Form 10-Q -- Q3 Fy'06


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

___________________

FORM 10-Q
___________________


QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2006

Commission File Number 0-25346

___________________


TRANSACTION SYSTEMS ARCHITECTS, INC.
(Exact name of registrant as specified in its charter)


                                                    Delaware
(State or other jurisdiction of
incorporation or organization)
47-0772104
(I.R.S. Employer
Identification No.)
 
 
                                        224 South 108th Avenue
                                        Omaha, Nebraska 68154
(Address of principal executive offices,
including zip code)
 
 
(402) 334-5101
(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    ü        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    ü               Accelerated filer ____             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    ü   

As of July 31, 2006, there were 37,520,962 shares of the registrant’s common stock, par value $.005 per share, outstanding (including options to purchase 2,212 shares of the registrant’s common stock at an exercise price of one cent per share).
 
 


 
 



TABLE OF CONTENTS
 
 
 
   
Page
PART I - FINANCIAL INFORMATION
Item 1.
Financial Statements
1
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
19
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
31
Item 4.
Controls and Procedures
32
 
PART II - OTHER INFORMATION
Item 1.
Legal Proceedings
33
Item 1A.
Risk Factors
34
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
35
Item 3.
Defaults Upon Senior Securities
35
Item 4.
Submission of Matters to a Vote of Security Holders
35
Item 5.
Other Information
35
Item 6.
Exhibits
36
   
Signature
37
Exhibit Index
38













PART I - FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

 
Page
Consolidated Balance Sheets as of June 30, 2006 and September 30, 2005
2
Consolidated Statements of Operations for the three and nine months ended June 30, 2006 and 2005
3
Consolidated Statements of Cash Flows for the nine months ended June 30, 2006 and 2005
4
Notes to Consolidated Financial Statements
5





1


TRANSACTION SYSTEMS ARCHITECTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)

   
June 30,
2006
 
September 30,
2005
 
ASSETS
   
(Unaudited)
 
 
 
Current assets:
             
Cash and cash equivalents
 
$
108,365
 
$
83,693
 
Marketable securities
   
67,725
   
72,819
 
Billed receivables, net of allowances of $2,057 and $2,390, respectively
   
62,324
   
63,530
 
Accrued receivables
   
9,992
   
5,535
 
Recoverable income taxes
   
-
   
3,474
 
Deferred income taxes, net
   
3,103
   
2,552
 
Other
   
13,740
   
13,009
 
Total current assets
   
265,249
   
244,612
 
Property and equipment, net
   
9,234
   
9,089
 
Software, net
   
11,044
   
4,930
 
Goodwill
   
88,411
   
66,169
 
Other intangible assets, net
   
17,985
   
13,573
 
Deferred income taxes, net
   
29,125
   
21,884
 
Other
   
6,288
   
3,123
 
Total assets
 
$
427,336
 
$
363,380
 
               
 LIABILITIES AND STOCKHOLDERS’ EQUITY
             
Current liabilities:
             
Current portion of debt - financing agreements
 
$
78
 
$
2,165
 
Accounts payable
   
6,960
   
9,521
 
Accrued employee compensation
   
15,794
   
19,296
 
Income taxes payable
   
8,362
   
-
 
Deferred revenue
   
78,808
   
81,374
 
Accrued and other liabilities
   
19,638
   
11,662
 
Total current liabilities
   
129,640
   
124,018
 
Debt - financing agreements
   
-
   
154
 
Deferred revenue
   
16,561
   
20,450
 
Other
   
2,638
   
1,640
 
Total liabilities
   
148,839
   
146,262
 
               
Commitments and contingencies (Note 12)
             
               
Stockholders' equity:
             
Preferred stock, $.01 par value; 5,000,000 shares authorized; no shares issued and outstanding at June 30, 2006 and September 30, 2005
   
-
   
-
 
Common stock, $.005 par value; 70,000,000 shares authorized; 40,823,728 and 40,327,678 shares issued at June 30, 2006 and September 30, 2005, respectively
   
204
   
202
 
Treasury stock, at cost; 3,138,411 and 2,943,109 shares at June 30, 2006 and September 30, 2005, respectively
   
(79,305
)
 
(68,596
)
Additional paid-in capital
   
292,322
   
274,344
 
Retained earnings
   
73,813
   
20,329
 
Accumulated other comprehensive loss
   
(8,537
)
 
(9,161
)
Total stockholders' equity
   
278,497
   
217,118
 
Total liabilities and stockholders' equity
 
$
427,336
 
$
363,380
 
 
The accompanying notes are an integral part of the condensed consolidated financial statements.

 
2


TRANSACTION SYSTEMS ARCHITECTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited and in thousands, except per share amounts)


   
Three Months Ended
June 30,
 
Nine Months Ended
June 30,
 
   
2006
 
2005
 
2006
 
2005
 
Revenues:
                 
Software license fees
 
$
41,955
 
$
37,656
 
$
133,077
 
$
128,415
 
Maintenance fees
   
25,989
   
24,938
   
76,053
   
69,667
 
Services
   
16,820
   
15,409
   
50,542
   
36,153
 
Total revenues
   
84,764
   
78,003
   
259,672
   
234,235
 
                           
Expenses:
                         
Cost of software license fees
   
7,895
   
6,539
   
22,335
   
18,170
 
Cost of maintenance and services
   
19,385
   
14,102
   
59,332
   
41,756
 
Research and development
   
10,191
   
9,704
   
29,921
   
29,842
 
Selling and marketing
   
15,896
   
16,183
   
48,437
   
46,852
 
General and administrative
   
15,877
   
16,289
   
48,410
   
44,301
 
Total expenses
   
69,244
   
62,817
   
208,435
   
180,921
 
                           
Operating income
   
15,520
   
15,186
   
51,237
   
53,314
 
                           
Other income (expense):
                         
Interest income
   
1,641
   
1,279
   
6,154
   
2,727
 
Interest expense
   
(10
)
 
(102
)
 
(126
)
 
(407
)
Other, net
   
(227
)
 
(453
)
 
(239
)
 
(1,445
)
Total other income (expense)
   
1,404
   
724
   
5,789
   
875
 
                           
Income before income taxes
   
16,924
   
15,910
   
57,026
   
54,189
 
Income tax benefit (provision)
   
6,384
   
(5,915
)
 
(3,542
)
 
(20,078
)
Net income
 
$
23,308
 
$
9,995
 
$
53,484
 
$
34,111
 
                           
 
Earnings per share information:
                         
Weighted average shares outstanding:
                         
Basic
   
37,529
   
37,576
   
37,341
   
37,825
 
 
Diluted
   
38,454
   
38,312
   
38,199
   
38,598
 
                           
Earnings per share:
                         
Basic
 
$
0.62
 
$
0.27
 
$
1.43
 
$
0.90
 
 
Diluted
 
$
0.61
 
$
0.26
 
$
1.40
 
$
0.88
 

The accompanying notes are an integral part of the condensed consolidated financial statements.


3


TRANSACTION SYSTEMS ARCHITECTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited and in thousands)

   
Nine Months Ended
June 30,
 
   
2006
 
2005
 
Cash flows from operating activities:
             
Net income
 
$
53,484
 
$
34,111
 
Adjustments to reconcile net income to net cash provided by operating activities:
             
Depreciation
   
3,035
   
2,869
 
Amortization
   
2,943
   
714
 
Deferred income taxes
   
(11,797
)
 
(7,007
)
Share-based compensation expense 
   
4,412
   
-
 
Tax benefit of stock options exercised 
   
1,456
   
2,736
 
Changes in operating assets and liabilities:
             
Billed and accrued receivables, net
   
293
   
4,325
 
Other current assets
   
(33
)
 
(3,131
)
Other assets
   
(3,021
)
 
(1,305
)
Accounts payable
   
(3,378
)
 
1,025
 
Accrued employee compensation
   
(3,855
)
 
(110
)
Accrued liabilities
   
246
   
896
 
Current income taxes
   
12,022
   
14,531
 
Deferred revenue
   
(8,210
)
 
(1,490
)
Other current and noncurrent liabilities
   
107
   
300
 
Net cash provided by operating activities
   
47,704
   
48,464
 
               
Cash flows from investing activities:
             
Purchases of property and equipment
   
(3,133
)
 
(3,170
)
Purchases of software
   
(2,401
)
 
(1,347
)
Purchases of marketable securities
   
(50,937
)
 
(76,875
)
Sales of marketable securities
   
56,038
   
36,166
 
Acquisition of business, net of cash acquired
   
(13,139
)
 
-
 
Net cash used in investing activities
   
(13,572
)
 
(45,226
)
               
Cash flows from financing activities:
             
Proceeds from issuance of common stock under Employee Stock Purchase Plan
   
909
   
736
 
Proceeds from exercises of stock options
   
11,608
   
8,489
 
Excess tax benefit of stock options exercised 
   
2,321
   
-
 
Purchases of common stock
   
(24,688
)
 
(28,897
)
Payments on debt and capital lease obligations
   
(2,949
)
 
(5,943
)
Other
   
(15
)
 
402
 
Net cash used in financing activities
   
(12,814
)
 
(25,213
)
               
Effect of exchange rate fluctuations on cash
   
3,354
   
792
 
               
Net increase (decrease) in cash and cash equivalents
   
24,672
   
(21,183
)
Cash and cash equivalents, beginning of period
   
83,693
   
134,198
 
Cash and cash equivalents, end of period
 
$
108,365
 
$
113,015
 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 
4


TRANSACTION SYSTEMS ARCHITECTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

1.  Consolidated Financial Statements

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated. The consolidated financial statements at June 30, 2006, and for the three and nine months ended June 30, 2006 and 2005, are unaudited and reflect all adjustments of a normal recurring nature, except as otherwise disclosed herein, which are, in the opinion of management, necessary for a fair presentation, in all material respects, of the financial position and operating results for the interim periods.

The consolidated financial statements contained herein should be read in conjunction with the consolidated financial statements and notes thereto, together with management's discussion and analysis of financial condition and results of operations, contained in the Company's annual report on Form 10-K for the fiscal year ended September 30, 2005. The results of operations for the three and nine months ended June 30, 2006 are not necessarily indicative of the results that may be achieved for the entire fiscal year ending September 30, 2006.

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

On July 29, 2005, the Company acquired the business of S2 Systems, Inc. (“S2”) through the acquisition of substantially all of its assets. S2 was a global provider of electronic payments and network connectivity software, and it primarily served financial services and retail customers. In addition to its U.S. operations, S2 had a significant presence in the Middle East, Europe, Latin America and the Asia/Pacific region. On May 31, 2006, the Company acquired eps Electronic Payment Systems AG (“eps”). eps, with operations in Germany, Romania, the United Kingdom and other European locations, offers electronic payment and complementary solutions focused largely in the German market. The consolidated financial statements at June 30, 2006, and for the three and nine months ended June 30, 2006, include amounts acquired from, as well as results of operations of, the acquired businesses. Included in the consolidated balance sheet at September 30, 2005 are amounts acquired from and operating results of S2 from the date of its acquisition.

2.  Revenue Recognition, Accrued Receivables and Deferred Revenue

Software License Fees. The Company recognizes software license fee revenue in accordance with American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition With Respect to Certain Transactions,” and Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin (“SAB”) 101, “Revenue Recognition in Financial Statements,” as amended by SAB 104, “Revenue Recognition.” For software license arrangements for which services rendered are not considered essential to the functionality of the software, the Company recognizes revenue upon delivery, provided (1) there is persuasive evidence of an arrangement, (2) collection of the fee is considered probable and (3) the fee is fixed or determinable. In most arrangements, vendor-specific objective evidence (“VSOE”) of fair value does not exist for the license element; therefore, the Company uses the residual method under SOP 98-9 to determine the amount of revenue to be allocated to the license element. Under SOP 98-9, the fair value of all undelivered elements, such as postcontract customer support (maintenance or “PCS”) or other products or services, is deferred and subsequently recognized as the products are delivered or the services are performed, with the residual difference between the total arrangement fee and revenues allocated to undelivered elements being allocated to the delivered elements.

When a software license arrangement includes services to provide significant modification or customization of software, those services are not separable from the software and are accounted for in accordance with Accounting Research Bulletin (“ARB”) No. 45, “Long-Term Construction-Type Contracts,” and the relevant guidance provided
 
5

 
by SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts.” Accounting for services delivered over time (generally in excess of twelve months) under ARB No. 45 and SOP 81-1 is referred to as contract accounting. Under contract accounting, the Company generally uses the percentage-of-completion method. Under the percentage-of-completion method, the Company records revenue for the software license fee and services over the development and implementation period, with the percentage of completion measured by the percentage of labor hours incurred to-date to estimated total labor hours for each contract. For those contracts subject to percentage-of-completion contract accounting, estimates of total revenue and profitability under the contract consider amounts due under extended payment terms. In certain cases, the Company provides its customers with extended payment terms whereby payment is deferred beyond when the services are rendered. In other projects, the Company provides its customer with extended payment terms that are refundable in the event certain milestones are not achieved or the project scope changes. The Company excludes revenues due on extended payment terms from its current percentage-of-completion computation until such time that collection of the fees becomes probable. In the event project profitability is assured and estimable within a range, percentage-of-completion revenue recognition is computed using the lowest level of profitability in the range. If the range of profitability is not estimable but some level of profit is assured, revenues are recognized to the extent direct and incremental costs are incurred until such time that project profitability can be estimated. In the event some level of profitability cannot be reasonably assured, completed-contract accounting is applied.
 
For software license arrangements in which a significant portion of the fee is due more than 12 months after delivery, the software license fee is deemed not to be fixed or determinable. For software license arrangements in which the fee is not considered fixed or determinable, the software license fee is recognized as revenue as payments become due and payable, provided all other conditions for revenue recognition have been met. For software license arrangements in which the Company has concluded that collection of the fees is not probable, revenue is recognized as cash is collected, provided all other conditions for revenue recognition have been met. In making the determination of collectibility, the Company considers the creditworthiness of the customer, economic conditions in the customer’s industry and geographic location, and general economic conditions.

SOP 97-2 requires the seller of software that includes PCS to establish VSOE of fair value of the undelivered element of the contract in order to account separately for the PCS revenue. For certain of the Company's products, VSOE of the fair value of PCS is determined by a consistent pricing of PCS and PCS renewals as a percentage of the software license fees. In other products, the Company determines VSOE by reference to contractual renewals, when the renewal terms are substantive. In those cases where VSOE of the fair value of PCS is determined by reference to contractual renewals, the Company considers factors such as whether the period of the initial PCS term is relatively long when compared to the term of the software license or whether the PCS renewal rate is significantly below the Company's normal pricing practices.

In the absence of customer-specific acceptance provisions, software license arrangements generally grant customers a right of refund or replacement only if the licensed software does not perform in accordance with its published specifications. If the Company’s product history supports an assessment by management that the likelihood of non-acceptance is remote, the Company recognizes revenue when all other criteria of revenue recognition are met.

For those software license arrangements that include customer-specific acceptance provisions, such provisions are generally presumed to be substantive and the Company does not recognize revenue until the earlier of the receipt of a written customer acceptance, objective demonstration that the delivered product meets the customer-specific acceptance criteria or the expiration of the acceptance period. The Company also defers the recognition of revenue on transactions involving less-established or newly released software products that do not have a product history. The Company recognizes revenues on such arrangements upon the earlier of receipt of written acceptance or the first production use of the software by the customer.

For software license arrangements in which the Company acts as a sales agent for another company's products, revenues are recorded on a net basis. These include arrangements in which the Company does not take title to the products, is not responsible for providing the product or service, earns a fixed commission, and assumes credit risk only to the extent of its commission. For software license arrangements in which the Company acts as a distributor of another company's product, and in certain circumstances, modifies or enhances the product, revenues are recorded on a gross basis. These include arrangements in which the Company takes title to the products and is responsible for providing the product or service.

6

For software license arrangements in which the Company permits the customer to vary their software mix, including the right to receive unspecified future software products during the software license term, the Company recognizes revenue ratably over the license term, provided all other revenue recognition criteria have been met. For software license arrangements in which the customer is charged variable software license fees based on usage of the product, the Company recognizes revenue as usage occurs over the term of the license, provided all other revenue recognition criteria have been met.

Certain of the Company’s software license arrangements are short-term, time-based license arrangements; allow the customer to vary their software mix; or include PCS terms that are relatively long as compared to the license term. For these arrangements, VSOE of fair value of PCS may not exist and revenues would therefore be recognized ratably over the PCS term. The Company typically classifies revenues associated with these arrangements in accordance with the contractually-specified amounts assigned to the various elements, including software license fees and maintenance fees. The following are amounts included in revenues in the consolidated statements of operations for which VSOE of fair value does not exist for each element:

   
Three Months Ended
June 30,
 
Nine Months Ended
June 30,
 
   
2006
 
2005
 
2006
 
2005
 
Software license fees 
 
$ 4,428
 
$ 4,686
 
$ 12,736
 
$ 14,751
 
Maintenance fees 
   
1,381
   
1,588
   
4,057
   
4,751
 
Total 
 
$
5,809
 
$
6,274
 
$
16,793
 
$
19,502
 

Maintenance Fees. Revenues for PCS are recognized ratably over the maintenance term specified in the contract. In arrangements where VSOE of fair value of PCS cannot be determined (for example, a time-based software license with a duration of one year or less), the Company recognizes revenue for the entire arrangement ratably over the PCS term.

Services. The Company provides various professional services to customers, primarily project management, software implementation and software modification services. Revenues from arrangements to provide professional services are generally recognized as the related services are performed. For those arrangements in which services revenue is deferred and the Company determines that the costs of services are recoverable, such costs are deferred and subsequently expensed in proportion to the services revenue as it is recognized.

Accrued Receivables. Accrued receivables represent amounts to be billed in the near future (less than 12 months).

Deferred Revenue. Deferred revenue includes (1) amounts currently due and payable from customers, and payments received from customers, for software licenses, maintenance and/or services in advance of providing the product or performing services, (2) amounts deferred whereby VSOE of the fair value of undelivered elements in a bundled arrangement does not exist, and (3) amounts deferred if other conditions for revenue recognition have not been met.

3.  Acquisition

On May 31, 2006, the Company acquired the outstanding shares of eps. The aggregate purchase price for eps totals $33.5 million, including cash payments of $22.2 million, 330,827 shares of Company common stock valued at $11.1 million, and direct costs of acquisition.

eps, with operations in Germany, Romania, the United Kingdom and other European locations, offers electronic payment and complementary solutions focused largely in the German market. The acquisition of eps will provide the Company additional opportunities to sell its solutions within Germany, as well as to sell eps’ solutions into markets beyond Germany.

The acquisition of eps is scheduled to occur in two closings. The initial closing occurred on May 31, 2006, and the second closing is scheduled to occur on October 31, 2006. Cash consideration paid at the initial closing totaled $16.1 million, with the remaining cash consideration to be paid at the second closing. All shares of the Company’s
 
7

 
common stock issued as consideration for the eps acquisition were issued at the initial closing. The Company has accounted for the acquisition of eps in its entirety as of May 31, 2006, and has recorded a liability, included in accrued and other liabilities, in the amount of $6.1 million for the remaining cash consideration to be paid at the second closing. The Company has accounted for this as a delayed delivery of consideration as the price is fixed and not subject to change, with complete decision-making and control of eps held by the Company as of the date of the initial closing. Contingencies that may prevent the second closing from occurring are limited and considered remote in likelihood.
 
As noted, the consideration paid for eps included 330,827 shares of the Company’s common stock, all of which were issued from the Company’s treasury stock. Under the terms of the eps acquisition, the shares issued have restrictions that prohibit their resale for five years, provided, however, that these resale restrictions expire with respect to 20% of the shares each year commencing with the first anniversary of the initial closing. Expiration of the restrictions is related to the passage of time and is in no way linked to ongoing employment by the Company of the respective shareholders. Due to the resale restrictions, with the assistance of an independent appraiser, the Company determined that a discount to the quoted market price of the Company’s common stock in the amount of 19% was appropriate for determining the fair market value of the shares issued for acquisition accounting purposes. The Company valued the shares issued using an average of the market price of the Company’s common stock two days prior and subsequent to the parties agreeing to the terms of the acquisition and its announcement (net of the 19% discount for the nonmarketability of the shares). The fair market value of each share issued related to the eps acquisition was determined to be $33.42 per share.

Under the terms of the acquisition, the parties established a cash escrow arrangement in which approximately $1.0 million of the cash consideration paid at the initial closing will be held in escrow as security for an identified potential obligation, the likelihood of which is deemed remote. Additionally, certain of the sellers of eps have committed to certain indemnification obligations as part of the sale of eps. Those obligations are secured by the shares of common stock issued to the sellers pursuant to the eps acquisition to the degree such shares are restricted at the time such an indemnification obligation is triggered, if at all, the likelihood of which is deemed remote.

The allocation of the purchase price to specific assets and liabilities was based, in part, upon outside appraisals of the fair value of certain assets of eps. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed in connection with the acquisition, as well as the weighted-average useful lives of intangible assets (in thousands, except weighted-average useful lives):

   
 
Amount
 
Weighted-Average Useful Lives
 
Current assets:
         
    Cash
 
$
3,056
   
 
    Billed receivables, net of allowances
   
1,902
   
 
    Accrued receivables 
   
175
   
 
    Other 
   
451
   
 
Noncurrent assets:
             
    Property and equipment 
   
183
   
 
    Developed technology 
   
5,012
   
5.0 years
 
    Goodwill 
   
22,349
   
 
    Customer relationships, trade names and other intangible assets 
   
5,681
   
7.4 years
 
Total assets acquired 
   
38,809
       
               
Current liabilities 
   
5,279
   
 
Long-term liabilities 
   
76
   
 
Total liabilities assumed 
   
5,355
       
               
Net assets acquired 
 
$
33,454
       

This purchase price allocation is preliminary due to limited information available related to computer equipment and software licenses financed under a capital lease arrangement and a related remote contingency, and due to uncertainty related to a contract arrangement which includes contingencies not presently resolved.

8

The $22.3 million in goodwill associated with the eps acquisition, which will be tax deductible, is recorded in the Company’s EMEA region. Factors contributing to the purchase price which resulted in the recognized goodwill include the acquisition of management, sales and technology personnel with the skills to develop and market new products for the Company.

The financial operating results of eps beginning June 1, 2006, have been included in the consolidated financial results of the Company for the quarter and nine months ended June 30, 2006.

The following represents unaudited pro forma combined results of operations of the Company and eps, as if the eps acquisition had occurred as of October 1, 2004 (in thousands, except per share amounts):

   
Three Months Ended June 30,
 
Nine Months Ended June 30,
 
   
2006
 
2005
 
2006
 
2005
 
Unaudited pro forma information:
                 
Revenues
 
$
85,390
 
$
81,437
 
$
267,377
 
$
245,519
 
Net income
   
22,560
   
10,188
   
53,444
   
35,052
 
                           
Earnings per share:
                         
Basic
   
0.60
   
0.27
   
1.43
   
0.93
 
Diluted
   
0.59
   
0.27
   
1.40
   
0.91
 

The pro forma financial information includes historical eps revenues and expenses, with adjustments to the accounting base for depreciation, amortization and income taxes. The pro forma financial information is shown for illustrative purposes only and is not necessarily indicative of future results of operations of the Company or the results of operations of the Company that would have actually occurred had the transaction been in effect for the periods presented.

4.  Share-Based Compensation Plans

Stock Incentive Plans - Active Plans

The Company has a 2005 Equity and Performance Incentive Plan (the “2005 Incentive Plan”) under which shares of the Company’s common stock have been reserved for issuance to eligible employees or non-employee directors of the Company. The 2005 Incentive Plan provides for the grant of incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock awards, performance awards and other awards. The maximum number of shares of the Company’s common stock that may be issued or transferred in connection with awards granted under the 2005 Incentive Plan will be the sum of (i) 3,000,000 shares and (ii) any shares represented by outstanding options that had been granted under designated terminated stock option plans that are subsequently forfeited, expire or are canceled without delivery of the Company’s common stock.

Stock options granted pursuant to the 2005 Incentive Plan are granted at an exercise price not less than the market value per share of the Company’s common stock on the day immediately preceding the date of the grant. Under the 2005 Incentive Plan, the term of the outstanding options may not exceed ten years. Vesting of options is determined by the Compensation Committee of the Board of Directors, the administrator of the 2005 Incentive Plan, and can vary based upon the individual award agreements.

Performance awards granted pursuant to the 2005 Incentive Plan become payable upon the achievement of specified management objectives. Each performance award specifies: (i) the number of performance shares or units granted, (ii) the period of time established to achieve the management objectives, which may not be less than one year from the grant date, (iii) the management objectives and a minimum acceptable level of achievement as well as a formula for determining the number of performance shares or units earned if performance is at or above the minimum level but short of full achievement of the management objectives, and (iv) any other terms deemed appropriate.

The Company also has a 1999 Stock Option Plan under which 4,000,000 shares of the Company’s common stock have been reserved for issuance to eligible employees of the Company and its subsidiaries. Stock options
 
9

 
granted pursuant to the 1999 Stock Option Plan are granted at an exercise price not less than the fair market value of the common stock at the time of the grant. The term of the outstanding options is ten years. The options generally vest in equal installments annually over a period of three years.
 
Employee Stock Purchase Plan

Under the Company's 1999 Employee Stock Purchase Plan (the "ESPP"), a total of 1,500,000 shares of the Company’s common stock have been reserved for issuance to eligible employees. Participating employees are permitted to designate up to the lesser of $25,000 or 10% of their annual base compensation for the purchase of common stock under the ESPP. Purchases under the ESPP are made one calendar month after the end of each fiscal quarter. The price for shares of common stock purchased under the ESPP is 85% of the stock’s fair market value on the last business day of the three-month participation period.

Additionally, the discount offered pursuant to the Company’s ESPP discussed above is 15%, which exceeds the 5% noncompensatory guideline in Statement of Financial Accounting Standards (“SFAS”) No. 123 (Revised 2004), “Share-Based Payment” (“SFAS No. 123R”) and exceeds the Company’s estimated cost of raising capital. Consequently, the entire 15% discount to employees is deemed to be compensatory.

Accounting for Share-Based Payments Pursuant to SFAS No. 123 R

The Company adopted SFAS No. 123R as of October 1, 2005 using the modified prospective transition method. This revised accounting standard eliminated the ability to account for share-based compensation transactions using the intrinsic value method in accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and requires instead that such transactions be accounted for using a fair-value-based method. SFAS No. 123R requires entities to record noncash compensation expense related to payment for employee services by an equity award in their financial statements over the requisite service period. In March 2005, the SEC issued SAB 107, which does not modify any of SFAS No. 123R’s conclusions or requirements, but rather includes recognition, measurement and disclosure guidance for companies as they implement SFAS No. 123R.

All of the Company’s existing share-based compensation awards have been determined to be equity classified awards. Under the modified prospective transition method, the Company is required to recognize noncash compensation costs for the portion of share-based awards that are outstanding as of October 1, 2005 for which the requisite service has not been rendered (i.e., nonvested awards). These compensation costs are based on the grant date fair value of those awards as calculated for pro forma disclosures under SFAS No. 123. The Company is recognizing compensation costs related to the nonvested portion of those awards in the financial statements from the SFAS No. 123R adoption date through the end of the requisite service period. 

A summary of stock options as of June 30, 2006 and changes during the nine months then ended is as follows:

 
 
 
 
 
Stock Options
 
 
 
 
 
 
Shares
 
 
 
Weighted-Average
Exercise
Price
 
Weighted-Average
Remaining
Contractual Term
(in years)
 
 
 
Aggregate Intrinsic Value (in thousands)
 
Outstanding at October 1, 2005
   
3,926,218
 
$
16.79
             
  Granted
   
100,000
   
32.82
             
  Exercised
   
(706,053
)
 
16.44
             
  Cancellations
   
(43,322
)
 
22.56
             
Outstanding at June 30, 2006
   
3,276,843
 
$
17.27
   
7.1
 
$
79,795
 
                           
Exercisable at June 30, 2006
   
1,868,653
 
$
13.06
   
5.9
 
$
53,297
 

All fully-vested stock options as of June 30, 2006 are exercisable and are included in the above table. During the first six months of fiscal 2006, the Company issued new shares of common stock for the exercise of stock options. Beginning in the third quarter of fiscal 2006, the Company issued treasury shares for the exercise of stock options. The intrinsic value of options exercised during the first nine months of fiscal 2006 was $11.0 million. The Company’s stock awards allow employees to exercise options through cash payment to the Company for the

10

 
shares of common stock or through a simultaneous broker-assisted cashless exercise of a share option, through which the employee authorizes the exercise of an option and the immediate sale of the option shares in the open market.
 
The fair value of options granted was estimated on the date of grant using the Black-Scholes option-pricing model, a pricing model acceptable under SFAS No. 123R, with the following weighted-average assumptions:

 
Three Months Ended
June 30,
 
Nine Months Ended
June 30,
 
2006
 
2005
 
2006
 
2005
Expected life 
 
4.5
     
3.6
     
4.4
     
4.1
 
Interest rate 
 
   5.0%
     
   3.7%
     
   4.7%
     
   4.0%
 
Volatility 
 
   42%
     
   46%
     
   42%
     
   48%
 
Dividend yield 
 
     
     
     
 

Expected volatilities are based on implied volatilities from traded options on the Company’s common stock and other industry factors. The expected life of options granted represents the period of time that options granted are expected to be outstanding, assuming differing exercise behaviors for stratified employee groupings.

During fiscal 2005, the Company granted 400,000 stock options with a grant date fair value of $9.12 per share and 40,000 stock options with a grant date fair value of $11.36 per share that vest, if at all, at any time following the second anniversary of the date of grant, upon attainment by the Company of a market price of at least $50 per share for sixty consecutive trading days. In order to determine the grant date fair value of the stock options granted during fiscal 2005 that vest based on the achievement of certain market conditions, a Monte Carlo simulation model was used to estimate (i) the probability that the performance goal will be achieved and (ii) the length of time required to attain the target market price. The Monte Carlo simulation model analyzed the Company’s historical price movements, changes in the value of The NASDAQ Stock Market over time, and the correlation coefficient and beta between the Company’s stock price and The NASDAQ Stock Market. The Monte Carlo simulation indicated that on a risk-weighted basis these stock options would vest 3.6 years after the date of grant. The expected vesting period was then incorporated into a statistical regression analysis of the historical exercise behavior of other Company senior executives to arrive at an expected option life. With respect to options granted that vest based on the achievement of certain market conditions, the grant date fair value of such options was estimated using a pricing model acceptable under SFAS No. 123 with the following weighted-average assumptions:

 
Three Months Ended
June 30, 2005
 
Nine Months Ended
June 30, 2005
Expected life 
 
5.7
     
5.7
 
Interest rate 
 
   4.2%
     
   4.2%
 
Volatility 
 
   46%
     
   46%
 
Dividend yield 
 
     
 

During the first nine months of fiscal 2006, pursuant to the Company’s 2005 Incentive Plan, the Company also granted long-term incentive program performance share awards (“LTIP Performance Shares”). A summary of nonvested LTIP Performance Shares as of June 30, 2006 and changes during the nine months then ended is as follows:

 
 
 
Nonvested LTIP Performance Shares
 
 
 
 
Number
 
Weighted-Average
Grant Date
Fair Value
 
Nonvested at October 1, 2005
   
37,000
 
$
28.27
 
Granted
   
124,000
   
29.18
 
Exercised
   
-
   
-
 
Cancellations
   
(5,000
)
 
28.27
 
Nonvested at June 30, 2006
   
156,000
 
$
29.00
 


11


These LTIP Performance Shares are earned, if at all, based upon the achievement, over a three-year period (the “Performance Period”), of performance goals related to (i) the compound annual growth over the Performance Period in the Company’s 60-month backlog as determined and defined by the Company, (ii) the compound annual growth over the Performance Period in the diluted earnings per share as reported in the Company’s consolidated financial statements, and (iii) the compound annual growth over the Performance Period in the total revenues as reported in the Company’s consolidated financial statements. In no event will any of the LTIP Performance Shares become earned if the Company’s earnings per share is below a predetermined minimum threshold level at the conclusion of the Performance Period. Assuming achievement of the predetermined minimum earnings per share threshold level, up to 150% of the LTIP Performance Shares may be earned upon achievement of performance goals equal to or exceeding the maximum target levels for compound annual growth over the Performance Period in the Company’s 60-month backlog, diluted earnings per share and total revenues. Management must evaluate, on a quarterly basis, the probability that the target performance goals will be achieved, if at all, and the anticipated level of attainment in order to determine the amount of compensation costs to record in the consolidated financial statements.

As of June 30, 2006, there were unrecognized compensation costs of $9.2 million related to nonvested stock options and $3.1 million related to nonvested LTIP Performance Shares which the Company expects to recognize over weighted-average periods of 2.4 years and 2.3 years, respectively.

Share-based compensation expenses recognized under SFAS No. 123R in the third quarter of fiscal 2006 related to stock options, LTIP Performance Shares, and the ESPP were $1.5 million, with corresponding tax benefits of $0.5 million. Share-based compensation expenses recognized under SFAS No. 123R in the first nine months of fiscal 2006 related to stock options, LTIP Performance Shares, and the ESPP were $4.4 million, with corresponding tax benefits of $1.6 million. No share-based compensation costs were capitalized during the third quarter or first nine months of fiscal 2006. Estimated forfeiture rates, stratified by employee classification, have been included as part of the Company’s calculations of compensation costs. The Company recognizes compensation costs for stock option awards which vest with the passage of time with only service conditions on a straight-line basis over the requisite service period.

Accounting for Share-Based Payments Prior to Adoption of SFAS No. 123R

Prior to October 1, 2005, the Company accounted for its stock-based compensation plans under the intrinsic value method in accordance with APB Opinion No. 25 and followed the disclosure provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure.” Because the significant majority of the Company’s stock options are subject only to time-based vesting provisions and include exercise prices that are equal to the fair market value of the Company’s stock at the time of grant, compensation expense generally was not recorded related to stock options under the intrinsic value method of APB Opinion No. 25.

Prior to October 1, 2005, the Company disclosed stock-based compensation pursuant to SFAS No. 123 using the straight-line method over the vesting period of the option. Had compensation cost for the Company's stock-based compensation plans been determined using the fair value method at the grant date of the stock options awarded under those plans, consistent with the fair value method of SFAS No. 123, the Company's net income and earnings per share for the third quarter and first nine months of fiscal 2005 would have approximated the following pro forma amounts (in thousands, except per share amounts):
 
 
 
 
 
12


     
Three Months
Ended
June 30, 2005 
   
Nine Months
Ended
June 30, 2005 
 
Net income: 
             
As reported
 
$
9,995
 
$
34,111
 
Deduct: stock-based employee compensation expense determined
             
    under the fair value method for all awards, net of related tax effects
   
(717
)
 
(2,010
)
Add: stock-based employee compensation expense recorded
             
    under the intrinsic value method, net of related tax effects
   
19
   
114
 
Pro forma
 
$
9,297
 
$
32,215
 
               
Earnings per share:
             
Basic, as reported
 
$
0.27
 
$
0.90
 
Basic, pro forma
 
$
0.25
 
$
0.85
 
               
Diluted, as reported
 
$
0.26
 
$
0.88
 
Diluted, pro forma
 
$
0.24
 
$
0.83
 

5.  Marketable Securities

The Company accounts for its investments in marketable securities in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” The Company’s portfolio consists of securities classified as available-for-sale, which are recorded at fair market values based on quoted market prices. Net unrealized gains and losses on marketable securities (excluding other than temporary losses) are reflected in the consolidated financial statements as a component of accumulated other comprehensive loss. Net realized gains and losses are computed on the basis of average cost and are recognized when realized. Components of the Company’s marketable securities portfolio at each balance sheet date were as follows (in thousands):

   
June 30,
2006
 
Sept. 30,
2005
 
Municipal auction rate notes 
 
$
66,725
 
$
71,825
 
Municipal bonds/notes 
   
1,000
   
994
 
Marketable securities
 
$
67,725
 
$
72,819
 

At each balance sheet date, all of the Company’s investments in municipal auction rate notes and municipal bonds/notes had a AAA rating. Due to the nature of the marketable securities in which the Company invests, the Company does not typically experience significant movements in the market values of its marketable securities investments. As a result, gross unrealized gains and losses on the Company’s investments in marketable securities are insignificant.

6.  Goodwill, Software and Other Intangible Assets

Net increases in the carrying amount of goodwill during the first nine months of fiscal 2006 were $22.2 million, consisting of goodwill in the amount of $22.3 million resulting from the acquisition of eps and a net increase of $0.3 million resulting from foreign currency translation adjustments, with a reduction to goodwill of $0.4 million related to S2 acquisition adjustments that were primarily related to reductions in severance liabilities associated with acquired S2 employees.
 
 

13


The carrying amount and accumulated amortization of the Company’s intangible assets that were subject to amortization at each balance sheet date were as follows (in thousands):

   
June 30,
2006
 
Sept. 30,
2005
 
Software:
         
Internally-developed software
 
$
15,711
 
$
14,916
 
Purchased software
   
49,982
   
43,177
 
     
65,693
   
58,093
 
Less: accumulated amortization
   
(54,649
)
 
(53,163
)
Software, net
 
$
11,044
 
$
4,930
 
               
               
 
   
June 30, 2006
   
Sept. 30,
2005
 
Other intangible assets:
             
Customer relationships
 
$
18,996
 
$
14,375
 
Purchased contracts
   
4,319
   
3,907
 
Trademarks and trade names
   
2,158
   
1,400
 
Covenant not to compete
   
1,280
   
1,150
 
     
26,753
   
20,832
 
Less: accumulated amortization
   
(8,768
)
 
(7,259
)
Other intangible assets, net
 
$
17,985
 
$
13,573
 

Internally-developed software includes capitalized costs of software developed for sale and capitalizable development or modification costs of software that will be used internally. Purchased software includes capitalized costs of software to be marketed externally that was acquired primarily as the result of business acquisitions and costs of computer software obtained for internal use. Amortization of software to be sold or marketed is computed using the greater of the ratio of current revenues to total estimated revenues expected to be derived from the software or the straight-line method over an estimated useful life of that software, which currently ranges from three to eight years. Software for internal use is amortized on a straight-line basis over an estimated useful life of three years. Software amortization expense recorded in the three and nine months ended June 30, 2006 totaled $0.5 million and $1.5 million, respectively. Other intangible assets amortization expense recorded in the three and nine months ended June 30, 2006 totaled $0.5 million and $1.5 million, respectively. Based on capitalized intangible assets at June 30, 2006, and assuming no impairment of these intangible assets, estimated amortization expense for the remainder of fiscal 2006 and in succeeding fiscal years is as follows (in thousands):

 
 
Fiscal Year Ending September 30,
 
 
Software Amortization
 
Other Intangible Assets Amortization
 
     2006 
 
$
1,096
 
$
998
 
     2007 
   
3,979
   
2,570
 
     2008
   
2,962
   
2,432
 
     2009 
   
1,745
   
2,339
 
     2010 
   
432
   
2,262
 
     Thereafter 
   
830
   
7,384
 
      Total 
 
$
11,044
 
$
17,985
 

7.  Corporate Restructuring and Other Reorganization Charges

On October 5, 2005, the Company announced a restructuring of its organization. In connection with this restructuring, the Company established a plan of termination which impacted 42 employees. These actions resulted in severance-related restructuring charges of $1.1 million and other reorganization charges of $0.2 million during the fourth quarter of fiscal 2005. Additional severance-related restructuring charges, net of adjustments to previously recognized liabilities, of $0.3 million and other reorganization charges of $0.4 million related to the Company’s restructuring of its organization were incurred during the first nine months of fiscal 2006. The allocation of net charges
 
14

 
incurred during the first nine months of fiscal 2006 was as follows: $70,000 in cost of software license fees, $8,000 credit in cost of maintenance and services, $62,000 credit in research and development, $218,000 in selling and marketing, and $451,000 in general and administrative. Cash expenditures related to restructuring and other reorganization charges totaled $1.5 million during the first nine months of fiscal 2006. The Company anticipates that these restructuring amounts will be paid by the end of fiscal 2006. The following table shows activity related to these restructuring and reorganization activities (in thousands):
 
   
Restructuring
Termination
Benefits
 
Other
Reorganization
Charges
   
Total
 
Fiscal 2005 restructuring charges
 
$
1,080
 
$
171
 
$
1,251
 
Amounts paid during fiscal 2005
   
(46
)
 
(171
)
 
(217
)
Balance, September 30, 2005
   
1,034
   
-
   
1,034
 
Additional restructuring charges incurred during fiscal 2006
   
409
   
396
   
805
 
Adjustments to previously recognized liabilities
   
(136
)
 
-
   
(136
)
Amounts paid during fiscal 2006
   
(1,146
)
 
(396
)
 
(1,542
)
Balance, June 30, 2006
 
$
161
 
$
-
 
$
161
 

8.  Common Stock, Treasury Stock and Earnings Per Share

Options to purchase 2,212 shares of the Company’s common stock at an exercise price of one cent per share are included in common stock for presentation purposes on the June 30, 2006 and September 30, 2005 consolidated balance sheets, and are included in common shares outstanding for earnings per share (“EPS”) computations for the three and nine months ended June 30, 2006 and 2005.

In fiscal 2005, the Company announced that its Board of Directors approved a stock repurchase program authorizing the Company, from time to time as market and business conditions warrant, to acquire up to $80.0 million of its common stock. In May 2006, the Company’s Board of Directors approved an increase of $30.0 million to the current stock repurchase program, bringing the total of the approved plan to $110.0 million. During the third quarter of fiscal 2006, the Company repurchased 280,645 shares of its common stock at an average price of $38.62 per share under this stock repurchase program. During the first nine months of fiscal 2006, the Company repurchased 768,767 shares of its common stock at an average price of $31.86 per share under this stock repurchase program. The maximum remaining dollar value of shares authorized for purchase under the stock repurchase program was $52.2 million as of June 30, 2006.

During the third quarter of fiscal 2006, the Company began to issue shares of treasury stock upon exercise of stock options and for issuances of common stock pursuant to the Company’s employee stock purchase plan. Shares of treasury stock were also issued during the third quarter of fiscal 2006 in connection with the acquisition of eps Electronic Payment Systems AG. Treasury shares issued during the third quarter of fiscal 2006 included 233,218 shares issued pursuant to stock option exercises, 9,421 issued pursuant to the Company’s employee stock purchase plan, and 330,827 related to the acquisition of eps Electronic Payment Systems AG. For purposes of determining the cost of the treasury shares sold, the Company has elected to use the average cost method.

EPS has been computed in accordance with SFAS No. 128, "Earnings Per Share." Basic EPS is calculated by dividing net income available to common stockholders (the numerator) by the weighted average number of common shares outstanding during the period (the denominator). Diluted EPS is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period, adjusted for the dilutive effect of any outstanding dilutive securities (the denominator). The differences between the basic and diluted EPS denominators for the three months ended June 30, 2006 and 2005, which amounted to 925,000 and 736,000 shares, respectively, and for the nine months ended June 30, 2006 and 2005, which amounted to 858,000 and 773,000 shares, respectively, were due to the dilutive effect of the Company's outstanding stock options. Excluded from the computations of diluted EPS for the three months ended June 30, 2006 and 2005 were options to purchase 540,000 shares and 1,624,000 shares, respectively, and for the nine months ended June 30, 2006 and 2005 were options to purchase 741,000 shares and 1,019,000 shares, respectively, because the stock options were for contingently issuable shares or because their impact would be antidilutive based on current market prices.

15

 
9.  Comprehensive Income

The Company's components of other comprehensive income were as follows (in thousands):

   
Three Months Ended
June 30,
 
Nine Months Ended
June 30,
 
   
2006
 
2005
 
2006
 
2005
 
Net income 
 
$
23,308
 
$
9,995
 
$
53,484
 
$
34,111
 
Other comprehensive income (loss):
                         
Foreign currency translation adjustments
   
855
   
568
   
618
   
495
 
Change in unrealized investment holding loss:
                         
     Unrealized holding gain (loss) arising during the period 
   
3
   
32
   
6
   
(15
)
Comprehensive income 
 
$
24,166
 
$
10,595
 
$
54,108
 
$
34,591
 

The Company's components of accumulated other comprehensive loss at each balance sheet date were as follows (in thousands):

   
Foreign
Currency
Translation
Adjustments
 
Unrealized
Investment
Holding
Loss
 
 Accumulated
Other
Comprehensive
Loss
 
Balance, September 30, 2005
 
$
(9,155
)
$
(6
)
$
$(9,161
)
Fiscal 2006 year-to-date activity
   
618
   
6
   
624
 
Balance, June 30, 2006
 
$
(8,537
)
$
-
 
$
(8,537
)

10.  Segment Information

Prior to fiscal 2006, the Company reviewed its operations within its three separate operating segments, which had been referred to as the Company’s business units. These business units were ACI Worldwide, Insession Technologies and IntraNet Worldwide. ACI Worldwide was the Company's largest business unit and its product line included the Company’s most mature and well-established applications, used primarily by financial institutions, retailers and electronic payment processors. These products are used to route and process transactions for automated teller machine networks; process transactions from point-of-sale devices, wireless devices and the Internet; control fraud and money laundering; authorize checks; establish frequent shopper programs; automate transaction settlement, card management and claims processing; and issue and manage multi-functional applications on smart cards. Insession Technologies included products that facilitated communication, data movement, monitoring of systems, and business process automation across computing systems involving mainframes, distributed computing networks and the Internet. IntraNet Worldwide included products that offered high value payments processing, bulk payments processing, global messaging and continuous link settlement processing.

On October 5, 2005, the Company announced a restructuring of its organization, combining products and services within these three business units into one operating unit under the ACI Worldwide name. In examining the Company’s market, opportunities and organization, the Company determined that combining the business units’ products and services provides the Company with better insight and therefore an enhanced ability to focus on operating efficiency and strategic acquisition integration. As a result of this restructuring, the Company's chief operating decision maker, together with other senior management personnel, currently focus their review of consolidated financial information and the allocation of resources based on reporting of operating results, including revenues and operating income, for the geographic regions of the Americas, Europe/Middle East/Africa (“EMEA”) and Asia/Pacific. Based on an evaluation of the criteria set forth in SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” and how the Company’s chief operating decision maker, together with other senior management personnel, view the Company’s business and the allocation of resources, the Company concluded that its three geographic regions are its reportable operating segments. The Company's products are sold and supported through distribution networks covering these three geographic regions, with each distribution network having its own sales force. The Company supplements its distribution networks with independent reseller and/or distributor arrangements.
 
 
16

 
The following are revenues and operating income for the periods indicated, with prior period amounts presented in conformity with current geographic region presentation (in thousands):

   
Three Months Ended
June 30,
 
Nine Months Ended
June 30,
 
   
2006
 
2005
 
2006
 
2005
 
Revenues:
                 
Americas
 
$
47,033
 
$
42,474
 
$
134,562
 
$
126,588
 
EMEA
   
29,684
   
27,658
   
100,704
   
84,201
 
Asia/Pacific
   
8,047
   
7,871
   
24,406
   
23,446
 
   
$
84,764
 
$
78,003
 
$
259,672
 
$
234,235
 
                           
Operating income:
                         
Americas
 
$
12,019
 
$
9,023
 
$
30,721
 
$
32,478
 
EMEA
   
1,405
   
4,323
   
14,723
   
15,259
 
Asia/Pacific
   
2,096
   
1,840
   
5,793
   
5,577
 
   
$
15,520
 
$
15,186
 
$
51,237
 
$
53,314
 

No single customer accounted for more than 10% of the Company's consolidated revenues during the third quarter or first nine months of fiscal 2006 or 2005. Revenues attributable to customers in Canada accounted for 14.8% and 10.6%, respectively, of the Company’s consolidated revenues during the third quarter and first nine months of fiscal 2006. Revenues attributable to customers in the United Kingdom accounted for 10.8% and 10.7% of the Company’s consolidated revenues during the first nine months of fiscal 2006 and 2005, respectively, and 10.8% of the Company’s consolidated revenues during the third quarter of fiscal 2005.

11.  Income Taxes

It is the Company’s policy to report income tax expense for interim reporting periods using an estimated annual effective income tax rate. The Company has estimated its fiscal 2006 annual effective income tax rate to be 35.3%. However, the tax effects of significant or unusual items are not considered in the estimated annual effective tax rate. The tax effect of such events is recognized in the interim period in which the event occurs.

The Company reached an agreement with the Internal Revenue Service (the “IRS”) to settle open audit issues related to years 1997 through 2003, resulting in a refund to the Company. The amount of the refund was $8.9 million. The refund and corresponding interest were dependent on the Company’s claims being approved by the Joint Committee on Taxation (the “Joint Committee”). In November 2005, the Company was notified that the Joint Committee approved the conclusions reached by the IRS with respect to the audit of the Company’s 1997 through 2003 tax years. During the first nine months of fiscal 2006, the Company received and recorded the effects of the refund in its consolidated financial statements, including estimated interest income of $2.0 million and entries to relieve related tax contingency reserves and other accruals relating to the audit in the amount of $3.9 million.

Each quarter, the Company evaluates its historical operating results as well as its projections for the future to determine the realizability of the deferred tax assets. During the third quarter of fiscal 2006, the Company released $12.6 million in valuation reserves related to carryover foreign tax credits. The decision to release the reserves was based on the Company’s history of utilizing foreign tax credits in its prior years’ federal income tax returns and in particular, its ability to utilize substantial amounts in its 2005 federal income tax return that was filed during the third quarter of fiscal 2006. In addition, the Company prepares ongoing estimates of future taxable income and associated foreign source income, as well as estimates of the ability to utilize foreign tax credits in excess of any credits that will be generated in the future. The Company anticipates that all of the foreign tax credits previously reserved will be utilized before the expiration of the carryforward period.


17


The effective tax rate for the third quarter of fiscal 2006 was a benefit of 37.7% as compared to a provision of 37.2% for the same period of fiscal 2005. The effective tax rate for the first nine months of fiscal 2006 was 6.2% as compared to 37.1% for the same period of fiscal 2005. Differences between the statutory federal income tax rate and the effective rates per the consolidated statements of operations are summarized as follows:

   
Three Months Ended
June 30,
 
Nine Months Ended
June 30,
 
   
2006
 
2005
 
2006
 
2005
 
Federal tax rate
   
35.0
%
 
35.0
%
 
35.0
%
 
35.0
%
State income taxes
   
1.7
   
2.2
   
1.9
   
2.2
 
Reduction of valuation allowance for deferred tax assets
   
(74.6
)
 
-
   
(22.2
)
 
-
 
Contingency reserves and accruals related to IRS audit
   
-
   
-
   
(6.9
)
 
-
 
Foreign withholding taxes and reserves
   
1.8
   
3.4
   
0.5
   
2.5
 
Extraterritorial income exclusion benefit
   
(0.6
)
 
(1.4
)
 
(0.7
)
 
(1.1
)
Other
   
(1.0
)
 
(2.0
)
 
(1.4
)
 
(1.5
)
Total (benefit) provision
   
(37.7
)%
 
37.2
%
 
6.2
%
 
37.1
%

The comparative decrease in the estimated fiscal 2006 effective income tax rate of 35.3%, from 37.0% for fiscal 2005, excluding discrete items such as the release of the valuation allowance on foreign tax credits and the release of reserves due to the IRS audit, is attributable primarily to the manufacturing deduction, a decrease in valuation allowances related to foreign withholding taxes, and an increase in nontaxable municipal interest offset by an increase related to the phase-out of the extraterritorial income exclusion.

12.  Contingencies

Legal Proceedings

From time to time, the Company is involved in litigation relating to claims arising out of its operations. Other than as described below, the Company is not currently a party to any legal proceedings, the adverse outcome of which, individually or in the aggregate, the Company believes would be likely to have a material adverse effect on the Company's financial condition or results of operations.

Class Action Litigation. In November 2002, two class action complaints were filed in the U.S. District Court for the District of Nebraska (the “Court”) against the Company and certain individuals, none of whom are currently executive officers of the Company, alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. Pursuant to a Court order, the two complaints were consolidated as Desert Orchid Partners v. Transaction Systems Architects, Inc., et al., with Genesee County Employees’ Retirement System designated as lead plaintiff. The Second Amended Consolidated Class Action Complaint (the “Consolidated Complaint”) previously alleged that, during the purported class period, the Company and the named defendants misrepresented the Company’s historical financial condition, results of operations and its future prospects, and failed to disclose facts that could have indicated an impending decline in the Company’s revenues. The Consolidated Complaint also alleged that, prior to August 2002, the purported truth regarding the Company’s financial condition had not been disclosed to the market. The Company and the individual defendants initially filed a motion to dismiss the lawsuit. In response, on December 15, 2003, the Court dismissed, without prejudice, Gregory Derkacht, the Company’s former president and chief executive officer, as a defendant, but denied the motion to dismiss with respect to the remaining defendants, including the Company.

On July 1, 2004, lead plaintiff filed a motion for class certification wherein, for the first time, lead plaintiff sought to add an additional class representative, Roger M. Wally. On August 20, 2004, defendants filed their opposition to the motion. On March 22, 2005, the Court issued an order certifying the class of persons that purchased the Company’s common stock from January 21, 1999 through November 18, 2002. 

On January 27, 2006, the Company and the individual defendants filed a motion for judgment on the pleadings, seeking a dismissal of the lead plaintiff and certain other class members, as well as a limitation on damages based upon plaintiffs' inability to establish loss causation with respect to a large portion of their claims. On February 6, 2006, additional class representative Roger M. Wally filed a motion to withdraw as a class representative and class member. On April 21, 2006, and based upon the pending motion for judgment, a motion to intervene as a class
 
18

 
representative was filed by the Louisiana District Attorneys Retirement System (“LDARS”). LDARS previously attempted to be named as lead plaintiff in the case. On July 5, 2006, the Magistrate denied LDARS’ motion to intervene, which LDARS has appealed to the District Judge. That appeal has not yet been decided.
On May 17, 2006, the Court denied the motion for judgment on the pleadings as being moot based upon the Court’s granting the lead plaintiff leave to file a Third Amended Complaint (the “Third Complaint”), which it did on May 31, 2006. The Third Complaint alleges the same misrepresentations as described above, while simultaneously alleging that the purported truth about the Company’s financial condition was being disclosed throughout that time, commencing in April 1999. The Third Complaint seeks unspecified damages, interest, fees and costs.

On June 14, 2006, the Company and the individual defendants filed a motion to dismiss the Third Complaint pursuant to Rules 8 and 12 of the Federal Rules of Civil Procedure. With the exception of one deposition, all discovery has been stayed in the case pending a ruling on the motion to dismiss.

13.  Recent Accounting Pronouncements

In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. (“FIN”) 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109,” which establishes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. For the Company, FIN 48 will be effective beginning with the fiscal year ending September 30, 2008. The Company is currently evaluating the impact that this interpretation will have on its financial condition and/or results of operations.
 
 
Item 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
              RESULTS OF OPERATIONS

Forward-Looking Statements

This report contains forward-looking statements based on current expectations that involve a number of risks and uncertainties. Generally, forward-looking statements do not relate strictly to historical or current facts, and include words or phrases such as management or the Company “anticipates,” “believes,” expects,” “plans,” “will,” and words and phrases of similar impact, and include, but are not limited to, statements regarding future operations, business strategy, business environment and key trends. The forward-looking statements are made pursuant to safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Any or all of the forward-looking statements in this report may turn out to be wrong. They can be affected by the judgments and estimates underlying such assumptions or by known or unknown risks and uncertainties. Many of these factors will be important in determining the Company’s actual future results. Consequently, no forward-looking statement can be guaranteed. Actual future results may vary materially from those expressed or implied in any forward-looking statements. In addition, the Company disclaims any obligation to update any forward-looking statements after the date of this report. Factors that could cause actual results to differ from those expressed or implied in the forward-looking statements include, but are not limited to, those discussed in Part II - Item 1A in the section entitled “Risk Factors - Factors That May Affect the Company’s Future Results or the Market Price of the Company’s Common Stock.”

Overview 

The Company develops, markets, installs and supports a broad line of software products and services primarily focused on facilitating electronic payments. In addition to its own products, the Company distributes, or acts as a sales agent for, software developed by third parties. The Company's products are sold and supported through distribution networks covering three geographic regions - the Americas, EMEA and Asia/Pacific. Each distribution network has its own sales force and supplements this with independent reseller and/or distributor networks. The Company’s products and services are used principally by financial institutions, retailers and electronic payment processors, both in domestic and international markets. Accordingly, the Company’s business and operating results are influenced by trends such as information technology spending levels, the growth rate of the electronic payments industry, mandated regulatory changes, and changes in the number and type of customers in the financial services industry. As set forth in Note 10 to the consolidated financial statements, at the beginning of fiscal 2006, the Company underwent a corporate reorganization, combining its products and services under the ACI Worldwide name.
 
 
19

 
The Company derives a majority of its revenues from non-domestic operations and believes its greatest opportunities for growth exist largely in international markets. Refining the Company’s global infrastructure is a critical component of driving its growth. The Company has launched a globalization strategy intended to streamline its supply chain and provide low-cost centers of expertise to support a growing international customer base. The Company established a new subsidiary in Ireland to serve as the focal point for certain international product development and commercialization efforts. This subsidiary will oversee remote software development operations in Romania and elsewhere, as well as manage certain of the Company’s intellectual property rights. The Company is forming a “Software as a Service” group to develop new business and market-entry vehicles where it sells a service directly to end-user banks, retailers or processors. The Company also is in the process of moving its principal executive offices to New York City to more strategically manage its global infrastructure.

Key trends that currently impact the Company’s strategies and operations include:
 
·  
Increasing electronic payment transaction volumes. Electronic payment volumes continue to increase around the world, taking market share from traditional cash and check transactions. The Company recently commissioned an industry study that determined that electronic payment volumes are expected to grow at approximately 13% per year for the next five years, with varying growth rates based on the type of payment and part of the world (source: 2006 ACI Worldwide Payments Market Forecast).The Company leverages the growth in transaction volumes through the licensing of new systems to customers whose older systems cannot handle increased volume and through the licensing of capacity upgrades from existing customers.

·  
Increasing competition. The electronic payments market is highly competitive and subject to rapid change. The Company's competition comes from in-house information technology departments, third-party electronic payment processors and third-party software companies located both within and outside of the United States. Many of these companies are significantly larger than the Company and have significantly greater financial, technical and marketing resources. As electronic payment transaction volumes increase, third-party processors tend to provide competition to the Company's solutions, particularly among customers that do not seek to differentiate their electronic payment offerings. As consolidation in the financial services industry continues, the Company anticipates that competition for those customers will intensify.

·  
Aging payments software. In many markets, electronic payments are processed using software developed by internal information technology departments, much of which was originally developed over ten years ago. Increasing transaction volumes, industry mandates and the overall costs of supporting these older technologies often serves to make these older systems obsolete, creating opportunities for the Company to replace this aging software with newer and more advanced products.

·  
Adoption of open systems technology. In an effort to leverage lower-cost computing technologies and current technology staffing and resources, many financial institutions, retailers and electronic payment processors are seeking to transition their systems from proprietary technologies to open technologies such as Windows, UNIX and Linux. The Company’s continued investment in open systems technologies is, in part, designed to address this demand.

·  
Electronic payments fraud and compliance. As electronic payment transaction volumes increase, criminal elements continue to find ways to commit a growing volume of fraudulent transactions using a wide range of techniques. Financial institutions, retailers and electronic payment processors continue to seek ways to leverage new technologies to identify and prevent fraudulent transactions. Due to concerns with international terrorism and money laundering, financial institutions in particular are being faced with increasing scrutiny and regulatory pressures. The Company continues to see opportunity to offer its fraud detection solutions to help customers manage the growing levels of electronic payment fraud and compliance activity.

·  
Adoption of smartcard technology. In many markets, card issuers are being required to issue new cards with embedded chip technology. Chip-based cards are more secure, harder to copy and offer the opportunity for multiple functions on one card (e.g. debit, credit, electronic purse, identification, health records, etc.). The Europay/Mastercard/Visa (“EMV”) standard for issuing and processing debit and credit card transactions has emerged as the global standard, with many regions throughout the world working on
 
20

 
 
EMV rollouts. The primary benefit of EMV deployment is a reduction in electronic payment fraud, with the additional benefit that the core infrastructure necessary for multi-function chip cards is being put in place (e.g. chip card readers in ATM’s and POS devices). The Company is working with many customers around the world to facilitate EMV deployments, leveraging several of the Company’s solutions.
 
·  
Basel II and Single Euro Payments Area (“SEPA”). The Basel II and SEPA initiatives, primarily focused on the European Economic Community, are designed to link the ability of a financial institution to understand enterprise risk to its capital requirements, and to facilitate lower costs for cross-border payments. The Company’s consumer banking and wholesale banking solutions are both key elements in helping customers address these government-sponsored initiatives.

·  
Financial institution consolidation. Consolidation continues on a national and international basis, as financial institutions seek to add market share and increase overall efficiency. There are several potential negative effects of increased consolidation activity. Continuing consolidation of financial institutions may result in a fewer number of existing and potential customers for the Company’s products and services. Consolidation of two of the Company’s customers could result in reduced revenues if the combined entity were to negotiate greater volume discounts or discontinue use of certain of the Company’s products. Additionally, if a non-customer and a customer combine and the combined entity in turn decides to forego future use of the Company’s products, the Company’s revenue would decline. Conversely, the Company could benefit from the combination of a non-customer and a customer when the combined entity continues usage of the Company’s products and, as a larger combined entity, increases its demand for the Company’s products and services. The Company tends to focus on larger financial institutions as customers, often resulting in the Company’s solutions being the solutions that survive in the consolidated entity.

·  
Electronic payments convergence. As electronic payment volumes grow and pressures to lower overall cost per transaction increase, financial institutions are seeking methods to consolidate their payment processing across the enterprise. The Company believes that the strategy of using service-oriented-architectures to allow for re-use of common electronic payment functions such as authentication, authorization, routing and settlement will become more common. Using these techniques, financial institutions will be able to reduce costs, increase overall service levels, enable one-to-one marketing in multiple bank channels and manage enterprise risk. The Company’s reorganization was, in part, focused on this trend, by facilitating the delivery of integrated payment functions that can be re-used by multiple bank channels, across both the consumer and wholesale bank. While this trend presents an opportunity for the Company, it may also expand the competition from third party electronic payment technology and service providers specializing in other forms of electronic payments. Many of these providers are larger than the Company and have significantly greater financial, technical and marketing resources.

Several other factors related to the Company’s business may have a significant impact on its operating results from year to year. For example, the accounting rules governing the timing of revenue recognition in the software industry are complex, and it can be difficult to estimate when the Company will recognize revenue generated by a given transaction. Factors such as maturity of the software product licensed, payment terms, creditworthiness of the customer and timing of delivery or acceptance of the Company’s products often cause revenues related to sales generated in one period to be deferred and recognized in later periods. For arrangements in which services revenue is deferred, related direct and incremental costs may also be deferred. While the U.S. dollar is the single largest currency in which the Company’s contracts are denominated, a substantial portion of its sales are made, and some of its expenses are incurred, in the local currency of countries other than the United States. Fluctuations in currency exchange rates in a given period may result in the Company’s recognition of gains or losses for that period.

On July 29, 2005, the Company acquired the business of S2 Systems, Inc. through the acquisition of substantially all of its assets. S2 was a global provider of electronic payments and network connectivity software, and it primarily served financial services and retail customers, which were homogeneous and complementary to the Company’s target markets. In addition to its U.S. operations, S2 had a significant presence in the Middle East, Europe, Latin America and the Asia/Pacific region, generating nearly half of its revenue from international markets. The S2 acquisition has been financially accretive in fiscal 2006 due to a combination of expense reductions, normalization of maintenance fee revenues and license upgrades to existing S2 systems.
 
21

 
On May 31, 2006, the Company acquired the outstanding shares of eps Electronic Payment Systems AG (“eps”), headquartered in Frankfurt, Germany. eps, with operations in Germany, Romania, the United Kingdom and other European locations, offers electronic payment and complementary solutions to the German market. The acquisition of eps will provide the Company additional opportunities to sell its value added solutions, such as Proactive Risk Manager and Smart Chip Manager, into the German marketplace, as well as to sell eps’ testing and dispute management solutions into markets beyond Germany. In addition, eps’ presence in Romania will help the Company more rapidly develop its global offshore development and support capabilities. The Company expects the eps acquisition to be financially accretive in fiscal 2007 due to a combination of expense reductions and cross-selling solutions into Germany and other parts of the world.

The Company continues to seek ways to grow, through both organic sources and acquisitions. The Company has increased its spending in fiscal 2006 to help drive organic growth from solutions such as BASE24-es, ACI Proactive Risk Manager and ACI Smart Chip Manager. In addition, the Company continually looks for potential acquisitions designed to improve its solutions’ breadth or provide access to new markets. As part of its acquisition strategy, the Company seeks acquisition candidates that are strategic, capable of being integrated into the Company’s operating environment and financially accretive to the Company’s financial performance.

The Company continues to evaluate strategies intended to improve its overall effective tax rate. The Company’s degree of success in this regard and related acceptance by taxing authorities of tax positions taken, as well as changes to tax laws in the United States and in various foreign jurisdictions, could cause the Company’s effective tax rate to fluctuate from period to period. During the third quarter of fiscal 2006, the Company began to manage certain intellectual property rights from its Irish subsidiary as part of the overall globalization strategy. The Company expects these globalization efforts to result in future improvements in profitability and reductions in its overall effective tax rate.

Critical Accounting Policies and Estimates

This disclosure is based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires that the Company make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The Company bases its estimates on historical experience and other assumptions that it believes to be proper and reasonable under the circumstances. The Company continually evaluates the appropriateness of estimates and assumptions used in the preparation of its consolidated financial statements. Actual results could differ from those estimates. The following key accounting policies are impacted significantly by judgments, assumptions and estimates used in the preparation of the consolidated financial statements.

Revenue Recognition

For software license arrangements for which services rendered are not considered essential to the functionality of the software, the Company recognizes revenue upon delivery, provided (1) there is persuasive evidence of an arrangement, (2) collection of the fee is considered probable, and (3) the fee is fixed or determinable. In most arrangements, because vendor-specific objective evidence of fair value does not exist for the license element, the Company uses the residual method to determine the amount of revenue to be allocated to the license element. Under the residual method, the fair value of all undelivered elements, such as postcontract customer support or other products or services, is deferred and subsequently recognized as the products are delivered or the services are performed, with the residual difference between the total arrangement fee and revenues allocated to undelivered elements being allocated to the delivered elements. For software license arrangements in which the Company has concluded that collectibility issues may exist, revenue is recognized as cash is collected, provided all other conditions for revenue recognition have been met. In making the determination of collectibility, the Company considers the creditworthiness of the customer, economic conditions in the customer’s industry and geographic location, and general economic conditions.

The Company’s sales focus continues to shift from its more-established (“mature”) products to its BASE24-es product and other less-established (collectively referred to as “newer”) products. As a result of this shift to newer products, absent other factors, the Company initially experiences an increase in deferred revenues and a corresponding decrease in current period revenues due to differences in the timing of revenue recognition for the
 
22

respective products. Revenues from newer products are typically recognized upon acceptance or first production use by the customer whereas revenues from mature products, such as BASE24, are generally recognized upon delivery of the product, provided all other conditions for revenue recognition have been met. For those arrangements where revenues are being deferred and the Company determines that related direct and incremental costs are recoverable, such costs are deferred and subsequently expensed as the revenues are recognized. Newer products are continually evaluated by Company management and product development personnel to determine when any such product meets specific internally defined product maturity criteria that would support its classification as a mature product. Evaluation criteria used in making this determination include successful demonstration of product features and functionality; standardization of sale, installation, and support functions; and customer acceptance at multiple production site installations, among others. A change in product classification (from newer to mature) would allow the Company to recognize revenues from new sales of the product upon delivery of the product rather than upon acceptance or first production use by the customer, resulting in earlier recognition of revenues from sales of that product, as well as related costs, provided all other revenue recognition criteria have been met.
 
When a software license arrangement includes services to provide significant modification or customization of software, those services are not considered to be separable from the software. Accounting for such services delivered over time is referred to as contract accounting. Under contract accounting, the Company generally uses the percentage-of-completion method. Under the percentage-of-completion method, the Company records revenue for the software license fee and services over the development and implementation period, with the percentage of completion generally measured by the percentage of labor hours incurred to-date to estimated total labor hours for each contract. Estimated total labor hours for each contract are based on the project scope, complexity, skill level requirements, and similarities with other projects of similar size and scope. For those contracts subject to contract accounting, estimates of total revenue and profitability under the contract consider amounts due under extended payment terms. The Company excludes revenues due on extended payment terms from its current percentage-of-completion computation until such time that collection of the fees becomes probable.

The Company may execute more than one contract or agreement with a single customer. The separate contracts or agreements may be viewed as one multiple-element arrangement or separate arrangements for revenue recognition purposes. Judgment is required when evaluating the facts and circumstances related to each situation in order to reach appropriate conclusions regarding whether such arrangements are related or separate. Those conclusions can impact the timing of revenue recognition related to those arrangements.

Share-Based Compensation

The Company accounts for share-based compensation transactions using a fair-value-based method, which requires it to record noncash compensation costs related to payment for employee services by an equity award, such as stock options, in its financial statements over the requisite service period. The significant majority of the Company’s stock options are subject only to time-based vesting provisions and include exercise prices that are equal to the fair market value of the Company’s stock at the time of grant. The Company also has outstanding stock options that vest, if at all, at any time following the second anniversary of the date of grant, upon attainment by the Company of a designated market price per share for sixty consecutive trading days.

In order to determine the grant date fair value of the stock options that vest based on the achievement of certain market conditions, a Monte Carlo simulation model was used to estimate (i) the probability that the performance goal will be achieved and (ii) the length of time required to attain the target market price. The Monte Carlo simulation model analyzed the Company’s historical price movements, changes in the value of The NASDAQ Stock Market over time, and the correlation coefficient and beta between the Company’s stock price and The NASDAQ Stock Market. The Monte Carlo simulation indicated an expected vesting period for these stock options on a risk-weighted basis, which was then incorporated into a statistical regression analysis of the historical exercise behavior of other Company senior executives to arrive at an expected option life. Achievement of the market conditions prior to completion of the expected vesting period for these stock options would require the Company to accelerate recognition of the related noncash compensation costs.

With respect to options granted that vest with the passage of time, the fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model using assumptions pertaining to expected life, interest rate, volatility and dividend yield. Expected volatilities are based on implied volatilities from traded options on the Company’s common stock and other industry factors. The expected life of options granted 
 
23

 
represents the period of time that options granted are expected to be outstanding, assuming differing exercise behaviors for stratified employee groupings. The assumptions used in the Black-Scholes option-pricing model and the Monte Carlo simulation model, and the results of the Monte Carlo simulation model relating to potential stock price appreciation, reflect the Company’s best estimates, as of the reporting date, of what future market conditions and the Company’s stock price may be in future periods, strictly for the purpose of applying SFAS No. 123R. The Company’s actual future stock prices could differ materially.
 
The Company also has outstanding long-term incentive program performance share awards that are earned, if at all, based upon the achievement, over a three-year period of performance goals related to (i) the compound annual growth over the three-year period in the Company’s 60-month backlog as determined by the Company, (ii) the compound annual growth over the three-year period in the diluted earnings per share, and (iii) the compound annual growth over the three-year period in the total revenues. In no event will any of the performance share awards become earned if the Company’s earnings per share is below a predetermined minimum threshold level at the conclusion of the three-year period. Management must evaluate, on a quarterly basis, the probability that the target performance goals will be achieved, if at all, and the anticipated level of attainment in order to determine the amount of compensation costs to record in the consolidated financial statements.

Related to the stock options and performance share awards outstanding, the Company must calculate estimated forfeiture rates, on an ongoing basis, that impact the amount of share-based compensation costs recorded in the consolidated financial statements. These estimated forfeiture rates may differ from actual forfeiture experience realized by the Company. Also, management’s assessment of the probability that the performance goals will be achieved, if at all, and the anticipated level of attainment, may prove to be inaccurate, which could impact the amount and timing of compensation costs that should have been recorded in the consolidated financial statements.

Prior to fiscal 2006, the Company accounted for its stock-based compensation plans under the intrinsic value method. Compensation expense generally was not recorded for options under the intrinsic value method. Instead, pro forma disclosure of the Company's net income and earnings per share was presented in the notes to the consolidated financial statements as if compensation cost for the Company's stock-based compensation plans had been determined and recorded using the fair value method.

Provision for Doubtful Accounts

The Company maintains a general allowance for doubtful accounts based on its historical experience, along with additional customer-specific allowances. The Company regularly monitors credit risk exposures in its accounts receivable. In estimating the necessary level of its allowance for doubtful accounts, management considers the aging of its accounts receivable, the creditworthiness of the Company's customers, economic conditions within the customer's industry, and general economic conditions, among other factors. Should any of these factors change, the estimates made by management would also change, which in turn would impact the level of the Company's future provision for doubtful accounts. Specifically, if the financial condition of the Company's customers were to deteriorate, affecting their ability to make payments, additional customer-specific provisions for doubtful accounts may be required. Also, should deterioration occur in general economic conditions, or within a particular industry or region in which the Company has a number of customers, additional provisions for doubtful accounts may be recorded to reserve for potential future losses. Any such additional provisions would reduce operating income in the periods in which they were recorded.

Accounting for Income Taxes

Accounting for income taxes requires significant judgments in the development of estimates used in income tax calculations. Such judgments include, but are not limited to, the likelihood the Company would realize the benefits of net operating and capital loss carryforwards and/or foreign tax credit carryforwards, the adequacy of valuation allowances, and the tax rates used to measure transactions with foreign subsidiaries. As part of the process of preparing the Company's consolidated financial statements, the Company is required to estimate its income taxes in each of the jurisdictions in which the Company operates. The judgments and estimates used are subject to challenge by domestic and foreign taxing authorities. It is possible that either domestic or foreign taxing authorities could challenge those judgments and estimates and draw conclusions that would cause the Company to incur tax liabilities in excess of, or realize benefits less than, those currently recorded. In addition, changes in the geographical mix or estimated amount of annual pretax income could impact the Company's overall effective tax rate.
 
24

 
To the extent recovery of deferred tax assets is not likely, the Company records a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. Although the Company has considered future taxable income along with prudent and feasible tax planning strategies in assessing the need for a valuation allowance, if the Company should determine that it would not be able to realize all or part of its deferred tax assets in the future, an adjustment to deferred tax assets would be charged to income in the period any such determination was made. Likewise, in the event the Company is able to realize its deferred tax assets in the future in excess of the net recorded amount, an adjustment to deferred tax assets would increase net income in the period any such determination was made.

Each quarter, the Company evaluates its historical operating results as well as its projections for the future to determine the realizability of the deferred tax assets. During the third quarter of fiscal 2006, the Company released $12.6 million in valuation reserves related to carryover foreign tax credits. The decision to release the reserves was based on the Company’s history of utilizing foreign tax credits in its prior years’ federal income tax returns and in particular, its ability to utilize substantial amounts in its 2005 federal income tax return that was filed during the third quarter of fiscal 2006. In addition, the Company prepares ongoing estimates of future taxable income and associated foreign source income, as well as estimates of the ability to utilize foreign tax credits in excess of any credits that will be generated in the future. The Company anticipates that all of the foreign tax credits previously reserved will be utilized before the expiration of the carryforward period.

Recent Accounting Pronouncements

In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. (“FIN”) 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109,” which establishes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. For the Company, FIN 48 will be effective beginning with the fiscal year ending September 30, 2008. The Company is currently evaluating the impact that this interpretation will have on its financial condition and/or results of operations.

Segment Information

As set forth in Note 10 to the consolidated financial statements, the Company underwent a corporate reorganization in the first quarter of fiscal 2006. As a result of the reorganization and in accordance with the criteria set forth in SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” the Company transitioned its operating segments from its prior three business units (ACI Worldwide, Insession Technologies and IntraNet Worldwide) to its three geographic operating regions (the Americas, EMEA and Asia/Pacific). The following are revenues and operating income for the periods indicated, with prior period amounts presented in conformity with current geographic region presentation (in thousands):

   
Three Months Ended
June 30,
 
Nine Months Ended
June 30,
 
   
2006
 
2005
 
2006
 
2005
 
Revenues:
                 
Americas
 
$
47,033
 
$
42,474
 
$
134,562
 
$
126,588
 
EMEA
   
29,684
   
27,658
   
100,704
   
84,201
 
Asia/Pacific
   
8,047
   
7,871
   
24,406
   
23,446
 
   
$
84,764
 
$
78,003
 
$
259,672
 
$
234,235
 
                           
Operating income:
                         
Americas
 
$
12,019
 
$
9,023
 
$
30,721
 
$
32,478
 
EMEA
   
1,405
   
4,323
   
14,723
   
15,259
 
Asia/Pacific
   
2,096
   
1,840
   
5,793
   
5,577
 
   
$
15,520
 
$
15,186
 
$
51,237
 
$
53,314
 


25

 
Backlog

Included in backlog are all software license fees, maintenance fees and services specified in executed contracts, as well as revenues from assumed contract renewals to the extent that the Company believes recognition of the related revenue will occur within the corresponding backlog period. The Company has historically included assumed renewals in backlog based upon automatic renewal provisions in the executed contract and the Company’s historic experience with customer renewal rates.

The Company’s 60-month backlog represents expected revenues from existing customers using the following key assumptions:

·  
Maintenance fees are assumed to exist for the duration of the license term for those contracts in which the committed maintenance term is less than the committed license term.
·  
License and facilities management arrangements are assumed to renew at the end of their committed term at a rate consistent with historical Company experiences.
·  
Non-recurring license arrangements are assumed to renew as recurring revenue streams.
·  
Foreign currency exchange rates are assumed to remain constant over the 60-month backlog period for those contracts stated in currencies other than the U.S. dollar.
·  
Company pricing policies and practices are assumed to remain constant over the 60-month backlog period.

In computing the Company’s 60-month backlog, the following items are specifically not taken into account:

·  
Anticipated increases in transaction volumes in customer systems.
·  
Optional annual uplifts or inflationary increases in recurring fees.
·  
Services engagements, other than facilities management, are not assumed to renew over the 60-month backlog period.
·  
The potential impact of merger activity within the Company’s markets and/or customers is not reflected in the computation of 60-month backlog.

The following table sets forth the Company’s 60-month backlog, by geographic region, as of June 30, 2006 and September 30, 2005 (in millions):

   
June 30, 2006
 
Sept. 30, 2005
 
Americas 
 
$
529
 
$
525
 
EMEA 
   
438
   
383
 
Asia/Pacific. 
   
125
   
123
 
   
$
1,092
 
$
1,031
 

The Company also reports 12-month backlog, segregated between monthly recurring and non-recurring revenues, using a methodology that is consistent with the 60-month calculation. Monthly recurring revenues include all monthly license fees, maintenance fees and facilities management fees. Non-recurring revenues include other software license fees and services. Amounts included in 12-month backlog assume renewal of one-time license fees on a monthly fee basis if such renewal is expected to occur in the next 12 months. The following table sets forth the Company’s 12-month backlog, by geographic region, as of June 30, 2006 and September 30, 2005 (in thousands):

 
June 30, 2006
 
September 30, 2005
 
Monthly Recurring
 
Non-
Recurring
 
Total
 
Monthly Recurring
 
Non-
Recurring
 
Total
Americas 
$ 97,340
 
$ 29,525
 
$126,865
 
$ 97,523
 
$ 32,343
 
$129,866
EMEA 
68,877
 
33,709
 
102,586
 
60,038
 
33,194
 
93,232
Asia/Pacific. 
25,400
 
3,372
 
28,772
 
25,711
 
1,217
 
26,928
 
$191,617
 
$ 66,606
 
$258,223
 
$183,272
 
$ 66,754
 
$250,026

 
 
26


The Company’s customers may attempt to renegotiate or terminate their contracts for a number of reasons, including mergers, changes in their financial condition, or general changes in economic conditions in the customer's industry or geographic location, or the Company may experience delays in the development or delivery of products or services specified in customer contracts which may cause the actual renewal rates and amounts to differ from historical experiences. Changes in foreign currency exchange rates may also impact the amount of revenue actually recognized in future periods. Accordingly, there can be no assurance that contracts included in backlog will actually generate the specified revenues or that the actual revenues will be generated within the corresponding 12-month or 60-month period.

Results of Operations

The following table sets forth certain financial data and the percentage of total revenues of the Company for the periods indicated (in thousands):

     
Three Months Ended June 30,
 
Nine Months Ended June 30,
     
2006
 
2005
 
2006
 
2005
 
 
 
Amount
 
% of
Revenue
 
Amount
 
% of
Revenue
 
Amount
 
% of
Revenue
 
Amount
 
% of
Revenue
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Initial license fees (ILFs) 
$
24,222
 
28.6
%
 
$
19,171
 
24.6
%
 
$
80,783
 
31.1
%
 
$
73,323
 
31.3
%
 
Monthly license fees (MLFs) 
 
17,733
 
20.9
 
 
 
18,485
 
23.7
 
 
 
52,294
 
20.1
 
 
 
55,092
 
23.5
 
 
Software license fees 
 
41,955
 
49.5
 
 
 
37,656
 
48.3
 
 
 
133,077
 
51.2
 
 
 
128,415
 
54.8
 
 
Maintenance fees 
 
25,989
 
30.7
 
 
 
24,938
 
32.0
 
 
 
76,053
 
29.3
 
 
 
69,667
 
29.8
 
 
Services 
 
16,820
 
19.8
 
 
 
15,409
 
19.7
 
 
 
50,542
 
19.5
 
 
 
36,153
 
15.4
 
 
 
Total revenues 
 
84,764
 
100.0
 
 
 
78,003
 
100.0
 
 
 
259,672
 
100.0
 
 
 
234,235
 
100.0
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cost of software license fees 
 
7,895
 
9.3
 
 
 
6,539
 
8.4
 
 
 
22,335
 
8.6
 
 
 
18,170
 
7.8
 
 
Cost of maintenance and services 
 
19,385
 
22.9
 
 
 
14,102
 
18.1
 
 
 
59,332
 
22.9
 
 
 
41,756
 
17.8
 
 
Research and development 
 
10,191
 
12.0
 
 
 
9,704
 
12.4
 
 
 
29,921
 
11.5
 
 
 
29,842
 
12.7
 
 
Selling and marketing 
 
15,896
 
18.8
 
 
 
16,183
 
20.7
 
 
 
48,437
 
18.7
 
 
 
46,852
 
20.0
 
 
General and administrative 
 
15,877
 
18.7
 
 
 
16,289
 
20.9
 
 
 
48,410
 
18.6
 
 
 
44,301
 
18.9
 
 
 
Total expenses 
 
69,244
 
81.7
 
 
 
62,817
 
80.5
 
 
 
208,435
 
80.3
 
 
 
180,921
 
77.2
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating income
 
15,520
 
18.3
 
 
 
15,186
 
19.5
 
 
 
51,237
 
19.7
 
 
 
53,314
 
22.8
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other income (expense):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income 
 
1,641
 
1.9
 
 
 
1,279
 
1.6
 
 
 
6,154
 
2.4
 
 
 
2,727
 
1.2
 
 
Interest expense 
 
(10)
 
(0.0)
 
 
 
(102)
 
(0.1)
 
 
 
(126)
 
(0.1)
 
 
 
(407)
 
(0.2)
 
 
Other, net 
 
(227)
 
(0.2)
 
 
 
(453)
 
(0.6)
 
 
 
(239)
 
(0.1)
 
 
 
(1,445)
 
(0.6)
 
 
 
Total other income (expense) 
 
1,404
 
1.7
 
 
 
724
 
0.9
 
 
 
5,789
 
2.2
 
 
 
875
 
0.4
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income before income taxes
 
16,924
 
20.0
 
 
 
15,910
 
20.4
 
 
 
57,026
 
21.9
 
 
 
54,189
 
23.2
 
Income tax benefit (provision)
 
6,384
 
7.5
 
 
 
(5,915)
 
(7.6)
 
 
 
(3,542)
 
(1.3)
 
 
 
(20,078)
 
(8.6)
 
Net income
$
23,308
 
27.5
%
 
$
9,995
 
12.8
%
 
$
53,484
 
20.6
%
 
$
34,111
 
14.6<