UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549  FORM 10-Q (Mark One)  x
        QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2006 o
        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period fromto  Commission file number 0-28572  OPTIMAL GROUP INC. (Exact name of registrant as specified in its charter)  Canada
        98-0160833(State or Other Jurisdiction of Incorporation)
        (I.R.S. Employer Identification No.)
  3500 de Maisonneuve Blvd. W., Suite 1700, Montreal, Québec, Canada H3Z 3C1 (Address of Principal Executive Offices, Including Zip Code)  (514) 738-8885 (Registrant's Telephone Number, Including Area Code)  Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes
        x
        No
  Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):  Large Accelerated filer
        
        Accelerated filer
        x
        Non-accelerated filer
  Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes
        
        No
        x
  At November 6, 2006, the registrant had 23,795,182 common shares designated as Class A shares (without nominal or par value) outstanding.  1   OPTIMAL GROUP INC.





PART I. FINANCIAL INFORMATION



Item 1. Financial Statements











Consolidated Financial Statements of

(Unaudited)



OPTIMAL GROUP INC.



Nine-month periods ended September 30, 2006 and 2005

(expressed in U.S. dollars)





2



OPTIMAL GROUP INC.

Consolidated Financial Statements

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in U.S. dollars)





Financial Statements




Consolidated Balance Sheets
        4Consolidated Statements of Operations
        5Consolidated Statements of Deficit
        6Consolidated Statements of Cash Flows
        7Notes to Consolidated Financial Statements
        8





3



OPTIMAL GROUP INC.Consolidated Balance Sheets(Unaudited)September 30, 2006 and December 31, 2005(expressed in thousands of U.S. dollars)September 30,
        December 31,2006
        
        2005AssetsCurrent assets:Cash and cash equivalents
        $
        138,545
        $
        98,236Cash held as reserves
        
        21,015
        
        22,722Short-term investments
        
        56,110
        
        82,361Short-term investments held as reserves
        
        4,510
        
        3,014Settlement assets
        
        16,894
        
        20,727Accounts receivable
        
        6,951
        
        4,681Income taxes receivable and refundable investment tax credits
        
        1,056
        
        1,055Prepaid expenses and deposits
        
        1,568
        
        1,006Future income taxes
        
        2,262
        
        2,349Current assets related to discontinued operations
        
        1,534
        
        10,944250,445
        
        247,095Long-term receivables (note 6)
        
        3,204
        
        3,528Property and equipment
        
        2,454
        
        2,660Goodwill and other intangible assets (note 7)
        
        107,632
        
        117,090Other asset (note 4)
        
        10,423
        
        10,462Long-term assets related to discontinued operations
        
        
        
        3,848$
        374,158
        $
        384,683Liabilities and Shareholders' EquityCurrent liabilities:Bank indebtedness (note 8)
        $
        7,324
        $
        8,390Customer reserves and security deposits
        
        98,831
        
        112,422Accounts payable and accrued liabilities
        
        24,303
        
        21,796Income taxes payable
        
        9,380
        
        9,003Future income taxes
        
        382
        
        836Current liabilities related to discontinued operations
        
        2,085
        
        7,062142,305
        
        159,509Non-controlling interest
        
        14,975
        
        12,926Future income taxes
        
        2,044
        
        8,958Shareholders' equity:Share capital (note 9)
        
        200,465
        
        195,149Additional paid-in capital (note 10 (d))
        
        23,161
        
        25,884Deficit
        
        (7,308)
        
        (16,259)Cumulative translation adjustment
        
        (1,484)
        
        (1,484)214,834
        
        203,290Contingencies and other (note 11)Subsequent event (note 18)$
        374,158
        $
        384,683See accompanying notes to unaudited consolidated financial statements.





4



OPTIMAL GROUP INC.Consolidated Statements of Operations(Unaudited)Periods ended September 30, 2006 and 2005(expressed in thousands of U.S. dollars, except per share amounts)Three months ended
        Nine months endedSeptember 30,
        September 30,2006
        2005
        2006
        2005Revenues
        $
        53,297
        $
        35,754
        $
        157,961
        $
        92,870Expenses:Transaction processing
        
        26,353
        
        15,184
        
        76,406
        
        41,390Selling, general and administrative
        
        15,014
        
        9,203
        
        41,533
        
        23,811Amortization of intangibles pertaining to transaction processing
        
        3,090
        
        2,338
        
        9,155
        
        4,845Amortization of property and equipment
        
        389
        
        270
        
        1,155
        
        978Stock-based compensation pertaining to selling, general and administrative (note 12)
        
        671
        
        3,211
        
        1,006
        
        7,318Research and development
        
        849
        
        578
        
        2,479
        
        1,850Operating leases
        
        409
        
        372
        
        1,161
        
        877Impairment loss (note 3)
        
        1,910
        
        -
        
        1,910
        
        -Earnings from continuing operations before undernoted items
        
        4,612
        
        4,598
        
        23,156
        
        11,801Investment income
        
        2,369
        
        847
        
        5,886
        
        1,678Gain on sale of interest in FireOne
        
        -
        
        (167)
        
        -
        
        30,411Earnings from continuing operations before income tax provision and non-controlling interest
        
        6,981
        
        5,278
        
        29,042
        
        43,890Income tax (recovery) provision (note 13)
        
        (3,098)
        
        1,424
        
        1,225
        
        7,721Earnings from continuing operations before non-controlling interest
        
        10,079
        
        3,854
        
        27,817
        
        36,169Non-controlling interest
        
        1,361
        
        1,508
        
        5,518
        
        1,738Earnings from continuing operations (note 1)
        
        8,718
        
        2,346
        
        22,299
        
        34,431Loss from discontinued operations (note 5 (b))
        
        (2,489)
        
        (1,879)
        
        (7,990)
        
        (13,211)Loss on disposal of discontinued operations (note 5 (b))
        
        (4,283)
        
        -
        
        (4,283)
        
        -Net earnings
        $
        1,946
        $
        467
        $
        10,026
        $
        21,220Weighted average number of shares:Basic
        
        23,687,171
        
        23,044,050
        
        23,574,945
        
        22,751,982Plus impact of stock options and warrants
        
        1,871,072
        
        2,595,454
        
        2,201,549
        
        2,260,674Diluted
        
        25,558,243
        
        25,639,504
        
        25,776,494
        
        25,012,656Earnings (loss) per share:Continuing operations:Basic
        $
        0.37
        $
        0.10
        $
        0.95
        $
        1.51Diluted
        
        0.34
        
        0.09
        
        0.87
        
        1.38Discontinued operations:Basic
        
        (0.29)
        
        (0.08)
        
        (0.52)
        
        (0.58)Diluted
        
        (0.26)
        
        (0.07)
        
        (0.48)
        
        (0.53)Net:Basic
        
        0.08
        
        0.02
        
        0.43
        
        0.93Diluted
        
        0.08
        
        0.02
        
        0.39
        
        0.85See accompanying notes to unaudited consolidated financial statements.
















































5



OPTIMAL GROUP INC.Consolidated Statements of Deficit(Unaudited)Periods ended September 30, 2006 and 2005(expressed in thousands of U.S. dollars)Three months ended
        Nine months endedSeptember 30,
        September 30,2006
        2005
        2006
        2005(Deficit) retained earnings, beginning of period
        $
        (9,254)
        $
        4,170
        $
        (16,259)
        $
        (16,583)Net earnings
        
        1,946
        
        467
        
        10,026
        
        21,220Excess of purchase price over book value of shares (note 9 (b))
        
        -
        
        -
        
        (1,075)
        
        -(Deficit) retained earnings, end of period
        $
        (7,308)
        $
        4,637
        $
        (7,308)
        $
        4,637See accompanying notes to unaudited consolidated financial statements.





6



OPTIMAL GROUP INC.Consolidated Statements of Cash Flows(Unaudited)Periods ended September 30, 2006 and 2005(expressed in thousands of U.S. dollars)Three months ended
        Nine months endedSeptember 30,
        September 30,2006
        
        2005
        
        2006
        
        2005Cash flows from (used in) operating activities:Net earnings
        $
        1,946
        $
        467
        $
        10,026
        $
        21,220Add:     loss from discontinued operations
        
        2,489
        
        1,879
        
        7,990
        
        13,211loss on disposal of discontinued operations
        
        4,283
        
        -
        
        4,283
        
        -Net earnings from continuing operations
        
        8,718
        
        2,346
        
        22,299
        
        34,431Adjustments for items not affecting cash:Non-controlling interest
        
        1,361
        
        1,508
        
        5,518
        
        1,738Gain on sale of interest in FireOne
        
        -
        
        167
        
        -
        
        (30,411)Amortization
        
        3,479
        
        2,608
        
        10,310
        
        5,823Future income taxes
        
        (4,959)
        
        307
        
        (7,500)
        
        1,566Impairment loss
        
        1,910
        
        -
        
        1,910
        
        -Stock-based compensation
        
        671
        
        3,211
        
        1,006
        
        7,318Foreign exchange
        
        145
        
        74
        
        (723)
        
        567Net change in operating assets and liabilities (note 15 (a))
        
        2,436
        
        22,038
        
        (9,037)
        
        25,33413,761
        
        32,259
        
        23,783
        
        46,366Cash flows from (used in) financing activities:Proceeds on exercise of RSUs in FireOne Group Plc
        
        3
        
        -
        
        24
        
        -FireOne Group Plc dividends paid to minority interest
        
        (2,689)
        
        -
        
        (4,796)
        
        -Proceeds from issuance of Class "A" shares
        
        31
        
        1,741
        
        4,078
        
        6,702Repurchase of Class "A" shares
        
        -
        
        -
        
        (2,264)
        
        -(Decrease) increase in bank indebtedness
        
        (1,657)
        
        50
        
        (719)
        
        (2,195)(4,312)
        
        1,791
        
        (3,677)
        
        4,507Cash flows from (used in) investing activities:Proceeds on sale of interest in FireOne
        
        -
        
        -
        
        -
        
        44,146Purchase of property, equipment and intangible assets
        
        (859)
        
        (622)
        
        (2,557)
        
        (1,425)(Acquisition of) proceeds from maturity of short-term investments
        
        (7,997)
        
        143
        
        26,251
        
        60,205(Increase) decrease in note receivable
        
        (265)
        
        (61)
        
        324
        
        76Decrease in cash held in escrow
        
        -
        
        816
        
        -
        
        3,536Acquisition of MCA, including acquisition costs of $49
        
        -
        
        (1,020)
        
        -
        
        (3,709)Payment of balance of sale of NPS
        
        -
        
        (1,500)
        
        -
        
        (3,000)Acquisition of UBC, including acquisition costs of $277
        
        -
        
        -
        
        -
        
        (44,277)Transaction costs
        
        -
        
        (1,491)
        
        -
        
        (5,918)(9,121)
        
        (3,735)
        
        24,018
        
        49,634Effect of exchange rate changes on cash and cash equivalents during the period
        
        (25)
        
        264
        
        377
        
        (404)Cash flows of discontinued operations (revised - see note 17):Operating cash flows
        
        (802)
        
        (2,240)
        
        (3,998)
        
        (5,823)Financing cash flows
        
        (42)
        
        -
        
        (107)
        
        (470)Investing cash flows
        
        (5)
        
        (81)
        
        (87)
        
        (790)(849)
        
        (2,321)
        
        (4,192)
        
        (7,083)Net (decrease) increase in cash and cash equivalents
        
        (546)
        
        28,258
        
        40,309
        
        93,020Cash and cash equivalents, beginning of period
        
        139,091
        
        127,699
        
        98,236
        
        62,937Cash and cash equivalents, end of period
        $
        138,545
        $
        155,957
        $
        138,545
        $
        155,957Supplemental disclosure of cash flow information (note 15).See accompanying notes to unaudited consolidated financial statements.




















7



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per share amounts)




1.
        Interim financial information:


These consolidated financial statements have been prepared by management in accordance with Canadian generally accepted accounting principles (GAAP).  The unaudited consolidated balance sheet as at September 30, 2006 and the unaudited consolidated statements of operations, deficit and cash flows for the periods ended September 30, 2006 and 2005 reflect all adjustments which, in the opinion of management, are necessary to present a fair statement of the results of the interim periods.  These interim consolidated financial statements follow the same accounting policies and methods of their application as described in note 3 to the annual audited consolidated financial statements for the year ended December 31, 2005.  The interim consolidated financial statements do not include all disclosures required for annual financial statements and should be read in conjunction
with the most recent annual audited consolidated financial statements of Optimal Group Inc. (the Company) as at and for the year ended December 31, 2005.

Earnings from continuing operations include the results of gaming transaction processing affected by the enactment of United States Unlawful Internet Gambling Enforcement Act of 2006, including impairment provisions and exceptional provisions arising therefrom. (Refer to note 3).

The Company's revenues and expenses are subject to seasonal variations.  The results of operations and cash flows for any quarter are not necessarily indicative of the results or cash flows for an entire year.

All amounts in the attached notes are unaudited unless specifically identified.




2.
        Basis of presentation:


Discontinued operations:

At the end of the first quarter of 2006, the Company decided to divest the hardware maintenance and repair outsourcing services business segment.  On March 31, 2006, the Company closed its repair and logistics facility in Santa Ana, California.  The net assets of this segment were written down in the third and fourth quarter of 2005 to their estimated fair values less disposal costs.  The results of operations and financial position of this segment have been segregated for the current and comparative periods as discontinued operations in the accompanying financial statements and related note disclosures.  The Company disposed of these operations on September 30, 2006.  The Company continues to operate in the payment processing services segment (refer to notes 5 (b) and 14).




3.
        Enactment of United States Unlawful Internet Gambling Enforcement Act of 2006:


On September 30, 2006, the United States Congress passed the Unlawful Internet Gambling Enforcement Act of 2006 (the Act).  The Act became law in the United States on October 13, 2006.  The Act prohibits any person engaged in the business of betting or wagering from knowingly accepting any financial instrument in connection with unlawful Internet gambling.  The Act does not define unlawful Internet gambling nor does it make unlawful any activities by financial institutions that are not themselves gambling businesses.  The Act directs the United States Federal Reserve and the Department of the Treasury to develop regulations that would direct financial institutions to identify and block certain types of financial transactions connected with unlawful Internet gambling.



8



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per share amounts)




3.
        Enactment of United States Unlawful Internet Gambling Enforcement Act of 2006 (continued):


Upon the enactment of the Act, the Company ceased processing settlement transactions originating from United States consumers that may be viewed as related to online gambling, which represented approximately 83% and 84% of the Company's total gaming payment processing services segment revenue in the three and nine months ended September 30, 2006, respectively (refer to note 14).  The Company may not be able to identify and engage in other opportunities that will offset the lost revenue.  The enactment of the Act has had and will have a significant negative impact on the Company's results as follows:


(a)
        Exceptional provision related to customer losses:


The Company records provisions for customer losses related to transactions that are disputed and cannot be recovered from merchants or consumers.  As a result of the enactment of the Act, the Company recorded exceptional provisions for customer losses of $3,959 in the three and nine months ended September 30, 2006.


(b)
        Impairment of intangible assets and goodwill:


As a result of the enactment of the Act and the resulting significant negative impact on the business, the Company performed its impairment testing for long-lived assets and goodwill at September 30, 2006.

The following impairment loss related to intangible assets was recorded in the three and nine months ended September 30, 2006:




Customer contracts and relationships
        $
        1,910



The impairment loss represents the estimated amount by which the carrying amount of this asset exceeded its fair value.  The fair value was determined using cash flow projections prepared by management.

The Company also tested the Payment Services - Gaming segment for goodwill impairment at September 30, 2006.  As a result of the enactment of the Act, the segment's earnings forecast was revised.  The fair value of the segment was estimated using the expected present value of future cash flows.  Management determined there was no impairment in the goodwill related to this segment at September 30, 2006.

Estimated future cash flows were discounted using a rate reflecting the uncertainty inherent in the continuing operations and the time value of money.  Cash flow projections were based on managements estimates of expected cash flows from ongoing operations.



9



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per share amounts)




3.
        Enactment of United States Unlawful Internet Gambling Enforcement Act of 2006 (continued):



(c)
        Restructuring:


The Company has embarked upon a restructuring of its operations and cost base and will record a restructuring charge for associated costs, such as employee termination benefits and costs of leased premises no longer utilized.  In accordance with generally accepted accounting principles, it is expected that this charge will be reflected in the Company's fourth quarter results and is currently estimated to be between $2.0 and $2.5 million.

The Company will continue to offer its multi-currency credit and debit card and FirePlay electronic wallet processing to the online gambling industry originating from non-U.S. consumers and not prohibited by the Act.




4.
        FireOne Group plc:


In April 2005, the Company created FireOne Group plc (FireOne) and transferred to this newly-created, wholly-owned Irish subsidiary and its subsidiaries the net assets of the payments processing business related to online gaming previously held in Optimal Payments Inc. and its subsidiaries.  On May 27, 2005, the Company completed the placing of 10 million ordinary shares of FireOne, representing a 20% interest, with institutional and other shareholders.  The ordinary shares of FireOne were admitted for trading on the Alternative Investment Market (AIM) of the London Stock Exchange plc on June 2, 2005.

At September 30, 2006 and December 31, 2005, the Company's interest in FireOne was 75.9% and 76.2%, respectively.  The Company's diluted interest in FireOne was effectively diluted after the placing as a result of the vesting of restricted share units issued by FireOne in fiscal 2005.  Non-controlling interest is recorded for the minority interest's share of the carrying value of net assets and the reported net earnings of FireOne.

Taxes paid or incurred as a result of the transfer of net assets to FireOne and its subsidiaries in 2005 have been recorded as an "Other asset" in the consolidated balance sheet, which will be recognized when the Company's interest in FireOne is transferred, by sale or otherwise, outside of the consolidated group.




5.
        Business acquisitions and disposals:



(a)
        Acquisitions:


In 2005, Optimal Payments Inc., ("OPI") a wholly-owned subsidiary of the Company, made the following acquisitions:



10



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per share amounts)




5.
        Business acquisitions and disposals (continued):



(a)
        Acquisitions (continued):



(i)
        On January 1, 2005, OPI acquired the operating assets of Merchant Card Acceptance Corp. and its affiliated companies, Precision Management Consulting Inc. and Merchant Card Interactive Corp. (collectively, "MCA"), for $3,722 subject to the determination of certain post-closing adjustments.  The agreement also provides for a contingent consideration of approximately $890 (CA$1,000) based on the attainment of specified operational targets.  MCA is an independent sales organization providing Canadian-based merchants with credit card and Interac PIN-based debit card acceptance;



(ii)
        On May 6, 2005, OPI acquired a portfolio of merchant processing from United Bank Card Inc., ("UBC") for a cash consideration of $44,277;



(iii)
        On October 6, 2005, OPI acquired a portfolio of U.S. merchant processing contracts and associated sales channel contracts from Moneris Solutions Inc., ("Moneris") for a cash consideration of $18,266.


All of the acquisitions related to the non-gaming payment processing services segment.

The acquisition of MCA was accounted for by using the purchase method and the acquisitions of UBC and Moneris were accounted for as acquisition of assets.  The following table summarizes the estimated fair value of the assets acquired at the date of acquisition:




MCA
        
        UBC
        
        Moneris
        
        TotalAssets acquired:Property and equipment
        $
        145
        $
        
        $
        
        $
        145Inventory
        
        23
        
        
        
        
        
        23Supplier contract
        
        779
        
        
        
        
        
        779Customer relationships
        
        
        
        43,777
        
        11,086
        
        54,863Customer service agreement
        
        
        
        500
        
        
        
        500ISO/ISA relationships
        
        
        
        
        
        7,180
        
        7,180Goodwill
        
        2,775
        
        
        
        
        
        2,775$
        3,722
        $
        44,277
        $
        18,266
        $
        66,265




(b)
        Sale of hardware maintenance and repair services segment:


As indicated in note 2, the Company divested of its hardware maintenance and repair services segment.  The results of operations for this business segment are included in discontinued operations on the consolidated statement of operations, and the remaining assets and liabilities of the segment are classified as discontinued in the consolidated balance sheets.



11



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per share amounts)




5.
        Business acquisitions and disposals (continued):



(b)
        Sale of hardware maintenance and repair services segment (continued):


The results of operations of this business for the three and nine-month periods ended September 30, 2006 and 2005 were as follows:







Three months ended
        Nine months endedSeptember 30,
        September 30,2006
        
        2005
        
        2006
        
        2005Revenue
        $
        7,675
        $
        9,032
        $
        25,879
        $
        31,598Expenses:Service costs
        
        6,489
        
        6,988
        
        21,765
        
        26,976Selling, general and administrative
        
        1,972
        
        2,264
        
        6,020
        
        8,066Restructuring
        
        1,031
        
        -
        
        3,414
        
        266Amortization of property, equipment and intangibles
        
        -
        
        385
        
        259
        
        1,434Stock-based compensation
        
        -
        
        368
        
        -
        
        995Goodwill impairment
        
        -
        
        -
        
        -
        
        5,305Operating leases
        
        615
        
        748
        
        1,937
        
        2,314Foreign exchange
        
        (33)
        
        444
        
        335
        
        57710,074
        
        11,197
        
        33,730
        
        45,933Net interest expense (income)
        
        90
        
        (286)
        
        (211)
        
        (932)Loss before income taxes
        
        (2,489)
        
        (1,879)
        
        (7,640)
        
        (13,403)Loss on disposal of net assets from discontinued operations
        
        -
        
        -
        
        -
        
        (188)Income tax (provision) recovery
        
        -
        
        -
        
        (350)
        
        380Net loss from discontinued operations
        $
        (2,489)
        $
        (1,879)
        $
        (7,990)
        $
        (13,211)





















The results of operations include management assumptions and adjustments related to cost allocations which are inherently subjective.



12



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per share amounts)




5.
        Business acquisitions and disposals (continued):



(b)
        Sale of hardware maintenance and repair services segment (continued):


The following table summarizes the book value of the assets and liabilities at September 30, 2006 relating to the business sold by the Company:










September 30,   2006Current assets:Accounts receivable
        $
        3,733Inventory
        
        2,074Prepaid expenses and deposits
        
        8076,614Long-term assets:Long-term receivable
        
        -Property and equipment
        
        2,546Future tax asset
        
        -9,160Current liabilities:Accounts payable and accrued liabilities
        
        4,014Deferred revenues
        
        395Obligations under capital lease
        
        2684,677Net assets relating to hardware maintenance and repair services segment
        
        4,483Proceeds from sale
        
        200Loss on sale of net assets of hardware maintenance and repair services segment before income taxes
        
        4,283Income taxes
        
        -Net loss on sale of net assets of hardware maintenance and repair services segment
        $
        4,283






6.
        Long-term receivables:


Included in long-term receivables is the net present value of an interest-free note received on the sale of the assets of a division of Terra Payments Inc. (Terra) in fiscal 2002.  The repayment terms require monthly payments equal to 10% of the debtors sales.



13



---



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per share amounts)



7.
        Goodwill and other intangible assets:




September 30,2006Grosscarrying
        
        Accumulated
        
        Net bookamount
        
        amortization
        
        valueGoodwill
        $
        49,243
        $
        
        $
        49,243Customer contracts, relationships and service agreements
        
        62,183
        
        12,939
        
        49,244Acquired technology
        
        4,520
        
        2,260
        
        2,260ISO/ISA relations
        
        7,180
        
        1,025
        
        6,155Supplier contract
        
        1,376
        
        646
        
        730$
        124,502
        $
        16,870
        $
        107,632






December 31,2005Grosscarrying
        
        Accumulated
        
        Net bookamount
        
        amortization
        
        valueGoodwill
        $
        49,243
        $
        
        $
        49,243Customer contracts, relationships and service agreements
        
        64,395
        
        7,398
        
        56,997Acquired technology
        
        4,520
        
        1,582
        
        2,938ISO/ISA relations
        
        7,180
        
        256
        
        6,924Supplier contract
        
        1,376
        
        388
        
        988$
        126,714
        $
        9,624
        $
        117,090




The United States Unlawful Internet Gambling Enforcement Act of 2006 resulted in the recognition of an impairment loss for customer contracts and relationships of $1,910 (refer to note 3 (b)).



8.
        Bank indebtedness:


The Company has credit facilities available in the amount of $11,720 (CA$13,100) which can be utilized in the form of loans, bankers' acceptances or letters of guarantee.  At September 30, 2006, the Company utilized $7,324 (CA$8,186) of the facilities in borrowings and $1,879 (CA$2,100) through the issuance of letters of guarantee.  The borrowings are due on demand and bear interest either at the bank's prime rate or the market rate for bankers' acceptances plus an acceptance fee of 0.75% per annum.  The facilities are secured by a first ranking moveable hypothec on certain short-term investments.



14



---



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per share amounts)



9.
        Share capital:


(a)
        Issued and outstanding share capital was as follows:




September 30, 2006
        December 31, 2005Number
        
        Book value
        Number
        
        Book valueClass "A" shares
        23,690,180
        $
        200,465
        23,277,126
        $
        195,149




Changes in the issued and outstanding share capital were as follows:



BookNumber
        
        ValueBalance, December 31, 2005
        23,277,126
        $
        195,149Exercise of stock options
        554,163
        
        6,505Cancellation of shares pursuant to stock buyback program
        (141,109)
        
        (1,189)Balance, September 30, 2006
        23,690,180
        $
        200,465




The amounts credited to share capital from the exercise of stock options in the period ended September 30, 2006 include a cash consideration of $4,078, as well as an ascribed value from additional paid-in capital of $2,427.

(b)
        On November 7, 2005, the Company announced a stock buyback program which authorizes the Company to purchase up to 1,100,000 or approximately 4.7% of its issued and outstanding Class "A" shares.  The shares may be purchased through the facilities of the Nasdaq Stock Market over the course of 12 months commencing November 21, 2005.  All shares purchased under the program will be cancelled.  For the nine months ended September 30, 2006, 141,109 Class "A" shares were settled and cancelled for a total consideration of $2,264 and having a book value of $1,189.  The excess of the purchase price over book value of the shares in the amount of $1,075 was charged to the deficit.  Subsequent to the period ended September 30, 2006, the stock buyback program was renewed (refer to note 18).




15



---



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per share amounts)



10.
        Stock options and warrants:


(a)
        Optimal Group Inc.:


The Company has a stock option plan that provides for the granting of options to employees and directors for the purchase of the Companys Class "A" shares to be issued from treasury.  Options may be granted by the Board of Directors for terms of up to ten years.  The Board of Directors establishes the exercise period, vesting terms and other conditions for each grant at the grant date.  Options may be granted with exercise prices at the then current market price.  Options currently outstanding under the plan expire five years after the date of grant and are fully vested as a result of the accelerated vesting of all outstanding options in the fourth quarter of 2005 (refer to note 12).

Details of the outstanding and exercisable stock options are as follows:



Weightedaverageexercise priceNumber
        
        per shareOptions outstanding and exercisable, December 31, 2005
        4,374,623
        $
        7.10Granted
        
        
        Expired/cancelled
        (2,285)
        
        7.10Exercised
        (379,595)
        
        7.13Options outstanding and exercisable, September 30, 2006
        3,992,743
        $
        7.10




The remaining contractual life of the options at September 30, 2006 is approximately 2.6 years.

(b)
        Terra Payments Inc. ("Terra"):


Under the terms of the Combination Agreement with Terra, the Company assumed Terra's stock option plan and, as such, stock options governed by this plan will be exercisable for the Company's Class "A" shares.  The exercise price and number of options outstanding on April 6, 2004, the effective date of the acquisition of Terra, were adjusted based on the exchange ratio of 0.4532 of the Company's Class "A" shares for each share of Terra.



16



---



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per share amounts)



10.
        Stock options and warrants (continued):


(b)
        Terra Payments Inc. ("Terra") (continued):


Details of the outstanding and exercisable stock options under the Terra plan are as follows:



U.S. dollar exercise price
        Canadian dollar exercise priceWeighted averageExercise price
        exercise priceNumber
        
        per share
        Number
        
        per shareOptions outstanding and exercisable, December 31, 2005
        217,451
        $
        7.43
        324,143
        $
        8.56Expired/cancelled
        
        
        
        (799)
        
        7.28Exercised
        (68,989)
        
        7.43
        (105,579)
        
        9.35Options outstanding and exercisable, September 30, 2006
        148,462
        $
        7.43
        217,765
        $
        8.18




The weighted average remaining contractual life of the options at September 30, 2006 is approximately 2.5 years.

As at December 31, 2005 and September 30, 2006, there were 28,499 and 22,200 warrants outstanding, respectively, with a weighted average exercise price of CA$0.01 and expiring on dates up to March 2008.

There are 939 Terra options that could potentially dilute basic earnings per share in the future that were not included in the computation of diluted earnings per share because to do so would have been antidilutive for the period ended September 30, 2006.

(c)
        FireOne:


FireOne established a restricted share unit plan whereby eligible individuals are awarded rights to receive ordinary shares in FireOne to be issued from treasury for a nominal consideration.  The plan is administered by FireOnes remuneration committee.  Awards are made to eligible individuals at the discretion of the remuneration committee, vest in accordance with a specified vesting schedule and terminate 7 years from date of award.



17



---



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per share amounts)



10.
        Stock options and warrants (continued):


(c)
        FireOne (continued):


In May 2005, FireOne made an initial award of 2,443,750 restricted share units to employees, officers and directors of FireOne and the Company.  In November 2005, an additional 56,248 restricted share units were awarded to the non-executive directors of FireOne.  As at December 31, 2005, all restricted share units are fully vested (refer to note 12).  In May 2006, an aggregate of 1,299,000 restricted share units were awarded to directors, officers and employees of FireOne and the Company.  These restricted share units had an estimated fair value of $8,049 on the grant date which is being amortized over the vesting period.  The vesting period of these restricted share units is one third on the first anniversary of the award, an additional one third on the second anniversary of the award and the remaining one third on the third anniversary of the award.  In addition, in May and August 2006,
an aggregate of 73,116 and 126,788 restricted share units, respectively, having a fair value of $460 and $534, were awarded to restricted share unit holders as a dividend equivalent.

Changes in restricted share units were as follows:



Weightedaveragefair valueNumber
        
        per unitRestricted share units outstanding and exercisable,
December 31, 2005
        1,793,667
        $
        2.47Granted
        1,299,000
        
        6.23Exercised
        (981,517)
        
        2.64Expired / cancelled
        (7,723)
        
        6.23Dividend equivalent
        199,904
        
        4.97Restricted share units outstanding and exercisable,
September 30, 2006
        2,303,331
        $
        4.76




The remaining contractual life of the restricted share units at September 30, 2006 is approximately 6.2 years.

FireOne also established a stock option plan for employees, directors and officers, which is also administered by the remuneration committee of FireOne.  The number of options as well as vesting and performance requirements, if any, are set by the remuneration committee.  The exercise price for stock option grants will be based on the average market price of FireOne's ordinary shares for the five days preceding the date of grant.  In general, options will expire seven years from date of grant.  No options have been granted under this plan.

Grants under the restricted share unit plan and the stock option plan are limited to 2.5% of the issued share capital of FireOne to any individual and to 10% of the total issued share capital of FireOne.



18



---



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per share amounts)



10.
        Stock options and warrants (continued):


(c)
        FireOne (continued):


In connection with the public flotation of FireOne in 2005, the Company granted the nominated advisor the right to subscribe for up to 375,000 ordinary shares of FireOne at any time between the first and fourth anniversaries of admission to the AIM (June 2, 2005) at the placing price of 241 pence.

(d)
        Changes in additional paid-in capital were as follows:




Balance, December 31, 2005
        $
        25,884Ascribed value credited to share capital from exercise of stock optionsand warrants (note 9 (a))
        
        (2,427)Ascribed value credited to non-controlling interest from exercise ofrestricted share units
        
        (2,296)Stock-based compensation
        
        1,006Stock dividend of restricted share units issued by FireOne to non-controlling interest
        
        994Balance, September 30, 2006
        $
        23,161




11.
        Contingencies and other:


(a)
        The Company received a legal letter from a claimant in 1999, and again in February 2001, alleging infringement of a patent related to theU-Scan®self-checkout business, which the Company sold to Fujitsu on April 8, 2004.  In March 2003, this claimant also sent a third demand letter alleging infringement of additional patents.  The Company believes these claims to be without merit and intends to vigorously defend its position should this claimant initiate a civil action.  No amounts have been specified in these claims.  It is not possible at this time to make an estimate of the amount of damages, if any, that may result and, accordingly, no provision has been made in these financial statements with respect to such claims.


(b)
        On March 11, 2005, and again on June 30, 2005, the Company received a letter from Fujitsu claiming recovery of expenses allegedly incurred and forecast by Fujitsu to be incurred in relation to the operation of the Companys formerU-Scan® self-checkout business.  In December 2005, the Company was notified by Fujitsu of its intention to arbitrate its claims.  In February 2006, the Company received a draft request for arbitration, detailing the claims by Fujitsu.  After consultation with counsel, the Company believes that there is no basis for these claims and intends to vigorously defend its position in any arbitration proceedings that might be initiated by Fujitsu to assert its claims.  Management is unable to determine the resolution of this matter or estimate the ultimate liability, if any, related thereto.  Accordingly, no provision
has been made in these financial statements with respect to such claims.




19



---



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per share amounts)



11.
        Contingencies and other (continued):


(c)
        The Company is pursuing the recovery of $6,800 withdrawn from a Terra bank account by one of its credit card suppliers for various service charges assessed pertaining to periods prior to December 31, 2001.  The Company believes these charges are largely unsubstantiated and is pursuing the claim through legal recourse.  The amount, if any, which the Company may recover cannot be quantified until the legal process is complete.


(d)
        The Company is party to litigation arising in the normal course of operations.  The Company does not expect the resolution of such matters to have a material adverse effect on the financial position or results of operations of the Company.  However, the results of legal proceedings cannot be predicted with certainty.  Should the Company fail to prevail in any of these legal matters or should several legal matters be resolved against the Company in the same reporting period, the consolidated operating results of a particular reporting period could be materially adversely affected.


(e)
        In the sale or other disposition of assets out of the ordinary course of business, in addition to possible indemnification relating to failure to perform covenants and breach of representations and warranties, the Company might agree to indemnify the buyer against claims from its past conduct of its business.  Typically, the term and amount of such indemnification will be limited by agreement.  The nature of these indemnification agreements prevents the Company from estimating the maximum potential liability to indemnified parties.  Accordingly, no provision has been made in these financial statements with respect to this item.


(f)
        The Companys gaming payment processing services segment derived a substantial portion of its revenue prior to October 13, 2006 from processing transactions from online gambling.  Therefore, the Company may be exposed to adverse consequences as a result of enforcement proceedings, governmental investigations or lawsuits initiated against it in jurisdictions where online gambling is or becomes restricted or prohibited.  In the event that the United States government initiates enforcement proceedings, or that any adverse findings, rulings or judgements are rendered in any such investigations or lawsuits directed at the Company or at its customers or suppliers, it may have a significant negative impact on the operations of the Company's business.  While best estimates have been used for reporting financial statement items subject to measurement uncertainty, management considers that it is
possible, based on existing knowledge, that changes in future conditions in the near term could require a material change in the recognized amounts of certain assets and liabilities.  Near term is considered to be within one year from the date of the financial statements.


At the present time, the Company is not aware of any enforcement proceedings, governmental investigations or lawsuit initiated against it in relation to the processing of online gambling transactions.



20



---



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per share amounts)



12.
        Stock-based compensation:


Stock-based compensation expense in the consolidated statements of operations was comprised of:



Three months ended
        Nine months endedSeptember 30,
        September 30,2006
        
        2005
        
        2006
        
        2005Expense related to options granted in 2004
        $
        
        $
        1,380
        $
        
        $
        4,076Expense related to FireOne restricted stock unit plan
        
        671
        
        1,621
        
        1,006
        
        2,505Amortization of deferredcompensation
        
        
        
        210
        
        
        
        737$
        671
        $
        3,211
        $
        1,006
        $
        7,318




On November 7, 2005, the Companys Board of Directors approved the accelerated vesting of all unvested stock options previously awarded to employees, officers and directors.  As a result of the accelerated vesting, and the concurrent accelerated vesting of unvested FireOne restricted share units, the Company recorded additional stock-based compensation of approximately $14,100 in the fourth quarter of 2005.  The primary purpose of the acceleration was the elimination of stock-based compensation expense in the same aggregate amount that would otherwise be required to be recognized over the period ending June 30, 2007.

In order to prevent unintended personal benefits to employees, officers and directors, the Board imposed restrictions on any shares received through the exercise of accelerated options held by those individuals.  These restrictions prevent the sale of any stock obtained through exercise of an accelerated option prior to the earlier of the original vesting date or the individual's termination of employment.  The Board of Directors of FireOne imposed a similar restriction upon the sale of the ordinary shares underlying the FireOne restricted share units in respect of which the vesting was accelerated.



21



---



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per share amounts)



13.
        Income taxes:


The income tax provision differs from the amount computed by applying the combined Canadian federal and Quebec provincial tax rates to earnings before income taxes.  The reasons for the difference and the related tax effects are as follows:



Three months ended
        Nine months endedSeptember 30,
        September 30,2006
        
        2005
        
        2006
        
        2005Earnings from continuing operations before income taxes
        $
        6,981
        $
        5,278
        $
        29,042
        $
        43,890Combined Canadian federal and Quebec provincial income taxes at 32% (2005 - 31%)
        $
        2,235
        $
        1,637
        $
        9,299
        $
        13,615Foreign exchange(1)
        
        (515)
        
        (2,169)
        
        (1,660)
        
        (2,013)Change in valuation allowance
        
        (3,530)
        
        136
        
        (3,015)
        
        (10,704)Stock-based compensation not deductible for tax
        
        157
        
        802
        
        232
        
        2,270Permanent differences and other
        
        (516)
        
        1,018
        
        439
        
        1,807Differences in tax rates
        
        (968)
        
        
        
        (4,109)
        
        Amortization of other asset
        
        39
        
        
        
        39
        
        2,746Income tax provision (recovery) of continuing operations
        $
        (3,098)
        $
        1,424
        $
        1,225
        $
        7,721




(1)
        For purposes of calculating the income tax provision of the Company, a tax effect is recognized on foreign exchange gains or losses which arise on the conversion into Canadian dollars of the net monetary assets denominated in U.S. dollars; such conversion is required for income tax purposes.  As these financial statements are presented in U.S. dollars, these foreign exchange gains or losses do not impact earnings (losses) before income taxes even though the income tax provision would include a tax effect for these items.  Future fluctuations in the foreign exchange rate between the Canadian and U.S. dollar will change the amount of the foreign exchange gains or losses and thus the provision for or recovery of income taxes thereon.






22



---



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per share amounts)



13.
        Income taxes (continued):


The provision for (recovery of) income taxes of continuing operations is composed of the following:



Three months ended
        Nine months endedSeptember 30,
        September 30,2006
        
        2005
        
        2006
        
        2005Current income taxes
        $
        1,861
        $
        1,117
        $
        8,725
        $
        6,155Future income taxes
        
        (4,959)
        
        307
        
        (7,500)
        
        1,566$
        (3,098)
        $
        1,424
        $
        1,225
        $
        7,721




14.
        Segmented information:


The Company now operates in two segments, namely gaming and non-gaming payment processing services. In 2005, the Company operated in three segments that included hardware maintenance and repair outsourcing services.  The net results of this segment are reported as discontinued operations.  Comparative figures have been reclassified to conform with this new presentation.  Transaction processing costs, administrative expenses and other fees charged among the segments are in the normal course of operations and are measured at the exchange amount, which is the amount of consideration established and agreed to by the parties.  Management measures the results of operations based on segment income before income taxes adjusted for certain non-cash and non-recurring items provided by each business segment.

On October 13, 2006, the Company ceased processing settlement transactions originating from the United States consumers that may be viewed as related to online gambling, which represented approximately 83% and 84% of the Companys total gaming payment processing services segment revenue for the three and nine months ended September 30, 2006, respectively (refer to note 3).



23



---



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per share amounts)



14.
        Segmented information (continued):


(a)
        Information on the operating segments is as follows:




Payment services
        Eliminations/Gaming
        Non-gaming
        Unallocated
        ConsolidatedThree months ended September 30, 2006:Revenues
        $
        26,204
        $
        29,290
        $
        (2,197)
        $
        53,297Transaction processing
        
        10,317
        
        17,029
        
        (993)
        
        26,353Selling, general and administrative
        
        8,668
        
        7,620
        
        (1,274)
        
        15,014Research and development
        
        135
        
        714
        
        
        
        849Operating leases
        
        88
        
        321
        
        
        
        4096,996
        
        3,606
        
        70
        
        10,672Stock-based compensation
        
        427
        
        244
        
        
        
        671Impairment loss
        
        1,910
        
        
        
        
        
        1,910Amortization
        
        268
        
        3,208
        
        3
        
        3,4794,391
        
        154
        
        67
        
        4,612Investment income
        
        1,343
        
        1,026
        
        
        
        2,369Earnings from continuing operations before income taxes and non-controlling interest
        
        5,734
        
        1,180
        
        67
        
        6,981Income tax provision (recovery)
        
        922
        
        (4,020)
        
        
        
        (3,098)Earnings from continuing operations before undernoted
        
        4,812
        
        5,200
        
        67
        
        10,079Non-controlling interest
        
        1,361
        
        
        
        
        
        1,361Earnings from continuing operations (note 1)
        
        3,451
        
        5,200
        
        67
        
        8,718Loss from discontinued operations (including restructuring of $1,031)
        
        
        
        
        
        (2,489)
        
        (2,489)Loss on disposal of discontinued operations
        
        
        
        
        
        (4,283)
        
        (4,283)Net earnings (loss)
        $
        3,451
        $
        5,200
        $
        (6,705)
        $
        1,946






24



---



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per share amounts)



14.
        Segmented information (continued):


(a)
        (Continued):




Payment services
        Eliminations/Gaming
        Non-gaming
        Unallocated
        ConsolidatedThree months ended September 30, 2005:Revenues
        $
        19,968
        $
        17,768
        $
        (1,982)
        $
        35,754Transaction processing
        
        8,001
        
        8,103
        
        (920)
        
        15,184Selling, general and administrative
        
        3,330
        
        6,935
        
        (1,062)
        
        9,203Research and development
        
        83
        
        495
        
        
        
        578Operating leases
        
        73
        
        299
        
        
        
        3728,481
        
        1,936
        
        
        
        10,417Stock-based compensation
        
        929
        
        2,282
        
        
        
        3,211Amortization
        
        235
        
        2,373
        
        
        
        2,6087,317
        
        (2,719)
        
        
        
        4,598Investment income
        
        51
        
        796
        
        
        
        847Earnings (loss) from continuing operations before income taxes and non-controlling interest
        
        7,368
        
        (1,923)
        
        
        
        5,445Income tax provision (recovery)
        
        2,696
        
        (1,272)
        
        
        
        1,424Earnings (loss) from continuing operations before undernoted
        
        4,672
        
        (651)
        
        
        
        4,021Sale of interest in FireOne
        
        
        
        
        
        167
        
        167Non-controlling interest
        
        1,508
        
        
        
        
        
        1,508Earnings (loss) from continuing operations
        
        3,164
        
        (651)
        
        (167)
        
        2,346Loss from discontinued operations
        
        
        
        
        
        (1,879)
        
        (1,879)Net earnings (loss)
        $
        3,164
        $
        (651)
        $
        (2,046)
        $
        467






25



---



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per share amounts)



14.
        Segmented information (continued):


(a)
        (Continued):




Payment services
        Eliminations/Gaming
        Non-gaming
        Unallocated
        ConsolidatedNine months ended September 30, 2006:Revenues
        $
        76,193
        $
        88,409
        $
        (6,641)
        $
        157,961Transaction processing
        
        27,359
        
        52,073
        
        (3,026)
        
        76,406Selling, general and administrative
        
        20,826
        
        24,535
        
        (3,828)
        
        41,533Research and development
        
        426
        
        2,053
        
        
        
        2,479Operating leases
        
        223
        
        938
        
        
        
        1,16127,359
        
        8,810
        
        213
        
        36,382Stock-based compensation
        
        641
        
        365
        
        
        
        1,006Impairment loss
        
        1,910
        
        
        
        
        
        1,910Amortization
        
        801
        
        9,501
        
        8
        
        10,31024,007
        
        (1,056)
        
        205
        
        23,156Investment income
        
        3,464
        
        2,422
        
        
        
        5,886Earnings from continuing operations before income taxes and non-controlling interest
        
        27,471
        
        1,366
        
        205
        
        29,042Income tax provision (recovery)
        
        4,963
        
        (3,896)
        
        158
        
        1,225Earnings from continuing operations before undernoted
        
        22,508
        
        5,262
        
        47
        
        27,817Non-controlling interest
        
        5,518
        
        
        
        
        
        5,518Earnings from continuing operations (note 1)
        
        16,990
        
        5,262
        
        47
        
        22,299Loss from discontinued operations (including restructuring of $3,414)
        
        
        
        
        
        (7,990)
        
        (7,990)Loss on disposal of discontinued operations
        
        
        
        
        
        (4,283)
        
        (4,283)Net earnings (loss)
        $
        16,990
        $
        5,262
        $
        (12,226)
        $
        10,026






26



---



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per share amounts)



14.
        Segmented information (continued):


(a)
        (Continued):




Payment services
        Eliminations/Gaming
        Non-gaming
        Unallocated
        ConsolidatedNine months ended September 30, 2005:Revenues
        $
        52,442
        $
        44,607
        $
        (4,179)
        $
        92,870Transaction processing
        
        21,502
        
        22,441
        
        (2,553)
        
        41,390Selling, general and administrative
        
        8,029
        
        17,408
        
        (1,626)
        
        23,811Research and development
        
        993
        
        857
        
        
        
        1,850Operating leases
        
        241
        
        636
        
        
        
        87721,677
        
        3,265
        
        
        
        24,942Stock-based compensation
        
        1,595
        
        5,723
        
        
        
        7,318Amortization
        
        719
        
        5,104
        
        
        
        5,82319,363
        
        (7,562)
        
        
        
        11,801Investment income
        
        159
        
        1,519
        
        
        
        1,678Earnings (loss) from continuing operations before income taxes and non-controlling interest
        
        19,522
        
        (6,043)
        
        
        
        13,479Income tax provision (recovery)
        
        7,193
        
        528
        
        
        
        7,721Earnings (loss) from continuing operations before undernoted
        
        12,329
        
        (6,571)
        
        
        
        5,758Gain on sale of interest inFireOne
        
        
        
        
        
        30,411
        
        30,411Non-controlling interest
        
        1,738
        
        
        
        
        
        1,738Earnings (loss) from continuing operations
        
        10,591
        
        (6,571)
        
        30,411
        
        34,431Loss from discontinued operations (including restructuring of $266)
        
        
        
        
        
        (13,211)
        
        (13,211)Net earnings (loss)
        $
        10,591
        $
        (6,571)
        $
        17,200
        $
        21,220






27



---



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per share amounts)



14.
        Segmented information (continued):


(a)
        (Continued):




Payment services
        
        Eliminations/Gaming
        
        Non-gaming
        
        Unallocated
        
        ConsolidatedSeptember 30, 2006:Total assets
        $
        165,523
        $
        159,675
        $
        48,960
        $
        374,158Total additions to property and equipment and other intangibles for the nine months ended September 30, 2006
        $
        162
        $
        2,390
        $
        5
        $
        2,557December 31, 2005:Total assets
        $
        112,828
        $
        197,915
        $
        73,940
        $
        384,683Total additions to goodwill for the yearended December 31, 2005
        $
        
        $
        2,775
        $
        
        $
        2,775Total additions to property and equipmentand other intangibles for the year endedDecember 31, 2005:- through business acquisitions
        $
        
        $
        63,519
        $
        
        $
        63,519- other
        
        615
        
        1,435
        
        
        
        2,050




Included in total assets under the unallocated column are $1,534 (2005 - $14,792) for assets of discontinued operations.

(b)
        Geographic information is as follows:




Property and equipment,Revenues
        goodwill and intangiblesThree months ended
        Nine months endedSeptember 30,
        September 30,
        September 30,
        December 31,2006
        
        2005
        
        2006
        
        2005
        
        2006
        
        2005United States
        $
        27,803
        $
        16,027
        $
        84,036
        $
        41,980
        $
        65,653
        $
        71,769Central America
        
        17,944
        
        14,073
        
        53,564
        
        35,196
        
        
        
        Canada
        
        2,335
        
        2,617
        
        6,837
        
        6,510
        
        44,085
        
        47,699Europe
        
        3,628
        
        1,183
        
        8,806
        
        3,518
        
        348
        
        282Other
        
        1,587
        
        1,854
        
        4,718
        
        5,666
        
        
        
        $
        53,297
        $
        35,754
        $
        157,961
        $
        92,870
        $
        110,086
        $
        119,750






28



---



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per share amounts)



14.
        Segmented information (continued):


(b)
        Geographic information is as follows (continued):


Revenues are attributed to countries based on the location of the customers. The Other caption includes countries in Africa and Asia, as well as Australia.



15.
        Supplemental disclosure of cash flow information:


(a)
        Net change in operating assets and liabilities:




Three months ended
        Nine months endedSeptember 30,
        September 30,2006
        
        2005
        
        2006
        
        2005Cash and short-term investments held as reserves
        $
        1,145
        $
        (1,312)
        $
        211
        $
        (1,871)Settlement assets
        
        (4,060)
        
        2,666
        
        3,834
        
        131Accounts receivable
        
        934
        
        (892)
        
        (2,071)
        
        (2,563)Income taxes receivable and refundable investment tax credits receivable
        
        397
        
        (618)
        
        (1)
        
        (412)Prepaid expenses and deposits
        
        (136)
        
        (442)
        
        (562)
        
        (1,046)Accounts payable and accrued liabilities
        
        2,580
        
        8,935
        
        2,507
        
        7,533Income taxes payable
        
        1,726
        
        1,476
        
        636
        
        7,189Customer reserves and security deposits
        
        (150)
        
        12,225
        
        (13,591)
        
        16,373Net change in operating assets and liabilities
        $
        2,436
        $
        22,038
        $
        (9,037)
        $
        25,334










(b)
        Cash paid for interest and income taxes:




Three months ended
        Nine months endedSeptember 30,
        September 30,2006
        
        2005
        
        2006
        
        2005Cash paid during the period for:Interest
        $
        5
        $
        72
        $
        14
        $
        87Income taxes
        
        2,264
        
        31
        
        5,954
        
        291






29



---



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per share amounts)



15.
        Supplemental disclosure of cash flow information (continued):




(c)
        Non-cash transactions:




Three months ended
        Nine months endedSeptember 30,
        September 30,2006
        
        2005
        
        2006
        
        2005FireOne transaction costs included in accounts payable and accrued liabilities
        $
        99
        $
        558
        $
        99
        $
        558Tax charge in connection with transfer of payments processing business related to online gaming to FireOne
        
        
        
        13,732
        
        
        
        13,732




(d)
        Cash and cash equivalents:




September 30,
        
        December 31,2006
        
        2005Cash and cash equivalents consist of:Cash balances with banks
        
        
        $
        64,291
        $
        55,636Short-term investment, bearing interest at 4.9% to 5.42% (2005 - 3.8% to 4.26%)
        
        
        
        74,254
        
        42,600$
        138,545
        $
        98,236






30



---



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per-share amounts)



16.
        Canada/U.S. reporting differences:


The consolidated financial statements of the Company are prepared in accordance with Canadian generally accepted accounting principles ("GAAP"), which conform, in all material respects, with accounting principles generally accepted in the United States, except as described below:

(a)
        Consolidated Balance Sheets:


Differences between Canadian and U.S. GAAP in the presentation of share capital, additional paid-in capital and retained earnings are as follows:

(i)
        Share capital:




September 30,
        
        December 31,2006
        
        2005Share capital in accordance with Canadian GAAP
        $
        200,465
        $
        195,149Stock-based compensation costs on options exercised(1):Cumulative effect of prior years
        
        39,868
        
        39,868Change in reporting currency (2)
        
        2,588
        
        2,588Share capital in accordance with U.S. GAAP
        $
        242,921
        $
        237,605




(ii)
        Additional paid-in capital:




September 30,
        
        December 31,2006
        
        2005Additional paid-in capital in accordance with Canadian GAAP
        $
        23,161
        $
        25,884Stock-based compensation costs (1):Cumulative effect of prior years
        
        68,757
        
        68,757Stock-based compensation costs on options exercised (1):Cumulative effect of prior years
        
        (39,868)
        
        (39,868)Change in reporting currency (2)
        
        968
        
        968Additional paid-in capital in accordance with U.S. GAAP
        $
        53,018
        $
        55,741






31



---



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per-share amounts)



16.
        Canadian/U.S. reporting differences (continued):


(a)
        Consolidated Balance Sheets (continued):


(iii)
        Deficit:




September 30,
        
        December 31,2006
        
        2005Deficit in accordance with Canadian GAAP
        $
        (7,308)
        $
        (16,259)Stock-based compensation costs(1):Cumulative effect of prior years
        
        (68,757)
        
        (68,757)Stock-based compensation to non-employees (1)
        
        (834)
        
        (834)Change in reporting currency(2)
        
        (1,189)
        
        (1,189)Deficit in accordance with U.S. GAAP
        $
        (78,088)
        $
        (87,039)




(1)
        Stock-based compensation:


For US GAAP purposes, the Company adopted Statement of Financial Accounting Standards (SFAS) No-123R,Share-based Payments, on January 1, 2006, which requires the expensing of all options issued, modified or settled based on the grant date fair value over the period during which the employee is required to provide service.  The Company adopted SFAS 123R using the modified prospective approach, which requires application of the standard to all awards granted, modified or cancelled after January 1, 2006 and to all awards for which the requisite service has not been rendered as at such date.  Previously, effective January 1, 2003, the Company adopted the fair value recognition provisions of SFAS 123.

A description of the Company's stock option plans and FireOne's restricted share unit plan is presented in note 9.

Additional disclosures required under SFAS 123R are as follows:



Terra
        
        FireOneStock
        
        options
        
        restrictedoption
        
        and
        
        shareplan
        
        warrants
        
        unit planAggregate intrinsic value:Options exercised during the period
        $
        3,945
        $
        1,557
        $
        5,626Options outstanding and exercisable
        
        18,606
        
        1,878
        
        7,555






32



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OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per-share amounts)



16.
        Canadian/U.S. reporting differences (continued):


(a)
        Consolidated Balance Sheets (continued):


(iii)
        Deficit (continued):


(1)
        Stock-based compensation (continued):


The aggregate intrinsic value for outstanding and exercisable options at September 30, 2006 represented the pre-tax intrinsic value based on the Company and FireOnes closing stock prices at September 30, 2006, which would have been received by option and restricted stock share unit holders had they exercised their securities at that date.

FireOne granted 1,299,000 restricted share units in the three-month period ended June 30, 2006.  At September 30, 2006, the unrecognized compensation cost related to these non-vested restricted share units was $7,043.  As explained in note 12, all other stock options and restricted share units were fully vested.

(2)
        Change in reporting currency:


In 1998, the Company adopted the U.S. dollar as its reporting currency.  Under Canadian GAAP, at the time of change in reporting currency, the historical financial statements were presented using a translation of convenience.  Under U.S. GAAP, the financial statements, including prior years, are translated according to the current rate method.  Accordingly, the cumulative translation account included as part of shareholders' equity under Canadian GAAP does not exist for U.S. GAAP purposes.

(b)
        Accumulated other comprehensive income (loss):


Under U.S. GAAP, SFAS No. 130,Reporting Comprehensive Incomeestablishes standards for reporting and presentation of comprehensive income and its components in a full set of financial statements.  Comprehensive income consists of net earnings (loss) and all other changes in shareholders' equity that do not result from transactions with shareholders.  These changes include cumulative foreign currency translation adjustments.  The statement requires only additional disclosures in the consolidated financial statements; it does not affect the Company's financial position or results of operations.

Accumulated other comprehensive income (loss), which resulted solely from the translation of the financial statements up to June 30, 2000, the date the Company adopted the United States dollar as its measurement currency, in accordance with the current rate method, is $(3,018) as at September 30, 2006 and December 31, 2005.



33



---



OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements, Continued

(Unaudited)



Nine-month periods ended September 30, 2006 and 2005

(expressed in thousands of U.S. dollars, except share and per-share amounts)



16.
        Canadian/U.S. reporting differences (continued):


(c)
        Supplementary information:


Under U.S. GAAP, separate disclosure is required for the following statement of operations item.  There is no similar requirement under Canadian GAAP.



Three months ended
        Nine months endedSeptember 30,
        September 30,2006
        
        2005
        
        2006
        
        2005Advertising expense
        $
        42
        $
        65
        $
        161
        $
        107




17.
        Comparative figures:


Certain of the comparative figures have been reclassified in order to conform with the current year's presentation.  In addition, in 2006, the Company has separately disclosed the operating, investing and financing portions of the cash flows attributed to its discontinued operations, which in prior periods were reported on a combined basis as a single amount.



18.
        Subsequent event - Renewal of stock buyback program:


On November 6, 2006, the Board of Directors approved a stock buyback program authorizing the Company to purchase 1.1 million of its Class "A" shares.  The Company may purchase the Class "A" shares on the open market through the facilities of the Nasdaq Stock Market over the course of twelve months commencing November 21, 2006 and ending November 20, 2007.  All shares purchased under the stock buyback program will be cancelled.







34



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Item 2. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



The following discussion of the financial condition and results of operations of our company describes our business, our vision and strategy, seasonality and trends within our business environment, the critical accounting policies of our company that will help you understand our interim consolidated financial statements, and the principal factors affecting our results of operations, liquidity and capital resources. This discussion should be read in conjunction with our consolidated financial statements for the year ended December 31, 2005, and the factors set forth below under Cautionary Statements Regarding Forward-Looking Statements. All dollar amounts are expressed in United States dollars (unless otherwise stated) and, other than those expressed in millions of dollars, have been rounded to the nearest thousand. We prepare our interim consolidated financial statements in
accordance with generally accepted accounting principles (GAAP) in Canada, with a reconciliation to U.S. GAAP, as disclosed in note 16 of the notes to our interim consolidated financial statements. Any reference in this report to uniform resource locator (URL) website locations are inactive textual references only and the contents of such websites do not form a part of this Form 10-Q.



Cautionary Statements Regarding Forward-Looking Statements



This Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.Words such as expects, intends, anticipates, plans, believes, seeks, estimates, or variations of such words and similar expressions are intended to identify such forward-looking statements. Forward-looking statements include, but are not limited to, statements about our current expectations with respect to our future growth strategies, opportunities and prospects, competitive position and industry environment. These forward-looking statements are subject to a number of risks, uncertainties and other factors that could cause our actual results, performance, prospects or opportunities,
or those of the markets we serve, to differ materially from those expressed in, or implied by, these forward-looking statements, including:




        existing and future governmental regulations;





        general economic and business conditions in the markets we serve;





        consumer confidence in the security of financial information transmitted via the Internet;





        levels of consumer and merchant fraud, disputes between consumers and merchants and merchant insolvency;





        our ability to safeguard against breaches of privacy and security when processing electronic transactions;





        the imposition of and our compliance with rules and practice procedures implemented by credit card and check clearing associations;





        our ability to adapt to changes in technology, including technology relating to electronic payments systems;





        our ability to protect our intellectual property;





        our relationships with our suppliers and the banking associations that we rely upon to process our electronic transactions;




35



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
        disruptions in the function of our electronic payments systems and technological defects; and





        the factors described under Item 1A Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2005, as amended below in Part II at Item 1A.




There may be additional risks and uncertainties and other factors that we do not currently view as material or that are not necessarily known. The forward looking statements made in this document are only made as of the date of this document.



Except as required by applicable securities laws, we undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, changes in circumstances or any other reason after the date of this quarterly report.



The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements to encourage companies to provide prospective information about their companies without fear of litigation. We are relying on the safe harbor provisions of the Private Securities Litigation Reform Act in connection with the forward-looking statements included in this quarterly report.



Overviewand Recent Developments



We are a payments company with operations throughout North America, the United Kingdom and Ireland.  We operate in two segments.  Through Optimal Payments (a segment comprised of Optimal Payments Inc. and its subsidiaries), we process credit card payments for small and medium-sized Internet businesses, mail-order/telephone-order merchants and retail point-of-sale merchants, and process electronic checks and direct debits online and by telephone. Through FireOne Group (a segment comprised of FireOne Group plc (London/AIM: FPA.L) and its subsidiaries), we process online gaming transactions through the use of credit and debit cards, electronic debit and through FirePay (www.firepay.com), a leading stored-value, electronic wallet. FireOne Group offers FirePay for non-gaming purchases as well.



On October 13, 2006, the United States Unlawful Internet Gambling Enforcement Act of 2006 was enacted.  Upon the passage of the Act, our FireOne Group business segment ceased processing settlement transactions originating from United States customers that may be viewed as related to online gaming.  Although FireOne Group continues to process online gaming transactions originating from non-U.S. consumers, the cessation of this portion of FireOne Groups business will have a material adverse effect on our revenues and our results of operations for at least the short-term.  See Outlook - Impact of the United States Unlawful Internet Gambling Enforcement Act of 2006.



On September 30, 2006, we sold substantially all of the assets and the business of our hardware maintenance and repair outsourcing services business segment, operated by Optimal Services Group Inc., which resulted in a loss of $4.3 million that is more fully discussed in note 5 (b) to our interim consolidated financial statements. The net loss of Optimal Services Group Inc. for the three and nine months ended September 30, 2006 were $2.5 and $8.0 million, respectively, and is being treated as discontinued operations on the interim consolidated statement of operations.



On October 6, 2005, we acquired a portfolio of U.S. merchant processing contracts and associated sales channel contracts from Moneris Solutions, Inc. for a cash consideration of $18.3 million.



36



---





On May 11, 2005 our assets relating to the processing of online gaming transactions were transferred to FireOne Group. On June 2, 2005, FireOne Group plc, our Irish-based subsidiary, commenced trading on the London Stock Exchanges AIM Market under the ticker symbol FPA following the successful public placement by us of 10 million FireOne Group plc ordinary shares, representing 20% of FireOne Group plcs issued and outstanding share capital.  As at September 30, 2006 our interest in FireOne Group plc was approximately 75.9%, reflecting the dilution resulting from the vesting of restricted share units that had been issued by FireOne Group plc.



On May 6, 2005, we acquired a portfolio of merchant processing accounts from United Bank Card, Inc. for a cash consideration of $44.3 million.



On January 1, 2005, we acquired the operating assets of Merchant Card Acceptance Corp. and affiliated companies, Precision Management Consulting Inc. and Merchant Card Interactive Corp., for approximately $3.7 million, subject to the determination of certain post-closing adjustments. Merchant Card Acceptance is an independent sales organization providing Canadian-based merchants with credit card and Interac PIN-based debit card acceptance.



Optimal Payments and FireOne Group



Optimal Payments and FireOne Group provide technology and services that businesses require to accept credit card, electronic check and direct debit payments.



Optimal Payments processes credit card payments for card-not-present and card-present transactions, including Internet businesses, mail-order/telephone-order (MOTO) merchants, and retail point-of-sale merchants. Optimal Payments also processes checks and direct debits online and by telephone.



FireOne Group processes online gaming transactions originating from non-U.S. consumers and not prohibited by the United States Unlawful Internet Gambling Enforcement Act of 2006, through the use of credit and debit cards, electronic debit and through FirePay, a leading stored-value, electronic wallet.  FireOne Group offers FirePay for non-gaming purchases as well.  FireOne Group began operations on May 11, 2005. Prior to that date, Optimal Payments Inc. and its subsidiaries carried out our activities relating to online gaming payment transaction processing.



Our payments businesses, Optimal Payments and FireOne Group, generate revenues primarily from fees charged to merchants for processing services, as well as, in the case of FireOne Group, from fees charged to consumers who utilize FireOne Groups FirePay wallet. Fees charged to merchants typically include a discount rate, based upon a percentage of the dollar amounts processed, and a variety of fixed transaction fees. Merchant fees charged are based upon the merchants transaction volume and risk profile. Higher discount rates are charged for card-not-present transactions than for card-present transactions in order to compensate for the higher cost of underwriting and managing the increased risk of fraud associated with these transactions.  Other fees are derived from a variety of fixed transaction fees, including set-up fees, fees for monthly minimum charge volume requirements,
statement fees, annual fees and fees for other miscellaneous items, such as handling chargebacks.  Fees charged to FireOne Groups FirePay consumers are based on a fixed amount per transaction. Revenue is recognized primarily at the time the transaction is performed. Where we are the primary party responsible for providing processing services, revenue is recorded on a gross basis and amounts paid to the acquiring processing supplier are recorded as part of our transaction processing expenses. FireOne Groups revenues are recorded on a gross basis. Where Optimal Payments is not the primary party in providing a merchant with processing services, Optimal Payments records revenue net of amounts paid to the acquiring processing supplier.



37



---



Disputes between a customer and a merchant periodically arise as a result of, among other things, consumer dissatisfaction with merchandise quality or merchant services.  Such disputes may not always be resolved in the merchants favor.  If a dispute is not resolved in the merchants favor, the transaction is charged back to us and the purchase price is refunded to the merchants customer. If we are unable to collect the disputed amount from the merchant, we bear the credit risk for the full amount of the transaction. As a result, our acquiring processing suppliers require us to maintain certain amounts with them as reserves. Amounts withheld from us by our acquiring processing suppliers as reserves are included as current assets on our balance sheet under held as reserves.  We retain a percentage of amounts owed to certain merchants based on processing dollar
volume, typically for a six-month period, to absorb potential losses arising as a result of, among other things, disputes between consumers and merchants or credit card or check clearing association fines related to disputes. The aggregate amount withheld from our merchants is recorded under the line item Customer reserves and security deposits on the balance sheet contained in our interim consolidated financial statements.



Seasonality



The payment processing segments (gaming and non-gaming) experience some seasonality. Less time is spent online during certain periods that straddle spring and summer months, which results in relatively lower processing volume.



Critical Accounting Policies and Estimates



The accompanying interim consolidated financial statements have been prepared in accordance with Canadian GAAP. In the preparation of our financial statements we are required to make numerous estimates and assumptions. Financial results as determined by actual events could differ from those estimates and assumptions, and therefore affect our reported results of operations and financial position. Our significant accounting policies are more fully described in note 3 of our annual audited consolidated financial statements included in our Form 10-K Annual Report for the year ended December 31, 2005. The critical accounting policies described here are those that are most important to the depiction of our financial condition and results of operations. They also reflect significant management judgment in making estimates about the effect of matters that are inherently uncertain. While best
estimates have been used for reporting financial statement items subject to measurement uncertainty, management considers that it is possible, based on existing knowledge, that changes in future conditions in the near term could require a material reduction in the recognized amounts of certain assets. Near term is considered to be within one year from the date of financial statements.



Stock-based Compensation



We use the fair value-based method to account for stock-based compensation and other stock-based payments, such as stock options and restricted share units. Under the fair value-based method, compensation cost is measured at fair value at the date of grant and is expensed over the awards vesting period. The fair value of stock options granted is determined at the date of grant using generally accepted valuation methods such as the Black-Scholes option pricing model. We must make certain assumptions in determining the fair value of stock options, including the volatility of the trading price of our common shares, the future dividend yield on our common shares, and the term over which stock options will remain outstanding.



38



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Provision for Customer Losses



When a consumer pays a merchant for goods or services using a credit card and the consumer disputes the charge, the amount of the disputed item is charged back to us and the credit card association may levy a fee against us. In addition, if our chargeback rate becomes excessive, credit card associations can also require us to pay fines. In turn, we attempt to recover from the merchant the disputed amount and the amount of such fines. However, we may not always be successful in doing so for reasons which could include merchant insolvency. In addition, we record a provision for losses pertaining to the guaranteed FirePay wallet offering.  We evaluate the risk associated with merchants and FirePay consumers and estimate our loss based primarily on historical experience and other relevant factors, such as the enactment of the Unlawful Internet Gambling Enforcement Act of 2006.



Goodwill and Other Intangibles



Goodwill is not amortized but rather evaluated under an impairment assessment approach. Other intangible assets with finite lives continue to be amortized over their estimated useful lives. The amounts recorded as intangible assets at the date of acquisition represent the estimated fair value of these assets based on estimated future cash flows discounted at appropriate discount rates. In addition, in our assessment of impairment, we are required to determine the fair value of the businesses acquired from which the goodwill and intangibles originated. For intangibles with finite lives, we make estimates of future cash flows to be generated from the related assets.



Income Taxes



We provide for income taxes using the asset and liability method of tax allocation. Under this method, future income tax assets and liabilities are estimated based on deductible or taxable temporary differences between financial statement values and tax values of assets and liabilities using substantively enacted income tax rates expected to be in effect for the year in which the differences are expected to reverse. We establish a valuation allowance against future income tax assets if, based on available information, it is more likely than not that some or all of the future income tax assets will not be realized.



Discontinued Operations



At the end of the first quarter of 2006, we decided to divest the hardware maintenance and repair outsourcing services business segment. The net assets of these operations were written down in the third and fourth quarters of 2005 to their estimated fair values less disposal costs and the results of operations and financial position of this segment have been segregated for the current and comparative periods as discontinued operations. On September 30, 2006, we divested this business segment. The loss resulting from this divestiture is presented as disposal of discontinued operations on the interim consolidated statements of operations.



Recent Accounting Pronouncements



In 2006, we adopted the new recommendations of the Canadian Institute of Chartered Accountants ("CICA") relating to non-monetary transactions, which require non-monetary transactions to be measured at fair value, subject to certain exceptions.  The revised standards were effective for non-monetary transactions initiated in fiscal periods beginning on or after January 1, 2006.  The CICA has also issued standards relating toFinancial Instruments, Hedges, Comprehensive Income and Equitythat we will adopt on January 1, 2007.  In addition, the Financial Accounting Standards Board ("FASB") recently issued FAS 123R,Share Based Payments, and FAS 154Accounting Changes and Accounting Corrections.We adopted FAS 123R on January 1, 2006 for U.S. GAAP
purposes. Refer to note 16 of the interim consolidated financial statements.



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The adoption of the new standards did not have a material effect on our interim consolidated financial statements as at September 30, 2006. In addition, we do not expect the adoption of the standards (effective January 1, 2007) to have a material effect on our consolidated financial statements.



Financial Condition



As at September 30, 2006, cash, cash equivalents, short-term investments and settlement assets totaled $237.1 million (including $25.5 million held as reserves), compared to $227.1 million as at December 31, 2005 (including $25.7 million held as reserves). The increase in cash, short-term investments and settlement assets is primarily due to cash generated from operations and proceeds from the issuance of common shares, partially offset by the portion of the FireOne Group plc dividends paid to minority shareholders in the quarters ended June 30, 2006 and September 30, 2006, the repurchase of our common shares, and the net change in operating assets and liabilities. As described above, a significant portion of cash, cash equivalents, and short-term investments have a corresponding liability as these cash amounts are derived from reserves and security deposits which are due to merchants
(see "Optimal Payments and FireOne Group"). Settlement assets result from timing differences in the settlement process of our payment processing business segments. Settlement assets are typically funded to us within days from the transaction processing date. As at September 30, 2006, our cash, short-term investments and settlement assets positions, net of bank indebtedness and customer reserves and security deposits, were as follows:



September 30,
        December 31,(U.S. dollars, in thousands)
        2006
        2005Cash and cash equivalents
        $
        138,545
        $
        98,236Cash held as reserves
        
        21,015
        
        22,722Short-term investments
        
        56,110
        
        82,361Short-term investments held as reserves
        
        4,510
        
        3,014Settlement assets
        
        16,894
        
        20,727237,074
        
        227,060Less:Bank indebtedness
        
        (7,324)
        
        (8,390)Customer reserves and security deposits
        
        (98,831)
        
        (112,422)Net
        $
        130,919
        $
        106,248




Our portfolio of liquid and investment grade short-term investments consists of U.S. and Canadian dollar denominated discounted and undiscounted notes and bonds.



Working capital, excluding cash and short-term investments held as reserves, as at September 30, 2006 was $82.6 million, as compared to $61.9 million at December 31, 2005.



Accounts receivable as at September 30, 2006 were $7.0 million compared to $4.7 million at December 31, 2005. The increase of $2.3 million resulted primarily from the timing of the collection of certain transaction processing revenues, as well as an increase in the amount recognized pertaining to the recovery of defaulted consumer transactions in our FireOne Group business segment.



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Goodwill and other intangible assets decreased by $9.5 million, from $117.1 million as at December 31, 2005 to $107.6 million as at September 30, 2006. This decrease resulted from the recognition of impairment losses of $1.9 million due to the enactment of the United States Unlawful Internet Gambling Enforcement Act of 2006 as well as amortization expense recorded on intangible assets for the period of approximately $9.2 million, offset by the acquisition of certain customer relationships in the Optimal Payments business segment. Significantly greater impairment losses were recorded in the third quarter results of FireOne Group plc, related to the value of its intangibles and goodwill that we had not previously recognized.



Customer reserves and security deposits as at September 30, 2006 were $98.8 million compared to $112.4 million as at December 31, 2005. The decrease of $13.6 million resulted primarily from the timing of payments to merchants at period-end. Customer reserves and security deposits were $16.3 million for the Optimal Payments business segment and $82.5 million for the FireOne Group business segment.



Shareholders equity as at September 30, 2006 was $214.8 million as compared to $203.3 million as at December 31, 2005. The increase is attributable primarily to the results of operations and the issuance of share capital resulting from the exercise of stock options.



Results of Operations



The following comments must be read in the context of the discussion appearing elsewhere in this Form 10-Q regarding the enactment of the United States Unlawful Internet Gambling Enforcement Act of 2006. As indicated, we expect our consolidated revenues and net earnings to decrease substantially in the fourth quarter of 2006 and fiscal 2007 as a result of the Acts impact on our FireOne Group business segment. Online gaming transactions originating from U.S. customers accounted for 83% and 84% of FireOne Groups revenues for the three and nine-month periods ended September 30, 2006. In addition, the FireOne Group business segment represented approximately 95% of our pre-tax consolidated earnings before discontinued operations for the nine-month period ended September 30, 2006. We recorded and will record a number of provisions and impairment losses as a result of the enactment of the Act. See
Overview and Recent Developments.



Nine-month period ended September 30, 2006 compared to the nine-month period ended September 30, 2005



Revenues increased by $65.1 million from $92.9 million for the nine-month period ended September 30, 2005 to $158.0 million for the nine-month period ended September 30, 2006. The increase in revenues is due primarily to the organic growth of both the Optimal Payments and the FireOne Group business segments as well as the following acquisitions, which were completed during fiscal 2005:




        On May 6, 2005, Optimal Payments acquired a portfolio of U.S. merchant processing from United Bank Card, Inc.; and



        On October 6, 2005, Optimal Payments acquired a portfolio of U.S. merchant processing contracts and associated sales channel contracts from Moneris Solutions, Inc.


Transaction processing expenses increased by $35.0 million, from $41.4 million for the nine-month period ended September 30, 2005 to $76.4 million for the nine-month period ended September 30, 2006. This increase is due primarily to increased transaction processing activity resulting from the organic growth of both the Optimal Payments and the FireOne Group business segments and the acquisitions described above.



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Selling, general and administrative expenses increased by $17.7 million, from $23.8 million for the nine-month period ended September 30, 2005 to $41.5 million for the nine-month period ended September 30, 2006. The increase in selling, general and administrative expenses resulted from the acquisitions described above, and the organic growth in both the Optimal Payments and FireOne Group business segments.



Amortization of intangibles pertaining to transaction processing increased by $4.4 million, from $4.8 million for the nine-month period ended September 30, 2005 to $9.2 million for the nine-month period ended September 30, 2006. The increase in amortization is due primarily to the intangible assets acquired through the acquisitions described above.



The enactment of the United States Unlawful Internet Gambling Enforcement Act of 2006 has reduced the expected cash flows from customer relationships related to the FireOne Group business segment, and resulted in our recognition of impairment losses of $1.9 million.



Stock-based compensation pertaining to selling, general and administrative expense is attributable to the accounting for the fair value of stock options that we have granted and restricted share units that have been awarded by FireOne Group plc. Stock-based compensation for the nine-month period ended September 30, 2006 decreased by $6.3 million to $1.0 million compared to $7.3 million for the nine-month period ended September 30, 2005. This decrease resulted primarily from our decision taken in the fourth quarter of 2005 to accelerate the vesting of all unvested stock options outstanding under our stock option plan and the concurrent decision of FireOne Group plc to accelerate the vesting of all unvested restricted share units outstanding under its restricted share unit plan. During the second quarter of 2006 FireOne Group plc issued approximately 1.3 million restricted share units
which accounted for the stock-based compensation of $1.0 million. These restricted share units vest over a period of three years following their date of grant.



Research and development expenses increased by $0.6 million from $1.9 million for the nine-month period ended September 30, 2005 to $2.5 million for the nine-month period ended September 30, 2006. Research and development expenses pertain mainly to the Optimal Payments business segment, and are comprised primarily of personnel-related expenditures associated with the development of new solutions and the enhancement of existing offerings.



Amortization of property and equipment remained constant for the nine-month periods ended September 30, 2005 and 2006.



The provision for income taxes was $1.2 million for the nine-month period ended September 30, 2006 compared to $7.7 million for the nine-month period ended September 30, 2005. Excluding the effect of the sale of our interest in FireOne Group plc in 2005, the effective tax rate is lower in the nine months ended September 30, 2006 compared to 2005. In 2006, a significant portion of income is taxable in Ireland, which has a lower effective tax rate than Canada, as a result of the transfer of the assets related to the processing of online gaming transactions to FireOne Group in May 2005 (see Overview and Recent Developments). For the comparable period in 2005, a significant portion of operations was taxable at Canadian rates.  We recorded a change of  $3.0 million in the valuation allowance in the nine-month period ended September 30, 2006, primarily due to the recognition of
previously unrecognized tax assets in the Optimal Payments business segment. We determined that the criteria for recognition of these assets was met at September 30, 2006. The change in the valuation allowance of $10.7 million recorded in 2005 consisted primarily of the recognition of previously unrecognized tax assets in connection with the sale of our FireOne Group interest. In addition, the 2005 tax provision included the effect of non-deductible stock-based compensation in the amount of $2.3 million compared to $0.2 million in 2006. The reduction is due to the decrease in stock-based compensation in 2006 compared to 2005.



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Our tax provision also includes the effect of future taxes on unrealized foreign exchange gains and losses, which arise upon the conversion into Canadian dollars of net monetary assets and liabilities denominated in U.S. dollars for purposes of determining taxable income under Canadian income tax regulations. Since the U.S. dollar is our measurement currency and our consolidated financial statements are presented in U.S. dollars, these foreign exchange gains/losses do not affect earnings before income taxes. In 2006, our tax provision includes a future tax recovery of $1.7 million related to unrealized foreign exchange compared to a recovery of $2.0 million for 2005.



We recorded a charge of $5.5 million for the non-controlling interest in the results of operations of FireOne Group in the nine-month period ended September 30, 2006 compared to $1.7 million in 2005. The increase is due primarily to the establishment of FireOne Group plc on May 11, 2005.



Our earnings from continuing operations for the nine-month period ended September 30, 2006 were $22.3 million (or $0.95 per share - basic and $0.87 per share - diluted), compared to net earnings from continuing operations of $34.4 million (or $1.51 per share - basic and $1.38 per share - diluted) for the nine-month period ended September 30, 2005, which includes a gain on our sale of an interest in FireOne Group plc of approximately $30.4 million. After accounting for losses from discontinued operations, as well as the loss on disposal of discontinued operations, our net earnings for the nine-month period ended September 30, 2006 were $10.0 million (or $0.43 per share - basic and $0.39 per share - diluted), compared to $21.2 million (or $0.93 per share - basic and $0.85 per share - diluted) for the nine-month period ended September 30, 2005, which includes a gain on our sale of an
interest in FireOne Group plc of approximately $30.4 million. The loss from discontinued operations includes restructuring charges primarily relating to the shut-down of the facilities, provision for severance, future lease costs and the write-down of inventory.



Adjusted earnings were $25.7 million (or $1.09 per share  basic and $1.00 per share  diluted) for the nine-month period ended September 30, 2006 compared to $11.9 million (or $0.52 per share  basic and $0.48 per share  diluted) for the nine-month period ended September 30, 2005. A reconciliation of this non-GAAP financial information is presented in the table below. We supplement our reporting of net earnings determined in accordance with Canadian and U.S. GAAP by reporting adjusted earnings as a measure of earnings. In establishing this supplemental measure of earnings, we exclude from net earnings foreign exchange gains and losses, impairment losses, discontinued operations (including restructuring costs), and stock-based compensation expense, as well as the gain on sale of interest in FireOne Group plc. We believe that adjusted earnings is useful to
investors as a measure of our earnings  because it is, for us, a primary measure of our growth and performance, and provides a more meaningful reflection of underlying trends of our business.



Adjusted earnings include the results of gaming transaction processing affected by the enactment of the United States Unlawful Internet Gambling Enforcement Act of 2006.



Adjusted earnings (loss) does not have a standardized meaning under Canadian or U.S. GAAP and therefore should be considered in addition to, and not as a substitute for, earnings (loss) from continuing operations before income taxes and non-controlling interest or any other amount determined in accordance with Canadian and U.S. GAAP. Our measure of adjusted earnings (loss) reflects our judgment in regard to the impact of particular items on our core operations, and may not be comparable to similarly titled measures reported by other companies.





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Reconciliation of Non-GAAP Financial Information(expressed in thousands of U.S. dollars)Nine months endedSeptember 30,2006
        
        2005Net earnings
        $
        10,026
        $
        21,220Add :Foreign exchange
        
        493
        
        577Stock-based compensation
        
        1,006
        
        7,318Impairment loss
        
        1,910
        
        -Gain on sale of interest in FireOne
        
        -
        
        (30,411)Loss from discontinued operations(including restructuring costs of $3,414 and 2005 - $266)
        
        7,990
        
        13,211Loss on disposal of discontinued operations
        
        4,283
        
        -Adjusted earnings
        $
        25,708
        $
        11,915




Results of Operations



Three-month period ended September 30, 2006 compared to the three-month period ended September 30, 2005



Revenues increased by $17.5 million from $35.8 million for the three-month period ended September 30, 2005 to $53.3 million for the three-month period ended September 30, 2006. The increase in revenues is due primarily to the organic growth of both the Optimal Payments and the FireOne Group business segments as well as the following acquisition, which was completed during fiscal 2005:




        On October 6, 2005, Optimal Payments acquired a portfolio of U.S. merchant processing contracts and associated sales channel contracts from Moneris Solutions, Inc.


Transaction processing expenses increased by $11.2 million, from $15.2 million for the three-month period ended September 30, 2005 to $26.4 million for the three-month period ended September 30, 2006. This increase is due primarily to increased transaction processing activity resulting from the organic growth of both the Optimal Payments and the FireOne Group business segments and the acquisition described above.



Selling, general and administrative expenses increased by $5.8 million, from $9.2 million for the three-month period ended September 30, 2005 to $15.0 million for the three-month period ended September 30, 2006. The increase in selling, general and administrative expenses resulted from the acquisition described above, and the organic growth in both the Optimal Payments and FireOne Group business segments.



Amortization of intangibles pertaining to transaction processing increased by $0.8 million, from $2.3 million for the three-month period ended September 30, 2005 to $3.1 million for the three-month period ended September 30, 2006. The increase in amortization is due primarily to the intangible assets acquired through the acquisition described above.



The enactment of the United States Unlawful Internet Gambling Enforcement Act of 2006 has reduced the expected cash flows from customer relationships related to the FireOne Group business segment, and resulted in our recognition of impairment losses of $1.9 million.



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Stock-based compensation pertaining to selling, general and administrative expense is attributable to the accounting for the fair value of stock options and restricted share units granted. Stock-based compensation for the three-month period ended September 30, 2006 decreased by $2.5 million to $0.7 million compared to $3.2 million for the three-month period ended September 30, 2005. This decrease resulted primarily from our decision taken in the fourth quarter of 2005 to accelerate the vesting of all unvested stock options outstanding under our stock option plan and the concurrent decision of FireOne Group plc to accelerate the vesting of all unvested restricted share units outstanding under its restricted share unit plan. During the second quarter of 2006 FireOne Group plc issued approximately 1.3 million restricted share units which accounted for the stock-based compensation of $0.7
million. These restricted share units vest over the period of three years following their date of grant.



Research and development expenses increased by $0.2 million, from $0.6 million for the three-month period ended September 30, 2005 to $0.8 million for the three-month period ended September 30, 2006. Research and development expenses pertain mainly to the Optimal Payments business segment, and are comprised primarily of personnel-related expenditures associated with the development of new solutions and the enhancement of existing offerings.



Amortization of property and equipment remained constant for the three-month periods ended September 30, 2005 and 2006.



The provision for income taxes consists of a recovery of $3.0 million for the three-month period ended September 30, 2006 compared to a charge of $1.4 million for the three-month period ended September 30, 2005. The effective tax rate is lower in the three months ended September 30, 2006 compared to 2005. In 2006, a significant portion of income is taxable in Ireland, which has a lower effective tax rate than Canada, as a result of the transfer of the assets related to the processing of online gaming transactions to FireOne Group in May 2005 (see Overview and Recent Developments). For the comparable period in 2005, a significant portion of operations was taxable at Canadian rates.  We recorded a change of $3.5 million in the valuation allowance in the three-month period ended September 30, 2006, primarily due to the recognition of previously unrecognized tax assets in the
Optimal Payments business segment. We determined that the criteria for recognition of these assets was met at September 30, 2006. In addition, the 2005 tax provision included the effect of non-deductible stock-based compensation in the amount of $0.8 million compared to $0.2 million in 2006. The reduction is due to the decrease in stock-based compensation in 2006 compared to 2005.



Our tax provision also includes the effect of future taxes on unrealized foreign exchange gains and losses, which arise upon the conversion into Canadian dollars of net monetary assets and liabilities denominated in U.S. dollars for purposes of determining taxable income under Canadian income tax regulations. Since the U.S. dollar is our measurement currency and our consolidated financial statements are presented in U.S. dollars, these foreign exchange gains/losses do not affect earnings before income taxes. In 2006, our tax provision includes a future tax recovery of $0.5 million related to foreign exchange compared to a recovery of $2.2 million for 2005.



We recorded non-controlling interest of $1.4 million for the three-month period ended September 30, 2006 compared to $1.5 million for the three-month period ended September 30, 2005.



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Our earnings from continuing operations for the three-month period ended September 30, 2006 were $8.7 million (or $0.37 per share - basic and $0.34 per share - diluted), compared to net earnings from continuing operations of $2.3 million (or $0.10 per share - basic and $0.09 per share - diluted) for the three-month period ended September 30, 2005. After accounting for losses from discontinued operations, as well as the loss on disposal of discontinued operations, our net earnings for the three-month period ended September 30, 2006 were $1.9 million (or $0.08 per share - basic and diluted), compared to $0.4 million (or $0.02 per basic and diluted share) for the three-month period ended September 30, 2005. Loss from discontinued operations includes a restructuring charge related to the disposal of the hardware maintenance and repair outsourcing services business segment.



Adjusted earnings were $11.3 million (or $0.48 per share  basic and $0.44 per share  diluted) for the three-month period ended September 30, 2006 compared to $6.2 million (or $0.27 per share  basic and $0.24 per share  diluted) for the three-month period ended September 30, 2005. A reconciliation of this non-GAAP financial information is presented in the table below. We supplement our reporting of net earnings determined in accordance with Canadian and U.S. GAAP by reporting adjusted earnings as a measure of earnings. In establishing this supplemental measure of earnings, we exclude from net earnings foreign exchange gains and losses, impairment losses, discontinued operations (including restructuring costs), and stock-based compensation expense. We believe that adjusted earnings is useful to investors as a measure of our earnings  because it is, for
us, a primary measure of our growth and performance, and provides a more meaningful reflection of underlying trends of our business.



Adjusted earnings include the results of gaming transaction processing affected by the enactment of the United States Unlawful Internet Gambling Enforcement Act of 2006.



Adjusted earnings (loss) does not have a standardized meaning under Canadian or U.S. GAAP and therefore should be considered in addition to, and not as a substitute for, earnings (loss) from continuing operations before income taxes and non-controlling interest or any other amount determined in accordance with Canadian and U.S. GAAP. Our measure of adjusted earnings (loss) reflects our judgment in regard to the impact of particular items on our core operations, and may not be comparable to similarly titled measures reported by other companies.



Reconciliation of Non-GAAP Financial Information(expressed in thousands of U.S. dollars)Three months endedSeptember 30,2006
        
        2005Net earnings
        $
        1,946
        $
        467Add :Foreign exchange
        
        11
        
        444Stock-based compensation
        
        671
        
        3,211Impairment loss
        
        1,910
        
        -Loss on sale of interest in FireOne
        
        -
        
        167Loss from discontinued operations(including restructuring costs of $1,031; 2005 - Nil)
        
        2,489
        
        1,879Loss on disposal of discontinued operations
        
        4,283
        
        -Adjusted earnings
        $
        11,310
        $
        6,168








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Liquidity and Capital Resources



As at September 30, 2006, cash, cash equivalents, short-term investments and settlement assets totaled $237.1 million (including $25.5 million held as reserves), compared to $227.1 million as at December 31, 2005 (including $25.7 million held as reserves). Working capital, excluding cash and short-term investments held as reserves, as at September 30, 2006 was $82.6 million (December 31, 2005  $61.9 million). As previously described, a significant portion of cash, cash equivalents, and short-term investments have a corresponding liability as these amounts are derived from reserves and security deposits which are due to merchants (see "Optimal Payments and FireOne Group").

Settlement assets result from timing differences in the settlement process of our payment processing business segments. Settlement assets are typically funded to us within days from the transaction processing date.

As at September 30, 2006, our cash, short-term investments and settlement assets positions, net of bank indebtedness and customer reserves and security deposits, were $130.9 million (see "Financial Condition" above).

Operating activities generated $23.8 million of cash and cash equivalents in the nine-month period ended September 30 2006, as compared to $46.4 million for the nine-month period ended September 30, 2005. The decrease in cash generated in the current period is as a result of decreased earnings from continuing operations and changes in operating assets.



Financing activities used $3.7 million of cash for the nine-month period ended September 30, 2006 compared to generating of $4.5 million for the nine-month period ended September 30, 2005.  Financing activities in 2006 include the portion of the dividends paid by FireOne Group plc that we did not retain, in the aggregate amount of $4.8 million; the repurchase of Class A shares, which used $2.3 million; a reduction of cash received from the issuance of Class A shares, in the amount of $2.6 million; and a reduction in the amount paid to reduce bank indebtedness.



Investing activities generated $24.0 million of cash for the nine-month period ended September 30, 2006 compared to $49.6 million of cash generated for the nine-month period ended September 30, 2005. In 2006, the amount generated represents primarily proceeds from the maturity of short-term investments. In 2005 we received $44.1 million from the proceeds of the sale of an interest in FireOne Group plc.



We believe that our cash, cash equivalents and short-term investments will be adequate to meet our needs for at least the next 12 months.



We have no financial obligations of significance, including any off-balance sheet arrangements, other than long-term lease commitments for our premises in the United States, United Kingdom, Ireland and Canada, and bank indebtedness of $7.3 million as at September 30, 2006.



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Outlook - Impact of the United States Unlawful Internet Gambling Enforcement Act of 2006



On October 13, 2006, the United States Unlawful Internet Gambling Enforcement Act of 2006 was enacted.  The Act prohibits any person engaged in the business of betting or wagering from knowingly accepting payments related to unlawful bets or wagers transmitted over the Internet.  The Act instructs the U.S. Treasury Department and Federal Reserve to impose new obligations upon financial institutions and other payment processors to establish procedures designed to block Internet gambling-related financial transactions.  It also expressly requires Internet bets and wagers to comply with the law of the jurisdiction where the wagers are initiated and received. Upon the passage of the Act, our FireOne Group business segment ceased processing settlement transactions originating from United States customers that may be viewed as related to online gaming.  Although FireOne Group continues to
process online gaming transactions originating from non-U.S. consumers, the cessation of this portion of FireOne Groups business will have a material adverse effect on our revenues and our results of operations for at least the short-term. FireOne groups total revenues in the third quarter accounted for approximately 49% of our consolidated revenues of $53.3 million and we expect that our consolidated revenues and net earnings will decrease substantially in the fourth quarter of 2006 and fiscal 2007 as a result of the Acts impact on our FireOne Group business segment. Online gaming transactions originating from U.S. consumers accounted for 83% and 84% of FireOne Groups revenues for the three and nine-month periods ended September 30, 2006. In addition, we have embarked upon a restructuring of our operations and cost base and as a result we expect to record a restructuring charge in the fourth quarter for associated costs, such as employee termination benefits
and cost of leased premises no longer utilized, in the range of $2.0 to $2.5 million. We intend to actively pursue opportunities to replace the revenues that were lost due to FireOne Groups cessation of processing transactions originating from U.S. consumers. However, we may not be able to identify and engage in other opportunities that will offset the loss of these revenues.







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Item 3.
        Quantitative and Qualitative Disclosures About Market Risk




There have been no material changes to the disclosures about market risk contained in our Annual Report on Form 10-K for the year ended December 31, 2005.



Item 4.
        Controls and Procedures




As of September 30, 2006 (the Evaluation Date), under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rule 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act).  Based upon this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms.



Additionally, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we concluded that there have been no changes in our internal control over financial reporting during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.







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PART II. OTHER INFORMATION



Item 1. Legal Proceedings



There were no material changes to the disclosure of legal proceedings contained in our Annual Report on Form 10-K for the year ended December 31, 2005.



Item 1A. Risk Factors



There were no material changes to the disclosure of risk factors contained in our Annual Report on Form 10-K for the year ended December 31, 2005, except as follows:



Due to recently enacted legislation in the United States, we have ceased processing settlements for online gaming transactions originating from United States customers and, as a result, our revenues will decrease significantly and our business and results of operations will be materially adversely affected during at least the short-term. We may not be able to replace the revenues lost from the cessation of this business.



On October 13, 2006, the United States Unlawful Internet Gambling Enforcement Act of 2006 was enacted.  The Act prohibits any person engaged in the business of betting or wagering from knowingly accepting payments related to unlawful bets or wagers transmitted over the Internet.  The Act also instructs the U.S. Treasury Department and Federal Reserve to impose new obligations upon financial institutions and other payment processors to establish procedures designed to block Internet gambling-related financial transactions.  It also expressly requires Internet bets and wagers to comply with the law of the jurisdiction where the wagers are initiated and received. Upon passage of the Act, our FireOne Group business segment ceased processing settlement transactions originating from United States customers that may be viewed as related to online gaming.  Although FireOne Group continues to
process online gaming transactions originating from non-U.S. consumers, the cessation of this portion of FireOne Groups business will have a material adverse effect on our revenues and our results of operations for at least the short-term.  Online gaming transactions originating from U.S. consumers accounted for 83% and 84% of FireOne Groups revenues for the three and nine-month periods ended September 30, 2006. FireOne Groups total revenues in the third quarter accounted for approximately 49% of our consolidated revenues of $53.3 million, and we expect that our consolidated revenues and net earnings will decrease substantially in the fourth quarter of 2006 and fiscal 2007 as a result of the Acts impact on our FireOne Group business segment. We intend to actively pursue opportunities to replace the revenues that were lost due to FireOne Groups cessation of processing transactions originating from U.S. consumers. However, we may not be able to identify and
engage in other opportunities that will offset the loss of these revenues.



The legal status of Internet gaming is uncertain in some of the jurisdictions in which we continue to provide settlement processing services for online gaming activities. Future regulation or enforcement proceedings may make it costly or impossible for us to continue processing transactions for gaming merchants in those jurisdictions and may subject us to substantial penalties.  Reports of regulatory initiatives or enforcement proceedings that are unfavorable to us or to our customers or suppliers may adversely affect the trading price of our common shares.







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In many jurisdictions there are few, if any, laws or regulations that deal directly with payment processing for Internet gaming transactions.  The legal status of Internet gaming itself is uncertain in many of the jurisdictions in which we operate. While some jurisdictions have taken the position that Internet gaming is legal and have adopted or are in the process of reviewing legislation to regulate Internet gaming, other jurisdictions have taken the opposite view and enacted legislation to attempt to restrict or prohibit Internet gaming. For example, the recently enacted United States Unlawful Internet Gambling Enforcement Act of 2006 prohibits any person engaged in the business of betting or wagering from knowingly accepting payments related to unlawful bets or wagers transmitted over the Internet, which resulted in our FireOne Group business segment ceasing to process settlement transactions origi




nating from United States customers that may be viewed as related to online gaming.  We expect that our exit from this business in the United States will have a substantial negative effect on our consolidated revenues in the fourth quarter of 2006 and fiscal 2007. If other governments also decide to enact legislation restricting or prohibiting Internet gaming activities in their jurisdictions, we may also have to cease processing settlement transactions in those jurisdictions. In addition, we may be exposed to adverse consequences as a result of future enforcement proceedings, governmental investigations or lawsuits initiated against us in jurisdictions where Internet gaming is or becomes restricted or
prohibited, including the United States in the aftermath of the Unlawful Internet Gambling Enforcement Act of 2006. Any adverse findings, rulings or judgments rendered against us could involve substantial penalties, fines, injunctions or other sanctions being invoked against us and have a material adverse effect on our business, revenues, operating results and financial condition. Any future enforcement or legal proceedings threatened or commenced against us relating to Internet gaming, whether or not ultimately successful, could involve substantial litigation expense and the diversion of the attention of key executives. The outcome of any litigation cannot be predicted. Future regulation, lawsuits, investigations, enforcement actions or other actions by law enforcement or regulatory authorities, whether directed against us, our competitors, customers or suppliers, may also make it costly or unfeasible for us to continue processing transactions for gaming merchants in the
jurisdictions in which we continue such processing activities.  Further, any actual or threatened legislative development or regulatory proceedings in those jurisdictions that negatively affects a participant in the Internet gaming industry could further adversely affect the trading price of our common shares. From time to time, reports about regulatory initiatives, or enforcement proceedings that are or would be unfavorable to us, or to our customers or suppliers, have had a swift and negative impact on the trading price of our common shares, and our common shares may again experience trading price volatility in the future due to such reports.



Our payments systems might be used for illegal or improper purposes.



Despite our measures to detect and prevent identity theft, unauthorized used of credit cards, and similar misconduct, and to monitor and comply with laws and regulations restricting or prohibiting the business lines of our merchant customers, our payments systems remain susceptible to potentially illegal or improper uses. These uses may include illegal Internet gaming, fraudulent sales of goods or services, illicit sales of prescription medications or controlled substances, software and other intellectual property piracy, money laundering, bank fraud, child pornography trafficking, prohibited sales of alcoholic beverages and tobacco products and online securities fraud. Illegal or improper use of our payments systems may lead to increased government regulation of us or other legal consequences which may have an adverse impact on our operations and profitability. Laws or regulations that
restrict or prohibit the business activities of our merchant customers may prevent us from providing, or may make it impracticable for us to continue to provide, our payments systems to such merchants and their customers, which would adversely affect our revenues from our payments processing segment. In particular, the legal and regulatory environment surrounding the online sale and distribution of prescription medications into and within the United States is complex and evolving, and we continue to closely monitor the impact that developments in this area may have on our ability to continue to provide payment processing services for this sector. Legal and regulatory developments that have an adverse impact on these transactions may significantly reduce or eliminate the payment processing revenues that we generate from pharmacies offering sale of prescription medications online and their customers.





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Item 2.
        Unregistered Sales of Equity Securities and Use of Proceeds




We did not repurchase any of our common shares during the three-month period ended September 30, 2006.



Item 3.
        Defaults Upon Senior Securities




The registrant has nothing to report under this item.



Item 4.
        Submission of Matters to a Vote of Security Holders




The registrant has nothing to report under this item.




Item 5.
        Other Information




The registrant has nothing to report under this item.



Item 6.
        Exhibits




Exhibits



Exhibit Number
        Exhibit31.1
        Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
        Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
        Certification pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
        Certification pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.








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Signatures



Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



November 9, 2006
        Optimal Group Inc.






By:
        /s/
        Neil S. Wechsler


Neil S. Wechsler, Co-Chairman


and Chief Executive Officer


(Principal Executive Officer)






By:
        /s/
        Gary S. Wechsler


Gary S. Wechsler, Chief Financial Officer

(Principal Accounting Officer)







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