1.1million.  These results compare torevenue of $29.6 million and net income of $199,000 in Q2 2004.  In YTD 2005, we generated revenue of $58.1 millionand net income of $1.6 million.  Theseresults compare to revenue of $59.4 million and a net loss of $613,000 in YTD2004.

 

OurRevenue Enhancement (“RevE”) business segment has increased revenue $855,000,or 8.5%, on a quarterly basis and $372,000, or 1.9%, on aYTD basis.  This increase in revenue hasbeen primarily driven by an increase in Customer Value Enhancement (“CVE”)software and services, particularly in our international markets.  CVE is our proprietary sales managementmethodologies and training programs. These increases on both a quarterly and YTD basis in CVE related revenuehave been partially offset by a reduction in traditional RevE consultingrevenue, particularly in the international markets.

 

OurGlobal Payments Technology (“GPT”) business segment experienced declines inrevenue of $730,000, or 4.0%, on a quarterly basis and $2.0 million, or 5.3%,on a YTD basis. These declines were centered within software license revenue within thePayments product group.  The Paymentsgroup includes such products as ExchgLink, Image-replacement document solutionsand Source Capture products.  The salesopportunities and the number of closed sales for these new Payments productshave been increasing, however the majority of the revenue recognized to datefrom these new product offerings has been largely limited to our developmental partnersand beta customers, and the remainder remains in deferred revenue until we gaincustomer acceptance of the products.

 

OurGlobal Payments Consulting (“GPC”) business segment experienced a decline inrevenue of $73,000, or 5.3%, on a quarterly basis and $158,000, or 6.5%, on a YTD basis. Declining consulting revenue has been partially offset by increasedsoftware license revenue related to our Float Management solutions.

 

Finally,Carretek is our 51% owned business outsourcer for payment and transaction processing.  Carretek signed its first agreement in Q22004.  In Q4 2004 and Q1 2005, weexpanded the scope of our outsourcing engagement with this single customer.  Revenue has increased to $241,000 in Q2 2005and $498,000 on a YTD basis.  We do not expect the financial results for thisbusiness to improve significantly unless and until we expand the scope of thisengagement or add additional customers.

 

Wecontinue to focus on increasing research and development to enhance ourexisting product offerings, and more importantly, developing new productofferings particularly within GPT.  Thereductions within selling, general and administrative were primarily related tocost savings from reductions in personnel in our corporate sales function, ournew health care plan and provider, and reductions within office services andfacilities.  

 

Additionally,on both a quarterly and YTD basis, Restructuring and Other Charges havedeclined significantly.  YTD 2005Restructuring and Other Charges is approximately $123,000 and is mostly relatedto severance costs.  YTD 2004Restructuring and other charges were $2.7 million and contained a $1.7 millionEPG litigation settlement, approximately $1.7 million of legal costs and $500,000of severance, which was offset by a $1.2 million reduction in our CheckFlowcustomer settlement reserve.

 

In Q22005, we used $5.9 million of cash from operating activities and decreasedtotal cash by $14.0 million, as compared to $2.3 million of cash used inoperating activities and a decrease in total cash of $3.0 million in Q22004.  On a YTDbasis, we used $3.8 million of cash from operating activities and decreasedtotal cash of $12.8 million in 2005, as compared to $7.5 million of cashgenerated from operating activities and a decrease of total cash of $156,000 in2004.

 

Duringthe first half of fiscal year 2005, cash flow was heavily dependent on thetiming of the cash collections on the December 31, 2004 maintenancerenewals.  Our continued improvements incash collection led to more of these renewals being collected in January 2005(the last month of fiscal 2004) as opposed to carrying over into Q1 and Q22005.  Additionally, a $4.0 million RevEconsulting invoice due in July 2005 was not collected until August 2005,thereby increasing our Accounts Receivable balance and reducing cash generatedfrom operating activities.  Additionallyin fiscal 2005, we purchased $4.6 million of marketable debt securities andhave also purchased $3.2 million of treasury stock pursuant to a publiclyannounced stock repurchase program, which further decreased our cash and cashequivalent balance at July 31, 2005.

 

32

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# **Overall,as we look across our three major business segments and Carretek, we believethat we are well positioned and have a competitive advantage to capitalize onthe significant changes brought about by factors affecting our customersincluding revenue pressures, technology and regulatory change (i.e., Check 21, Sarbanes-Oxley,USA Patriot Act and Basel II), growing costs and the reputational riskassociated with identity and transaction fraud.** For the 2005 fiscal year, we anticipaterevenue to exceed 2004 fiscal year levels due to sales of new products and anincrease in consulting opportunities. Revenue for Q3 2005 is expected to be in line with Q2 2005. Operatingincome is expected to decline due to a Q3 2005 change in revenue mix associatedwith the timing of certain RevE business segment engagements and arestructuring charge of approximately $775,000, associated with recentpersonnel reductions.  The reductions inpersonnel were implemented in an effort to position the Global PaymentsTechnology business segment for increased flexibility and improved long-termprofitability.  Payments Solutions remainscore to our growth strategy as demonstrated by our research and developmentinvestments in this area.  On an ongoingbasis, we expect an annual benefit of approximately $2.4 million from thisaction.  Approximately $400,000 and$600,000 of this benefit is expected to be recognized beginning in Q3 2005 andQ4 2005, respectively.

# ** **

# **For Q4 2005, we anticipaterevenue to increase over the prior quarters in fiscal 2005 due primarily to therecognition of revenue associated with previous sales.  Additionally, we expect Q4 2005 operatingincome to increase over the prior quarters in fiscal 2005 due to decreasedcosts associated with the recent expense initiatives as well as the anticipatedQ4 2005 revenue increase.**

# ** **

**Resultsof Operations**

 

***Comparisonof Three Months Ended July 31, 2005 (“Q2 2005”) to Three Months Ended July 31,2004 (“Q2 2004”) and Six Months Ended July 31, 2005 (“YTD 2005”) to SixMonths Ended July 31, 2004 (“YTD 2004”)***

 

***Revenues***

 

*Revenues by Segment ($ in thousands):*

 

 
| ** **                      | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|--------------|------------|-------------------------------------|------------|--------------|------------|
| ** **                      | ** ** | **2005**                              | ** ** | **2004**     | ** ** | **$**                               | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                            |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Revenue Enhancement             |       | $                                     | 10,897     |         | $          | 10,042                              |       | $            | 855        |   | 8.5 | % | $ | 19,896 |   | $ | 19,524 |   | $ | 372 |   | 1.9 | % |
| Global Payments Technologies    |       | 17,481                                |       | 18,211       |       | (730                                | )          | (4.0         | )          | 35,449 |   | 37,436 |   | (1,987 | ) | (5.3 | ) |
| Global Payments Consulting      |       | 1,301                                 |       | 1,374        |       | (73                                 | )          | (5.3         | )          | 2,275 |   | 2,433 |   | (158 | ) | (6.5 | ) |
| Corporate (Outsourcing) Revenue |       | 241                                   |       | 10           |       | 231                                 |       | —       |       | 498 |   | 10 |   | 488 |   | — |   |
|                            |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Total Revenues                  |       | $                                     | 29,920     |         | $          | 29,637                              |       | $            | 283        |   | 1.0 | % | $ | 58,118 |   | $ | 59,403 |   | $ | (1,285 | ) | (2.2 | )% |

 

OurRevE business segment increased revenue $855,000, or 8.5%, in Q2 2005 ascompared to Q2 2004 and $372,000, or 1.9%, for YTD 2005 as compared to YTD 2004primarily through increased CVE software and services revenue.  CVE is our proprietary sales managementmethodologies and sales training programs. In the last nine months this group has entered into two large multi-yearterm license engagements to provide software, services and maintenance.  Additionally in Q2 2005, this group was alsoengaged by another large international bank to provide CVE related servicesover a multi-year period.  The increaseswithin CVE were partially offset by decreases in RevE’s traditional consultingrevenue, particularly in the international markets.

 

OurGPT business segment revenue declined $730,000, or 4.0%, in Q2 2005 as comparedto Q2 2004 and declined $2.0 million, or 5.3%, for YTD 2005 as compared to YTD2004.  These declines are both centeredwithin software license revenue, particularly within our Payments Solutions productgroup.  In fiscal 2003 and aided by Check21 legislation, we began to develop several software products that enabledbanks to transition from paper-based to electronic payments systems.  These products include Image Exchange,Image-replacement document creation software along with Source Capture, a productto capture these check images earlier in the payment processing stream.  The sales opportunities and the number ofclosed sales for these new Payments products have been increasing, and weclosed a Source Capture deal in Q4 2004 and a new Image Exchange deal in Q22005.  However, the majority of therevenue derived from these new Payments products remains in deferred revenue atJuly 31, 2005 until we gain customer acceptance of the products.  The revenue recognized to date from theseproducts has been largely limited to our developmental partners and beta customers.

 

Additionallyin Q2 2004 and YTD 2004, the Payments product group of GPT derived $484,000 and$3.4 million, respectively, from a software license sale to a single customerof our Check Image Archive product, while the 2005 periods did not include anylarge single sales.  These licenserevenues did not include any corresponding essential services.

 

33

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Thedecline in the GPC business segment revenue, on a quarterly and YTD basis, wasprimarily the result of decreased consulting services within our Payments Strategygroup.  These declines in Paymentsconsulting were partially offset by increases in consulting and softwarederived from our Float product group. With recent increases in interest rates, we expect to have futureincreased customer demand for our Float product offerings.  Additionally, with our expanded sales focusand the repositioning of the GPC consulting business to enterprise-wide paymentand risk strategies and image enablement planning and integration, we expect tobe well positioned for revenue growth opportunities within this segment duringthe last half of fiscal 2005.

 

*Consulting ($ in thousands):*  

 
| ** ** | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|------------|------------|---------------------------------------|------------|--------------|------------|-------------------------------------|------------|--------------|------------|
| ** ** | ** ** | **2005**                              | ** ** | **2004**     | ** ** | **$**                               | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|       |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Consulting |       | $                                     | 9,502      |         | $          | 10,514                              |       | $            | (1,012     | ) | (9.6 | )% | $ | 17,820 |   | $ | 19,571 |   | $ | (1,751 | ) | (8.9 | )% |
|            |            |                                       |            |              |            |                                     |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Mostof our consulting revenue is derived from our RevE business segment.  Consulting revenue in the RevE segmentdecreased $519,000, or 5.5%, to $8.8 million in Q2 2005 from $9.3 million in Q22004.  Domestically, consulting revenuefor RevE increased $304,000 on a quarterly comparison basis, and there were 14domestic revenue producing engagements in Q2 2005, as compared to 13 in Q22004.  In Q2 2005, RevE had one domesticengagement that yielded $4.0 million of consulting revenue.  This revenue represents 45.3% of all RevEconsulting revenue in Q2 2005 and 13.4% of total consolidated revenue in Q22005.  International RevE consultingrevenue decreased $823,000 in Q2 2005, as compared to Q2 2004, and there wasonly 2 non-U.S. revenue producing engagements in Q2 2005 as compared to 3 in Q22004.  

 

Consultingrevenue in the RevE segment decreased $1.3 million, or 7.2%, to $16.6 millionin YTD 2005 from $17.9 million in YTD 2004. Domestically, consulting revenue increased slightly to $228,000 on a YTD basis and there were 15 domestic revenue producingengagements in both YTD 2005 and YTD 2004. International RevE consulting revenue decreased $1.5 million in YTD 2005to $3.9 million in YTD 2005, as compared to $5.4 million in YTD 2004.  In YTD 2005, there were 2 revenue producinginternational engagements, as compared to 4 in YTD 2004.

 

Consultingrevenue in our GPC segment decreased $181,000, or 21.3%, to $668,000 in Q2 2005from $849,000 in Q2 2004, and decreased $169,000, or 12.2%, to $1.2 million inYTD 2005 as compared to $1.4 million in YTD 2004.  GPC Payment Strategy consulting declined andwas partially offset by increased Float consulting.  With the recent increase in interest rates,we expect the demand for our Float consulting and related software to continueto increase.

 

Consultingrevenue within our GPT segment decreased $311,000, or 99.2%, to $3,000 in Q22005 from $314,000 in Q2 2004 and decreased $297,000, or 85%, to $53,000 in YTD2005 as compared to $350,000 in YTD 2004. This decline was primarily the result of one engagement in 2004 in whichour GPT segment provided cash consulting services; this type of engagement didnot recur in 2005.

 

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*Software License ($ in thousands):*  

 
| ** **       | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|------------------|------------|---------------------------------------|------------|--------------|------------|-------------------------------------|------------|--------------|------------|
| ** **       | ** ** | **2005**                              | ** ** | **2004**     | ** ** | **$**                               | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|             |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Software License |       | $                                     | 3,782      |         | $          | 4,577                               |       | $            | (795       | ) | (17.4 | )% | $ | 7,141 |   | $ | 10,433 |   | $ | (3,292 | ) | (31.6 | )% |
|                  |            |                                       |            |              |            |                                     |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Mostof our software license fees are derived from our GPT business segment.  GPT software license revenue decreased $1.2million, or 25.2%, to $3.4 million in Q2 2005 from $4.6 million in Q2 2004.  Additionally, GPT software license revenuedecreased $3.7 million, or 36.6%, to $6.5 million in YTD 2005 as compared to$10.2 million in YTD 2004.  Thesedeclines are both centered within software license revenue, particularly withinour Payments product group, as described above under “– Revenues by Segment.”

 

The software revenuederived from our CVE product offering, contained in our RevE business segment,increased $239,000 to $252,000 in Q2 2005, as compared to $13,000 in Q2 2004,and increased $361,000 to $553,000 in YTD 2005 as compared to $192,000 in YTD2004.  This increase is the result ofreformulating our sales strategy to position our CVE product as an enhancementto an existing CRM customer installation, as opposed to a replacement for anexisting CRM customer installation. Additionally, we began marketing a multi-year term software license asopposed to a traditional perpetual software license, which reduces the up-frontinvestment for our customers, but results in recognition of the related revenueover a longer period of time.  In thelast nine months, the CVE group has entered into two large multi-year termlicense engagements to provide software, maintenance and services under thisnew strategy.  

 

*Software Maintenance ($ in thousands):*  

 
| ** **           | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|----------------------|------------|---------------------------------------|------------|--------------|------------|-------------------------------------|------------|--------------|------------|
| ** **           | ** ** | **2005**                              | ** ** | **2004**     | ** ** | **$**                               | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                 |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Software Maintenance |       | $                                     | 10,576     |         | $          | 10,232                              |       | $            | 344        |   | 3.4 | % | $ | 21,888 |   | $ | 21,316 |   | $ | 572 |   | 2.7 | % |
|                      |            |                                       |            |              |            |                                     |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

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*Software Implementation and Other Services ($ in thousands):*  

 
| ** **                                 | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|--------------------------------------------|------------|---------------------------------------|------------|--------------|------------|-------------------------------------|------------|--------------|------------|
| ** **                                 | ** ** | **2005**                              | ** ** | **2004**     | ** ** | **$**                               | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                                       |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Software Implementation and Other Services |       | $                                     | 4,892      |         | $          | 3,642                               |       | $            | 1,250      |   | 34.3 | % | $ | 9,026 |   | $ | 6,521 |   | $ | 2,505 |   | 38.4 | % |
|                                            |            |                                       |            |              |            |                                     |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Themajority of our software implementation fees are derived from our GPT business segment, however the CVE product group within the RevEbusiness segment has increased their service revenues in the first half offiscal 2005.  

 

GPT software servicesincreased $239,000, or 7.3%, to $3.5 million in Q2 2005 as compared to $3.3million in Q2 2004, and they increased $1.3 million, or 21.1%, to $7.1 millionin YTD 2005 as compared to $5.8 million in YTD 2004.  These services revenues have increasedprimarily because of several large customization service engagements related toexisting customer software product installations.

 

Within the CVE productgroup, services have increased $1.0 million to $1.2 million in Q2 2005, ascompared to $159,000 in Q2 2004, and have increased $1.3 million to $1.6million in YTD 2005 as compared to $314,000 in YTD 2004.  In the last nine months this group hasentered into two large multi-year engagements to provide software, services andmaintenance.  In Q2 2005, this group wasalso engaged by another large international bank to provide CVE relatedservices over a multi-year period.

 

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

 
| ** **           | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|----------------------|------------|---------------------------------------|------------|--------------|------------|-------------------------------------|------------|--------------|------------|
| ** **           | ** ** | **2005**                              | ** ** | **2004**     | ** ** | **$**                               | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                 |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Outsourcing Services |       | $                                     | 241        |         | $          | 10                                  |       | $            | 231        |   | — | % | $ | 498 |   | $ | 10 |   | $ | 488 |   | — | % |
|                      |            |                                       |            |              |            |                                     |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Ouroutsourcing service revenue is derived through Carretek, our 51% owned businesswhich outsources payment and transaction processing.  Carretek was formed in fiscal 2003 and signedits first agreement in Q2 2004.  Thefiscal 2004 revenues were minimal; however in late Q4 2004, we expanded ourscope of business with our initial customer to include a second set oftransaction processing functions, and in Q1 2005 we added a third set oftransaction processing functions.  

 

36

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*Out-of-Pocket Expense Reimbursements ($ in thousands)*:  

 
| ** **                           | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|--------------------------------------|------------|---------------------------------------|------------|--------------|------------|-------------------------------------|------------|--------------|------------|
| ** **                           | ** ** | **2005**                              | ** ** | **2004**     | ** ** | **$**                               | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                                 |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Out-of-Pocket Expense Reimbursements |       | $                                     | 927        |         | $          | 662                                 |       | $            | 265        |   | 40.0 | % | $ | 1,745 |   | $ | 1,552 |   | $ | 193 |   | 12.4 | % |
|                                      |            |                                       |            |              |            |                                     |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The increase in thesereimbursements on both a quarterly and YTD basis occurred within all threebusiness segments, and corresponds with the increase in services revenue notedabove.  Most of our software services andconsulting engagements require our employees to be at the customer location forextended periods of time, which gives rise to out-of-pocket expensereimbursements.  These reimbursements arerecognized as revenue when they are billable to the customer and can fluctuatefrom period to period.

 

***Cost of Revenues***

 

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

 
| ** **                       | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|----------------------------------|------------|---------------------------------------|------------|--------------|------------|-------------------------------------|------------|--------------|------------|
| ** **                       | ** ** | **2005**                              | ** ** | **2004**     | ** ** | **$**                               | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                             |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Revenue Enhancement              |       | $                                     | 4,911      |         | $          | 4,598                               |       | $            | 313        |   | 6.8 | % | $ | 9,381 |   | $ | 8,974 |   | $ | 407 |   | 4.5 | % |
| % of revenue                     |       | 45.1                                  | %          | 45.8         | %          |                                |       |         |       | 47.2 | % | 46.0 | % |   |   |   |   |
|                             |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Global Payments Technologies     |       | $                                     | 8,248      |         | $          | 8,659                               |       | $            | (411       | ) | (4.7 | )% | $ | 16,391 |   | $ | 17,177 |   | $ | (786 | ) | (4.6 | )% |
| % of revenue                     |       | 47.2                                  | %          | 47.5         | %          |                                |       |         |       | 46.2 | % | 45.9 | % |   |   |   |   |
|                             |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Global Payments Consulting       |       | $                                     | 872        |         | $          | 1,343                               |       | $            | (471       | ) | (35.1 | )% | $ | 1,774 |   | $ | 2,686 |   | $ | (912 | ) | (34.0 | )% |
| % of revenue                     |       | 67.0                                  | %          | 97.7         | %          |                                |       |         |       | 78.0 | % | 110.4 | % |   |   |   |   |
|                             |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Corporate (Outsourcing Services) |       | $                                     | 434        |         | $          | 14                                  |       | $            | 420        |   | — | % | $ | 1,013 |   | $ | 14 |   | $ | 999 |   | — | % |
| % of revenue                     |       | 180.1                                 | %          | 140.0        | %          |                                |       |         |       | 203.4 | % | 140.0 | % |   |   |   |   |
|                             |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Total Cost of Revenues           |       | $                                     | 14,465     |         | $          | 14,614                              |       | $            | (149       | ) | (1.0 | )% | $ | 28,559 |   | $ | 28,851 |   | $ | (292 | ) | (1.0 | )% |
| % of revenue                     |       | 48.3                                  | %          | 49.3         | %          |                                |       |         |       | 49.1 | % | 48.6 | % |   |   |   |   |

 

The increase in the costof revenues on an absolute dollar basis in the RevE business segment, on both aquarterly and YTD basis, is primarily the result of increases within the costof services within the CVE product group as they manage and staff three newlarge engagements.  These increases inCVE services costs have been partially offset by declining consulting costsprimarily due to less personnel related expense recorded for the RevEconsulting business.

 

The decrease in the costof revenues on an absolute basis within the GPT business segment, on both aquarterly and YTD basis, is the result of reductions in the cost of servicesthrough personnel reductions in the last half of fiscal 2004, and increasedcross-utilization of services personnel on maintenance or research anddevelopment projects.

 

These cost reductionswithin GPT’s cost of services were partially offset by an increase in cost ofsoftware licenses due to increased third-party royalty costs.

 

The absolute dollar costreductions, on both a quarterly and YTD basis, within GPC were primarilyattributable to personnel reductions achieved during the latter half of fiscal2004 to bring our costs in line with expected consulting revenues.  With total revenue for GPC basically flat, onboth a quarterly and YTD basis, cost of revenues as a percentage of total GPCrevenue decreased dramatically.

 

The direct cost increaserelated to Carretek, our 51% owned business which outsources payment andtransaction processing, is related to the direct costs related to our singlecustomer which began in Q2 2004.  Asdescribed earlier, we do not expect the financial results for this business toimprove significantly unless and until we expand the scope of this engagementor we retain additional outsourcing customers.

 

37

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*Cost of Consulting ($ in thousands):*

 
| ** **              | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|-------------------------|------------|---------------------------------------|------------|--------------|------------|-------------------------------------|------------|--------------|------------|
| ** **              | ** ** | **2005**                              | ** ** | **2004**     | ** ** | **$**                               | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                    |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Cost of Consulting      |       | $                                     | 4,277      |         | $          | 5,082                               |       | $            | (805       | ) | (15.8 | )% | $ | 8,518 |   | $ | 9,611 |   | $ | (1,093 | ) | (11.4 | )% |
| % of consulting revenue |       | 45.0                                  | %          | 48.3         | %          |                                |       |         |       | 47.8 | % | 49.1 | % |   |   |   |   |
|                         |            |                                       |            |              |            |                                     |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The cost of consultingwithin the GPC business segment decreased $418,000, or39.3%, to $645,000 in Q2 2005 as compared to $1.1 million in Q2 2004 anddecreased $773,000, or 37.2% to $1.3 million for YTD 2005 as compared to $2.1million for YTD 2004.  The decline incosts, on both a quarterly and YTD basis, within our GPC business segment wereachieved through personnel reductions made in the latter half of fiscal year2004 to bring costs in line with expected GPC consulting revenues.  

 

Thecost of consulting within the RevE business segment decreased $398,000, or10.1%, to $3.6 million in Q2 2005 as compared to $4.0 million in Q2 2004 anddecreased $281,000, or 3.8%, to $7.1 million in YTD 2005 as compared to $7.4million in Q2 2004.  The declines in bothperiods can be attributed to lower personnel related expenses recorded duringthe fiscal 2005 quarterly and YTD periods.

 

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

 
| ** **                    | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|-------------------------------|------------|---------------------------------------|------------|--------------|------------|-------------------------------------|------------|--------------|------------|
| ** **                    | ** ** | **2005**                              | ** ** | **2004**     | ** ** | **$**                               | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                          |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Cost of Software Licenses     |       | $                                     | 1,828      |         | $          | 1,670                               |       | $            | 158        |   | 9.5 | % | $ | 3,364 |   | $ | 3,268 |   | $ | 96 |   | 2.9 | % |
| % of software license revenue |       | 48.3                                  | %          | 36.5         | %          |                                |       |         |       | 47.1 | % | 31.3 | % |   |   |   |   |
|                               |            |                                       |            |              |            |                                     |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The cost of softwarelicenses consists primarily of amortization of capitalized and acquiredsoftware costs along with royalties payable to third parties recorded in theGPT business segment.  The increase inthe cost of software license revenue, on a quarterly and YTD basis,is primarily the result of higher royalty expense in Q2 2005, due to softwareproduct mix.  The decline in softwarerevenue, on both a quarterly and YTD basis, along with increased costs,resulted in an increase in the cost of software license revenue as a percentageof software license revenue.

 

Inconnection with software license and maintenance agreements entered into withcertain banks and purchase agreements entered into with vendors under which weacquired software technology used in products sold to our customers, we arerequired to pay royalties on sales of certain software products.  Under these arrangements, we accrue royaltyexpense when the associated revenue is recognized.  The royalty percentages generally range from20% to 50% of the associated revenue.  InQ2 2005, we recorded $462,000 of software royalty expense compared to $263,000 ofsoftware royalty expense recorded in Q2 2004. In YTD 2005, we recorded $554,000 of software royalty expense comparedto $442,000 in YTD 2004.  Depending onour future product mix, our margins from software license fees may be positivelyor negatively impacted by fluctuations in software royalty expense.

 

38

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

 
| ** **                        | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|--------------|------------|-------------------------------------|------------|--------------|------------|
| ** **                        | ** ** | **2005**                              | ** ** | **2004**     | ** ** | **$**                               | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                              |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Cost of Software Maintenance      |       | $                                     | 3,436      |         | $          | 3,386                               |       | $            | 50         |   | 1.5 | % | $ | 7,411 |   | $ | 7,184 |   | $ | 227 |   | 3.2 | % |
| % of software maintenance revenue |       | 32.5                                  | %          | 33.1         | %          |                                |       |         |       | 33.9 | % | 33.7 | % |   |   |   |   |
|                                   |            |                                       |            |              |            |                                     |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Costof software maintenance consists primarily of personnel and facility costs toprovide telephone support, product 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 cost of maintenancewas relatively flat for Q2 2005, as compared to Q2 2004, and increased$227,000, or 3.2%, on a YTD basis as a result of anincreased use of contract labor, particularly in Q1 2005, within our GPTbusiness segment related to and reflecting an increased emphasis on supportingand enhancing our current product mix.  

 

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

 

*Cost of Software Implementation and Other Services ($ inthousands):*  

 
| ** **                                               | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------|------------|--------------|------------|-------------------------------------|------------|--------------|------------|
| ** **                                               | ** ** | **2005**                              | ** ** | **2004**     | ** ** | **$**                               | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                                                     |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Cost of Software Implementation and Other Services       |       | $                                     | 3,682      |         | $          | 3,810                               |       | $            | (128       | ) | (3.4 | )% | $ | 6,655 |   | $ | 7,179 |   | $ | (524 | ) | (7.3 | )% |
| % of software implementation and other services  revenue |       | 75.3                                  | %          | 104.6        | %          |                                |       |         |       | 73.7 | % | 110.1 | % |   |   |   |   |
|                                                          |            |                                       |            |              |            |                                     |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Costs of softwareimplementation and other services consist primarily of personnel and facilitycosts to provide software implementation and project management support tocustomer software implementations within our GPT business segment and the CVEsoftware product within our RevE segment. The cost of software implementation and other services decreased$645,000, or 18.6%, to $2.8 million in Q2 2005 as compared to $3.5 million inQ2 2004, and decreased $1.1 million, or 17.1%, to $5.4 million in YTD 2005 ascompared to $6.5 million in YTD 2004. The decline in costs of software implementationreflect decreased personnel costs within our GPT business segment.  These headcount reductions were achieved inthe latter half of fiscal 2004 to improve utilization.  These declines were partially offset byincreases within the CVE group of our RevE segment.  The cost of software implementation and otherservices increased $515,000, or 206.9%, to $764,000 in Q2 2005 as compared to$249,000 in Q2 2004, and increased to $584,000, or 112.9%, to $1.1 million inYTD 2005 as compared to $517,000 in YTD 2004. The increase in costs is primarily related to third party contract laborcosts used to manage and staff the three large CVE engagements.  The decline in the costs of softwareimplementation and other services, as a percentage of software implementationrevenue and other services, was the result of overall decreased costs alongwith an increased volume of active services engagements.

 

39

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

 
| ** **                        | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|--------------|------------|-------------------------------------|------------|--------------|------------|
| ** **                        | ** ** | **2005**                              | ** ** | **2004**     | ** ** | **$**                               | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                              |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Cost of Outsourcing Service       |       | $                                     | 434        |         | $          | 14                                  |       | $            | 420        |   | — | % | $ | 1,013 |   | $ | 14 |   | $ | 999 |   | — | % |
| % of outsourcing services revenue |       | 180.1                                 | %          | 140.0        | %          |                                |       |         |       | 203.4 | % | 140.0 | % |   |   |   |   |
|                                   |            |                                       |            |              |            |                                     |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Theincrease in the cost of outsourcing service fees is due to the creation ofCarretek, our 51% owned business outsourcer for payment and transactionprocessing.  In Q2 2004, this businessretained its first customer.  

 

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

 
| ** **                                | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|-------------------------------------------|------------|---------------------------------------|------------|--------------|------------|-------------------------------------|------------|--------------|------------|
| ** **                                | ** ** | **2005**                              | ** ** | **2004**     | ** ** | **$**                               | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                                      |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Cost of Out-of-Pocket Expenses            |       | $                                     | 808        |         | $          | 652                                 |       | $            | 156        |   | 23.9 | % | $ | 1,598 |   | $ | 1,595 |   | $ | 3 |   | 0.2 | % |
| % of out-of-pocket expense reimbursements |       | 87.2                                  | %          | 98.5         | %          |                                |       |         |       | 91.6 | % | 102.8 | % |   |   |   |   |
|                                           |            |                                       |            |              |            |                                     |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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 increased on a quarterly basis due to increasedCVE and GPT service engagements.  Inaddition, certain customer contracts contain expense maximums, so in certaincases not all expenses incurred can be passed along to the customer withoutcontractual revisions or the customer’s express written approval, which canincrease the volatility of the cost of out-of-pocket expenses as a percentageof out-of-pocket expense reimbursements. 

 

40

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***Operating Costs and Expenses:* **

 

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

 
| ** **                                   | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|----------------------------------------------|------------|---------------------------------------|------------|--------------|------------|-------------------------------------|------------|--------------|------------|
| ** **                                   | ** ** | **2005**                              | ** ** | **2004**     | ** ** | **$**                               | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                                         |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Selling, General and Administrative Expenses |       | $                                     | 11,593     |         | $          | 11,971                              |       | $            | (378       | ) | (3.2 | )% | $ | 22,497 |   | $ | 24,163 |   | $ | (1,666 | ) | (6.9 | )% |
| % of total revenue                           |       | 38.7                                  | %          | 40.4         | %          |                                |       |         |       | 38.7 | % | 40.7 | % |   |   |   |   |
|                                              |            |                                       |            |              |            |                                     |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

Wecontinue to focus on decreasing costs throughout the organization.  Some of the primary drivers of the overall decreasein SG&A costs in Q2 2005, as compared to Q2 2004 and YTD 2005 as comparedto YTD 2004, were as follows:

 

•                  Decreased corporate selling and marketingcosts and business unit software sales and product management costs of $606,000for Q2 2005, as compared to Q2 2004, and $899,000 in YTD 2005 as compared toYTD 2004 due primarily to personnel reductions within our corporate salesfunction.

•                  Decreased employee benefits costs of$43,000 in Q2 2005, as compared to Q2 2004, and $629,000 in YTD 2005 ascompared to YTD 2004 due primarily to savings achieved through the selection ofa new, lower cost health care plan and provider and passing a higher percentageof the health care costs to our employees.

•                  Decreased office services andfacility costs of $253,000 in Q2 2005, as compared to Q2 2004, and $620,000 inYTD 2005 as compared to YTD 2004.

•                  Increased general and administrativecosts of $522,000 in Q2 2005, as compared to Q2 2004, and $481,000 in YTD 2005,as compared to YTD 2004, were primarily driven by increased contract labor andthird party consulting costs related to an ERP system upgrade and businessprocess reengineering project begun in late Q1 2005.  Additionally because of a significantreduction in our delinquent accounts receivable in 2004, our allowance fordoubtful accounts was reduced $212,000 in Q2 2004 and $392,000 in YTD 2004 ascompared to a reduction of only $31,000 in Q2 2005 and $41,000 in YTD 2005.

 

41

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

 
| ** **                        | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|--------------|------------|-------------------------------------|------------|--------------|------------|
| ** **                        | ** ** | **2005**                              | ** ** | **2004**     | ** ** | **$**                               | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                              |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Research and Development Expenses |       | $                                     | 2,516      |         | $          | 1,874                               |       | $            | 642        |   | 34.3 | % | $ | 5,037 |   | $ | 3,582 |   | $ | 1,455 |   | 40.6 | % |
| % of total revenue                |       | 8.4                                   | %          | 6.3          | %          |                                |       |         |       | 8.7 | % | 6.0 | % |   |   |   |   |
|                                   |            |                                       |            |              |            |                                     |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Research and development expenses consist primarily of personnel,contract labor, travel and facilities expensesincurred by our research and development organization primarily within the GPTbusiness segment.  Research anddevelopment costs have increased on a quarterly basis as a result of increasednew product development and less software costs capitalized in Q2 2005, ascompared to Q2 2004 and in YTD 2005 as compared to YTD 2004.  Beginning in the latter half of fiscal 2003and carrying through fiscal 2004 and the first half of fiscal 2005, we havedeveloped or are currently developing 11 new software offerings within the GPTsegment.  Research and development costsare typically limited to development of new software products, or enhancementsto existing software products, which extend the product’s life cycle and/orsubstantially increase its marketability.

 

In accordance with SFAS No. 86, “*Accountingfor Costs of Computer Equipment**tobe Sold, Leased or Otherwise Marketed,”* we capitalized $271,000 inQ2 2005, as compared to $698,000 in Q2 2004, and we capitalized $708,000 in YTD2005 as compared to $1.6 million in YTD 2004. In Q1 2005, we began to develop two new Cash solutions and the costsassociated with these two products represented 98% of the amount capitalized inYTD 2005.  The firstproduct verifies cash logistic invoices with automated precision and the secondproduct is an internet-based track and trace system that streamlines the cashdelivery management process.  In YTD 2004, 100% of the capitalization wasrelated to the development of Payments products, primarily ExchgLink, our productoffering to send and receive check images, and Source Capture, an applicationwhich enables bank customers to capture check images at corporate sites and toextend the functionality of our anti-money laundering software and other risksolutions.  These product developmentprojects in YTD 2004 were of a larger scale and effort and therefore the amountof costs capitalized was larger in 2004 as compared to 2005 on both a quarterlyand YTD basis.

 

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

 

*Amortization of Intangible Assets:*  

 

Amortization of intangible assets was $350,000 for Q2 2005 and Q2 2004,and $700,000 for YTD 2005 and YTD 2004. The amortization results from the periodic recognition of amortizationexpense, through the second quarter of fiscal 2007, of intangible customerrelationships acquired in the Check Solutions acquisition in 2001. 

 

42

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

** **
| ** **                                 | ** ** | **Workforce  Reductions** | ** ** | **EPG  Litigation  Settlement** | ** ** | **Legal and  Professional  Fees** | ** ** | **Other**  | ** ** | **Total**  | ** ** |
|--------------------------------------------|------------|---------------------------|------------|---------------------------------|------------|-----------------------------------|------------|------------|------------|------------|------------|
| ** **                                 | ** ** | ** **                | ** ** | ** **                      | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| **YTD 2004:**                              | ** ** | ** **                | ** ** | ** **                      | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Quarterly period ended April 30, 2004 |       | 308                       |       | 1,686                           |       | 521                               |       | —     |       | 2,515      |       |
| Quarterly period ended July 31, 2004  |       | 192                       |       | 14                              |       | 1,206                             |       | (1,215     | )          | 197        |       |
| Total YTD 2004                             |       | $                         | 500        |                            | $          | 1,700                             |       | $          | 1,727      |       | $          | (1,215 | ) | $ | 2,712 |   |
|                                       |       |                      |       |                            |       |                              |       |       |       |       |       |
| **YTD 2005:**                              | ** ** | ** **                | ** ** | ** **                      | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Quarterly period ended April 30, 2005 |       | 127                       |       | —                          |       | —                            |       | (32        | )          | 95         |       |
| Quarterly period ended July 31, 2005  |       | 28                        |       | —                          |       | —                            |       | —     |       | 28         |       |
| Total YTD 2005                             |       | $                         | 155        |                            | $          | —                            |       | $          | —     |       | $          | (32 | ) | 123 |   |
|                                            |            |                           |            |                                 |            |                                   |            |            |            |            |            |  |  |  |  |  |

** **

**Quarter Ended April 30, 2004**

** **

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

 

**Quarter Ended July 31, 2004**

** **

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

 

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

 

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

 

**Quarter Ended April 30, 2005**

** **

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

 

43

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**Quarter Ended July 31, 2005**

** **

**We recorded $28,000 inrestructuring and other charges during the three month period ended July 31,2005, principally associated with the separation of 2 employees. **

** **

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

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

 

Weanticipate the remaining reserve accruals at July 31, 2005 will be paid orremaining customer obligations completed within the next 9 months.

 

44

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

 

*Interest Income ($ in thousands):*

 
| ** **      | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|-----------------|------------|---------------------------------------|------------|--------------|------------|-------------------------------------|------------|--------------|------------|
| ** **      | ** ** | **2005**                              | ** ** | **2004**     | ** ** | **$**                               | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|            |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Interest Income |       | $                                     | 166        |         | $          | 66                                  |       | $            | 100        |   | 151.5 | % | $ | 310 |   | $ | 115 |   | $ | 195 |   | 169.6 | % |
|                 |            |                                       |            |              |            |                                     |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Interestincome consists of interest earned on cash and cash equivalents and marketablesecurities.  The increasequarter-over-quarter is primarily the result of higher average cash and cashequivalent balances during Q2 2005, as compared to Q2 2004 and YTD 2005 ascompared to YTD 2004, and slightly higher yields on these investments.

 

*Interest Expense ($ in thousands):*

 
| ** **       | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|------------------|------------|---------------------------------------|------------|--------------|------------|-------------------------------------|------------|--------------|------------|
| ** **       | ** ** | **2005**                              | ** ** | **2004**     | ** ** | **$**                               | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|             |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Interest Expense |       | $                                     | (107       | )            | $          | (121                                | )          | $            | (14        | ) | (11.6 | )% | $ | (212 | ) | $ | (230 | ) | $ | (18 | ) | (7.8 | )% |
|                  |            |                                       |            |              |            |                                     |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

*Other income ($ in thousands):*

 
| ** **                                                  | ** ** | **Three Months Ended  July 31,** | ** ** | **Variance** | ** ** | **Six Months Ended  July 31,** | ** ** | **Variance** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------------|------------|--------------|------------|-------------------------------------|------------|--------------|------------|
| ** **                                                  | ** ** | **2005**                              | ** ** | **2004**     | ** ** | **$**                               | ** ** | **%**        | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                                                        |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Gain on sale of Cash Services Australia Pty. Limited        |       | $                                     | —     |         | $          | —                              |       | $            | —     |   | — |   | $ | — |   | $ | 539 |   | (539 | ) | (100 | )% |
| Equity in earnings of Cash Services Australia Pty.  Limited |       | —                                |       | —       |       | —                              |       | —       |       | — |   | (17 | ) | 17 |   | 100 | % |
| Minority share of net loss of Carretek LLC                  |       | 213                                   |       | 133          |       | 80                                  |       | 60.2         | %          | 530 |   | 219 |   | 311 |   | 142.0 | % |
| Foreign exchange losses                                     |       | (84                                   | )          | (159         | )          | 75                                  |       | 47.2         | %          | (101 | ) | (288 | ) | 187 |   | 64.9 | % |
| Other                                                       |       | —                                |       | (1           | )          | 1                                   |       | 100.0        | %          | 6 |   | 4 |   | 2 |   | 50.0 | % |
|                                                        |       |                                  |       |         |       |                                |       |         |       |   |   |   |   |   |   |   |   |
| Total                                                       |       | $                                     | 129        |         | $          | (27                                 | )          | $            | (156       | ) | (577.8 | )% | $ | 435 |   | $ | 457 |   | $ | (22 | ) | (4.8 | )% |
|                                                             |            |                                       |            |              |            |                                     |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

We owna 51% interest in Carretek LLC (“Carretek”), through which we offer financialinstitutions offshore-centric outsourcing of their business processes.  Carretek has generated approximately $434,000and $272,000 in losses for Q2 2005 and Q2 2004, respectively, and $1.1 millionand $446,000 in losses for YTD 2005 and YTD 2004, respectively.  Accordingly, the 49% share relating to theminority interest in these losses, or $213,000 and $133,000 on a quarterlybasis and $530,000 and $219,000 on a YTD basis, wasrecorded in other income (expense).

 

45

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*Provision for Income Taxes:*  

 

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

 

The net tax provision was $102,000 and $183,000 for the three and sixmonths ended July 31, 2005 and consists of a provision for foreigntaxes.  Only $15,000 of U.S. Federal taxexpense was recorded in the three months ended July 31, 2005 foralternative minimum tax purposes due to the availability of net operatinglosses from prior years.  No U.S. Federalincome tax benefit was recorded at July 31, 2005 due to the uncertaintyregarding the Company’s ability to generate taxable income, and resultinguncertainty relative to the recoverability of deferred tax assets. 

 

In May 2004, the federal tax law changed to allow software licenserevenue to be deferred for tax purposes similar to the percent-complete revenuerecognition model we use for financial statement purposes.  The impact of this change in the tax lawincreased the amount of the net operating loss carryforwards by $8.6 million.

 

**Liquidityand Capital Resources**

 

Historically,we have funded our operations and cash expenditures primarily with cashgenerated from operating activities.  At July 31,2005, we had working capital of $14.4 million compared to $12.3 million at January 31,2005.  We had $21.7 million in cash andcash equivalents at July 31, 2005, a decrease of $12.8 million from $34.5million in cash and cash equivalents at January 31, 2005.  However, we also had $4.6 million of “availablefor sale” marketable securities at July 31, 2005, compared to nomarketable securities at January 31, 2005. At July 31, 2005 and January 31, 2005, we did not have anyborrowings outstanding under our revolving line of credit.  We expect that existing cash, marketablesecurities and cash generated from operating activities will be sufficient tomeet our presently anticipated requirements for the foreseeable future.

 

Cash used in operatingactivities was $5.9 million for the three months ended July 31, 2005compared to cash used in operating activities of $2.3 million in the threemonths ended July 31, 2004.  Cashused in operating activities was $3.8 million for the six months ended July 31,2005 compared to cash provided by operating activities of $7.5 million for thesix months ended July 31, 2004.  Thisdecline in 2005 was primarily the result of the timing of the collection of 2005calendar year maintenance billings as compared to the prior year.  Additionally, a $4.0 million RevE invoice dueat the end of July 2005 was not collected until August 2005, therebydecreasing the three and six months ended July 31, 2005 cash flow fromoperating activities and increasing our DSO approximately 12 days at July 31,2005, as shown in the table below.

 

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

 
| **Quarter ended**     | ** ** | **DSO** | ** ** |
|-----------------------|------------|---------|------------|
| July 31, 2005    |       | 49      |       |
| April 30, 2005   |       | 35      |       |
| January 31, 2005 |       | 35      |       |
| October 31, 2004 |       | 35      |       |
| July 31, 2004    |       | 46      |       |
| April 30, 2004   |       | 46      |       |

 

Cash used in investingactivities increased to $5.5 million during the three months ended July 31,2005 as compared to $1.8 million during the three months ended July 31,2004.  The cash used in investingactivities increased to $6.6 million during the six months ended July 31,2005 as compared to $3.0 million during the six months ended July 31,2004.  The increase was primarily theresult of the purchase of $4.6 million of marketable securities during thethree months ended July 31, 2005, partially offset by a decline in bothcapital expenditures and capitalized software development. 

 

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Financing activities usedcash of $2.7 million in the three months ended July 31, 2005 as comparedto financing activities providing cash of $1.1 million in the three monthsended July 31, 2004.  This use ofcash was primarily the result of $2.8 million of treasury stock purchases made inthe open market pursuant to a publicly announced stock repurchase program duringthe three months ended July 31, 2005. The program to purchase up to $5.0 million of our treasury stock wasauthorized for the period April 18, 2005 through October 14, 2005.

 

Financing activitiesused cash of $2.4 million for the six months ended July 31, 2005 ascompared to a use of cash of $4.7 million during the six months ended July 31,2004.  During the six months ended July 31,2005, we purchased a total of $3.2 million of treasury stock under the programdescribed above.  These treasury stockpurchases were offset by $551,000 of equity contributions by the minorityshareholder of Carretek LLC and $266,000 related to the proceeds from theexercise of stock options.  During thesix months ended July 31, 2004, we made a $6.3 million debt payment, whichwas offset by $1.3 million of proceeds related to stock options and $260,000equity contributions by the minority shareholder of Carretek LLC.  

 

We are a party to arevolving credit agreement with a group of banks providing for a commitmentamount of $30.0 million and a maturity date of July 31, 2006.  At July 31, 2005 and July 31, 2004,the Company did not have any borrowings outstanding.  Borrowings under the credit agreementcurrently bear interest equal to either the greater of prime or federal fundsrate plus a margin ranging from 1.25% to 2.25% depending on our ratio of fundeddebt to Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”);or London Interbank Offered Rate (“LIBOR”) plus a margin equal to 2.75% to3.75% depending on our ratio of funded debt to EBITDA.  Interest payments are due quarterly.  We are required to pay a commitment fee equalto 0.50% on the unused amount of the revolving credit agreement.  The revolving credit agreement containscustomary affirmative and negative covenants, some of which have been amended,including financial covenants requiring the maintenance of specified interestcoverage, ratio of EBITDA to funded debt, and ratio of 80% of accountsreceivable, cash and short term investments to funded debt.  Additionally, the payment of dividends andthe purchase of treasury stock is precluded subject tothe approval of the banks.  We obtained awritten waiver to this covenant in April 2005 when we announced our stockrepurchase program.  Substantially all ofour assets collateralize this revolving credit agreement.  As of July 31, 2005, we are incompliance with the covenants of the revolving credit agreement, as amended.

 

Thefollowing summarizes our contractual obligations at July 31, 2005 and theeffect these contractual obligations are expected to have on our liquidity andcash flows in future periods (in thousands):  

 
| ** **       | ** ** | **Payments Due by Period** | ** ** |
|------------------|------------|----------------------------|------------|
| ** **       | ** ** | **Total**                  | ** ** | **1 Year  or Less** | ** ** | **Years 2-3** | ** ** | **Years 4-5** | ** ** | **After  5 Years** | ** ** |
|             |       |                       |       |   |   |   |   |   |   |   |   |
| Operating leases |       | $                          | 13,376     |   | $ | 3,177 |   | $ | 5,840 |   | $ | 4,319 |   | $ | 40 |   |
|                  |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

We believe that currentcash balances and marketable securities and expected future cash flows will besufficient to meet our anticipated cash needs for working capital, capitalexpenditures and other activities during fiscal 2005.  However, if current sources are notsufficient to meet our needs, we may seek additional equity or debtfinancing.  There can be no assurancethat additional financing would be available on acceptable terms, if atall.  

 

We are presentlyinvolved in a number of lawsuits.  Whilewe do not expect any negative outcomes, the final resolutions of the lawsuits areunknown, and could include judgments against us, or settlements that couldrequire additional substantial payments by us. See Note 8 in our Notes to Condensed Consolidated Unaudited FinancialStatements.  The timing of the finalresolution of these matters is uncertain. We believe that a material adverse outcome or outcomes with respect tothe lawsuits could have a material adverse effect on our financial results, ourbusiness or our management including but not limited to, significantlyimpacting our liquidity in a negative manner as well as causing covenantviolations under our revolving credit agreement, possibly resulting in adefault thereunder.  Further, we may inthe future pursue acquisitions of businesses, products or technologies thatcould complement or expand our business and product offerings, and change ourfinancing needs.  Our forecast of theperiod of time through which our financial resources will be adequate tosupport our operations is a forward looking statement that involves risks anduncertainties, and actual results could vary. The failure to secure additional financing when needed could have amaterial adverse effect on our business, financial condition and results ofoperations.

 

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**CriticalAccounting Policies**

** **

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

 

RevenueRecognition

 

Ourrevenue recognition policies are in accordance with Statement of Position (“SOP”)97-2, *“Software Revenue Recognition,”* asamended by SOP 98-9, “*Modification of SOP 97-2,Software Revenue Recognition with Respect to Certain Transactions,”*and Staff Accounting Bulletin (“SAB”) No. 104, *“RevenueRecognition,”* and EmergingIssues Task Force (“EITF”) No. 00-21,*“RevenueArrangements with Multiple Deliverables.”* In the case of software arrangements thatrequire significant production, modification, or customization of software, orthe license agreement requires us to provide implementation services that aredetermined to be essential to other elements of the arrangement,we follow the guidance in SOP 81-1, *“Accounting forPerformance of Construction – Type and Certain Production – Type Contracts.”*  

 

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

 

*Consulting.*  We employ three primary pricing methods inconnection with our delivery of consulting services. First, we may price ourdelivery of consulting services on the basis of time and materials, in whichcase the customer is charged agreed-upon daily rates for services performed andout-of-pocket expenses. In this case, we are generally paid fees and relatedamounts usually on a monthly basis, and we recognize revenues as the servicesare performed. Second, we may deliver consulting services on a fixed-pricebasis. In this case, we are generally paid on a monthly basis or pursuant to anagreed upon payment schedule, and we recognize revenues on a proportionateperformance basis. We believe that this method is appropriate because of ourability to determine performance milestones and determine dependable estimatesof our costs applicable to each phase of a contract.  Because financial reporting of thesecontracts depends on estimates, which are assessed continually during the termof the contract, costs are subject to revisions as the contractprogresses.  Anticipated losses onfixed-priced contracts are recognized when estimable.  Third, we may deliver consulting servicespursuant to a value-priced contract with the customer. In this case, we arepaid, on an agreed upon basis with the customer, either a specified percentageof (1) the projected increased revenues and/or decreased costs that areexpected to be derived by the customer generally over a period of up to twelvemonths following implementation of our solution or (2) the actualincreased revenues and/or decreased costs experienced by the customer generallyover a period of up to twelve months following implementation of our solution,subject in either case to a maximum, if any is agreed to, on the total amountof payments to be made to us.  We mustfirst commit time and resources to develop projections associated withvalue-pricing contracts before a bank will commit to purchase our solutions,and we therefore assume the risk of making these commitments with no assurancethat the customer will purchase the solution. Costs associated with these value-pricing contracts are expensed asincurred**.**  These contracts typically include payments tobe made to us pursuant to an agreed upon schedule ranging from one totwelve months in length. We recognize revenues generated from consultingservices in connection with value-priced contracts based upon projected resultsonly upon completion of all services and agreement upon the actual fee to bepaid (even though billings for these services may be delayed by mutualagreement for periods not to exceed twelve months). In an effort to allowcustomers 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 paymentdate.  

 

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

 

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

 

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

 

*Software License.*  A perpetual software license is sold eithertogether with 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, providedthat the license fee is fixed and determinable, no significant production,modification or customization of the software is required and collection isconsidered probable by management.  Whenthe software license arrangement requires us to provide implementation servicesthat are essential to the functionality of the software or significantproduction, customization or modification of the software is required,both the product license revenue and implementation fees are recognized asservices are performed.  A term softwarelicense is sold either together with implementation services and/or withmaintenance services.  These termlicenses are usually paid in annual installments over the term of thelicense.  If the term software license issold without essential implementation services, the revenue is recognizedratably over the non-cancelable license term. If the term license is sold with essential implementation services, thelicense revenue is recognized as the lesser of the amount of license revenuerecognized as services are performed or on a ratable basis.

 

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

 

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

 

Although substantiallyall of our current software licenses provide for a fixed-price license fee,some licenses provide for the customer to pay a monthly license fee based onthe actual use of the software product. 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 isrecognized on a monthly basis as the usage becomes determinable.

 

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

 

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*Software Implementation and OtherServices.*  Inconnection with the sale of a software license, a customer may elect topurchase software implementation services, including software enhancements andother software services.  Most of thecustomers that purchase software licenses from us also purchase softwareimplementation services.  We price ourimplementation services on a time-and-material or on a fixed-price basis, andwe recognize the related revenues as services are performed.  Costs associated with these engagements areexpensed as incurred.

 

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

 

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

 

Royalties

 

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

 

Allowancefor Doubtful Accounts

 

Alarge proportion of our revenues and receivables are attributable to ourcustomers in the banking industry.  Ourtrade accounts receivable balance is recorded net of allowances for amounts notexpected to be collected from our customers. Because our accounts receivable are typically unsecured, we periodicallyevaluate the collectibility of our accounts based on a combination of factors,including a particular customer’s ability to pay as well as the age ofreceivables.  In cases where the evidencesuggests a customer may not be able to satisfy its obligation to us or if thecollection of the receivable becomes doubtful due to a dispute that arisessubsequent to the delivery of our products and services, we set up a specificreserve in an amount we determine appropriate for the perceived risk.  If circumstances change, such as higher thanexpected defaults or an unexpected material adverse change in a customer’sability to meet their financial obligations to us, our estimates ofrecoverability of amounts due us could be reduced by a material amount. 

 

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

 

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

 

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Goodwillis assessed on an annual basis for impairment at the reporting unit level byapplying a fair value based test.  Weperformed the initial impairment test of goodwill at February 1, 2002 anda follow up test at November 1, 2002 to determine if an impairment chargeshould be recognized under SFAS 142.  Theinitial impairment analysis did not result in any write-down of capitalizedcosts.  We perform an annual impairmentassessment on November 1st of each year or when factorsindicate that other long-lived assets should be evaluated for possibleimpairment.  We use an estimate ofundiscounted future net cash flows over the remaining life of the asset todetermine if impairment has occurred. Assets are grouped at the lowest level for which thereare identifiable cash flows that are largely independent from otherasset groups.  Animpairment in the carrying value of an asset is assessed when theundiscounted, expected future operating cash flows derived from the asset areless than its carrying value.  Managementbelieves that assumptions used to determine cash flows are reasonable, butactual future cash flows may differ from those estimated.  If we determine an asset has been impaired,the impairment is recorded based on the estimated fair value of the impairedasset.  During the quarterly period endedJanuary 31, 2005, we performed our annual evaluation for goodwillimpairment and determined that the carrying amount of goodwill was not impairedand have not noted any factors subsequent that would indicate impairment.  Goodwill at July 31, 2005 totaled $20.8 million.  Any deterioration in market conditions, increases in interest rates and changes in ourprojections with respect to the Global Payments Technologies reporting unit towhich goodwill is allocated would result in additional impairment charges inthe future.

 

**Restructuring and Other Charges**

** **

During fiscal year 2001,we recorded reserves in connection with our acquisition of Check Solutions andsubsequent operational restructurings. Additional reserves were recorded during each of the succeeding fiscalyears.  These reserves containsignificant estimates pertaining to work force reductions, and the settlementof contractual obligations resulting from our actions.  In the six month period ended July 31,2005, we revised our estimate to reflect our remaining costs related to thediscontinuance of one of our software offerings originally recorded in January 2004and reversed $32,000.  Although we do notanticipate any significant changes in the future, the actual costs may differfrom these estimates.

 

**Contingencies**

** **

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

 

**Income Taxes**

** **

Werecognize deferred tax assets or liabilities for the expected future taxconsequences of temporary differences between the book and tax basis of assetsand liabilities.  We review our deferredtax assets for recoverability and establish a valuation allowance based onhistorical taxable income, projected future taxable income and the expectedtiming of the reversals of existing temporary differences.  As a result of our cumulative net losses wehave provided a full valuation allowance against our net deferred taxassets.  In addition, we expect toprovide a full valuation allowance of any future tax benefits until we cansustain a level of profitability that demonstrates our ability to utilize theseassets.

 

**Recently Issued Accounting Standards**

** **

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

 

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

 

**Interest Rate Risk**

** **

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

 

Investments in bothfixed rate and floating rate interest earning instruments carry a degree ofinterest rate risk.  Fixed ratesecurities may have their fair market value adversely impacted due to a rise ininterest rates, while floating rate securities may produce less income thanexpected if interest rates fall.  Due inpart to these factors, our future investment income may fall short ofexpectations due to changes in interest rates, or we may suffer losses inprincipal if forced to sell securities which have seen a decline in marketvalue due to changes in interest rates. At July 31, 2005, we held $4.6 million of auction rate notes.  The interest rate for these notes will adjustto the current market interest rate at each interest reset date, which istypically on at least a monthly basis.  

 

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

 

**Foreign Currency Risk**

** **

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

 

An insignificant portion of our accounts receivable balance at July 31,2005 was denominated in a foreign currency. Our exposure to adverse movements in foreign exchange rates is typicallynot significant.  Therefore, we do notcurrently hedge our foreign currency exposure; however, we do try to limit ourforeign currency exposure by negotiating these foreign contracts in U.S.Dollars.  In the future we may changethis practice.  We will continue toevaluate the need to adopt a hedge strategy in the future and may implement aformal strategy in future periods.  

 

Foreign exchange losses were $84,000 and $159,000 in the three monthsended July 31, 2005 and 2004, respectively, and $101,000 and $288,000 inthe six months ended July 31, 2005 and 2004.  

 

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

 

*DisclosureControls and Procedures*

 

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

 

Ourmanagement, under the supervision and with the participation of our ChiefExecutive and Chief Financial Officers, is responsible for evaluating theeffectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) of the Exchange Act).  Asof July 31, 2005, they carried out an evaluation of our disclosurecontrols and procedures, and the Chief Executive and Chief Financial Officersbelieve that these disclosure****controls andprocedures are effective to ensure that we are able to collect, process anddisclose the information we are required to disclose in the reports we filewith the SEC within the required time periods.

 

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

 

*Changesin Internal Control over Financial Reporting*

 

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

 

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**PART II:   OTHER INFORMATION**

 

**ITEM 1.****                             LEGALPROCEEDINGS**

 

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

 

Wefiled a motion to dismiss the shareholders’ derivative action pending in theUnited States District Court and the motion is awaiting a ruling from thejudge.

 

TheShareholders’ derivative action pending in the state District Court, DallasCounty, Texas has been voluntarily dismissed without prejudice by theplaintiff.

 

On July 29,2005, the Company filed a motion to dismiss the Amended Consolidated Class ActionComplaint pending before the United States District Court for the NorthernDistrict of Texas, Dallas Division, primarily based on various provisions ofthe Private Securities Litigation Reform Act of 1995.  The court has not yet ruled on thismotion.  

 

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

 

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

 

The following tableprovides information about the Company’s purchases of shares of its commonstock in the open market during the six months ended July 31, 2005:

 
| **Period**                | ** ** | **Total  Number of  Shares  Purchased** | ** ** | **Average  Price Paid  Per Share** | ** ** | **Total Number of  Shares Purchased as  part of Publicly  Announced Plans or  Programs** | ** ** | **Maximum Number  of Shares that may  yet be Purchased  under the Plans or  Programs** | ** ** |
|---------------------------|------------|-----------------------------------------|------------|------------------------------------|------------|------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
|                      |       |                                    |       |                               |       |                                                                                     |       |                                                                                   |       |
| 4/1/2005 – 4/30/2005 |       | 70,000                                  |       | $                                  | 4.98       |                                                                                     | 70,000     |                                                                                   |       | (1) |
| 5/1/2005 – 7/31/2005 |       | 560,511                                 |       | 5.04                               |       | 560,511                                                                                  |       |                                                                                   | (1)        |
| Total                     |       | 630,511                                 |       | $                                  | 5.03       |                                                                                     | 630,511    |                                                                                   |       | (1) |

 

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(1)          Under ashare repurchase program approved by the Board of Directors of CarrekerCorporation on April 18, 2005, the Company is authorized to repurchase upto $5.0 million of its common stock through October 14, 2005.  The repurchase program is designed to complywith Rules 10b5-1 and 10b-18 under the Securities Exchange Act of 1934under which an agent appointed by the Company will determine the time, amount,and price at which purchases of common stock will be made, subject to certainparameters established in advance by the Company.  For the period August 1, 2005 through August 31,2005, the Company has purchased an additional 900 shares of its common stock.

 

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**ITEM 3.**                           DEFAULTSUPON SENIOR SECURITIES

** **

None.  

 

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

** **

At our Annual Meeting ofStockholders held on June 14, 2005, two proposals were adopted by ourstockholders: (1) the election of three directors as Class Idirectors for terms expiring at the Annual Meeting of Stockholders in 2008 asdescribed in our Proxy Statement for the Annual Meeting (Messrs. John D.Carreker, Jr., James R. Erwin, and Donald L. House were re-elected asdirectors), and (2) the ratification of the appointment of Ernst &Young LLP as independent registered public accountants of the Company for thefiscal year ending January 31, 2006. The number of shares cast for and against as well asthe number of abstentions as to each of these matters (other than the electionof directors) are as follows:

 
| **Election of Directors**  | ** ** | **Shares For** | ** ** | **Shares Withheld** | ** ** |
|----------------------------|------------|----------------|------------|---------------------|------------|
|                       |       |           |       |                |       |
| John D. Carreker, Jr. |       | 22,440,177     |       | 837,771             |       |
| James R. Erwin             |       | 22,195,599     |       | 1,082,349           |       |
| Donald L. House.           |       | 22,478,933     |       | 799,015             |       |

 

 
| **Proposal**                | ** ** | **Shares For** | ** ** | **Shares Against** | ** ** | **Abstentions** | ** ** |
|-----------------------------|------------|----------------|------------|--------------------|------------|-----------------|------------|
|                        |       |           |       |               |       |            |       |
| Ratification of accountants |       | 23,195,310     |       | 65,115             |       | 17,523          |       |

 

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

 

None.

 

**ITEM6.**                           EXHIBITS

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

 

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**SIGNATURES**

 

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

 

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