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 March 31, 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 April 27, 2006, there were 37,392,497 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
18
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
29
Item 4.
Controls and Procedures
29
 
PART II - OTHER INFORMATION
Item 1.
Legal Proceedings
30
Item 1A.
Risk Factors
31
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
32
Item 3.
Defaults Upon Senior Securities
32
Item 4.
Submission of Matters to a Vote of Security Holders
32
Item 5.
Other Information
33
Item 6.
Exhibits
33
   
Signature
34
Exhibit Index
35













PART I - FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

 
Page
Consolidated Balance Sheets as of March 31, 2006 and September 30, 2005
2
Consolidated Statements of Operations for the three and six months ended March 31, 2006 and 2005
3
Consolidated Statements of Cash Flows for the six months ended March 31, 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)

   
March 31,
2006
 
September 30,
2005
 
ASSETS
 
(Unaudited)
 
 
 
Current assets:
             
Cash and cash equivalents
 
$
113,539
 
$
83,693
 
Marketable securities
   
76,182
   
72,819
 
Billed receivables, net of allowances of $2,102 and $2,390, respectively
   
59,110
   
63,530
 
Accrued receivables
   
8,547
   
5,535
 
Recoverable income taxes
   
-
   
3,474
 
Deferred income taxes, net
   
4,509
   
2,552
 
Other
   
11,959
   
13,009
 
Total current assets
   
273,846
   
244,612
 
Property and equipment, net
   
9,642
   
9,089
 
Software, net
   
4,275
   
4,930
 
Goodwill
   
66,248
   
66,169
 
Other intangible assets, net
   
12,481
   
13,573
 
Deferred income taxes, net
   
21,566
   
21,884
 
Other
   
2,737
   
3,123
 
Total assets
 
$
390,795
 
$
363,380
 
               
 LIABILITIES AND STOCKHOLDERS’ EQUITY
             
Current liabilities:
             
Current portion of debt - financing agreements
 
$
308
 
$
2,165
 
Accounts payable
   
6,316
   
9,521
 
Accrued employee compensation
   
15,967
   
19,296
 
Income taxes payable
   
8,999
   
-
 
Deferred revenue
   
80,134
   
81,374
 
Accrued and other liabilities
   
10,666
   
11,662
 
Total current liabilities
   
122,390
   
124,018
 
Debt - financing agreements
   
-
   
154
 
Deferred revenue
   
20,429
   
20,450
 
Other
   
1,854
   
1,640
 
Total liabilities
   
144,673
   
146,262
 
               
Commitments and contingencies (Note 11)
             
               
Stockholders' equity:
             
      Preferred stock, $.01 par value; 5,000,000 shares authorized; no shares issued and outstanding at
            March 31, 2006 and September 30, 2005
   
-
   
-
 
Common stock, $.005 par value; 70,000,000 shares authorized; 40,823,727 and 40,327,678 shares issued at March 31, 2006 and September 30, 2005, respectively
   
204
   
202
 
Treasury stock, at cost; 3,431,231 and 2,943,109 shares at March 31, 2006 and September 30, 2005, respectively
   
(82,251
)
 
(68,596
)
Additional paid-in capital
   
287,059
   
274,344
 
Retained earnings
   
50,505
   
20,329
 
Accumulated other comprehensive loss
   
(9,395
)
 
(9,161
)
Total stockholders' equity
   
246,122
   
217,118
 
Total liabilities and stockholders' equity
 
$
390,795
 
$
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
March 31,
 
Six Months Ended
March 31,
 
   
2006
 
2005
 
2006
 
2005
 
Revenues:
                         
Software license fees
 
$
47,730
 
$
42,953
 
$
91,122
 
$
90,759
 
Maintenance fees
   
24,746
   
22,649
   
50,064
   
44,729
 
Services
   
17,357
   
10,024
   
33,722
   
20,744
 
Total revenues
   
89,833
   
75,626
   
174,908
   
156,232
 
                           
Expenses:
                         
Cost of software license fees
   
7,505
   
5,725
   
14,440
   
11,631
 
Cost of maintenance and services
   
19,056
   
13,818
   
39,947
   
27,654
 
Research and development
   
9,978
   
10,223
   
19,730
   
20,138
 
Selling and marketing
   
16,529
   
15,368
   
32,541
   
30,669
 
General and administrative
   
15,563
   
14,449
   
32,533
   
28,012
 
Total expenses
   
68,631
   
59,583
   
139,191
   
118,104
 
                           
Operating income
   
21,202
   
16,043
   
35,717
   
38,128
 
                           
Other income (expense):
                         
Interest income
   
1,586
   
864
   
4,513
   
1,448
 
Interest expense
   
(87
)
 
(137
)
 
(116
)
 
(305
)
Other, net
   
354
   
255
   
(12
)
 
(992
)
Total other income (expense)
   
1,853
   
982
   
4,385
   
151
 
                           
Income before income taxes
   
23,055
   
17,025
   
40,102
   
38,279
 
Income tax provision
   
(8,069
)
 
(5,832
)
 
(9,926
)
 
(14,163
)
Net income
 
$
14,986
 
$
11,193
 
$
30,176
 
$
24,116
 
                           
 
Earnings per share information:
                         
Weighted average shares outstanding:
                         
Basic
   
37,241
   
38,121
   
37,247
   
37,949
 
                Diluted
   
38,065
   
38,903
   
38,041
   
38,731
 
                           
Earnings per share:
                         
Basic
 
$
0.40
 
$
0.29
 
$
0.81
 
$
0.64
 
                Diluted
 
$
0.39
 
$
0.29
 
$
0.79
 
$
0.62
 
 
 
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)

   
Six Months Ended
March 31,
 
   
2006
 
2005
 
Cash flows from operating activities:
             
Net income
 
$
30,176
 
$
24,116
 
Adjustments to reconcile net income to net cash provided by operating activities:
             
Depreciation
   
2,042
   
1,945
 
Amortization
   
1,861
   
441
 
Deferred income taxes
   
(1,631
)
 
(5,285
)
Share-based compensation expense 
   
2,884
   
-
 
Tax benefit of stock options exercised 
   
681
   
2,526
 
Changes in operating assets and liabilities:
             
Billed and accrued receivables, net
   
1,094
   
(3,464
)
Other current assets
   
1,044
   
(1,540
)
Other assets
   
(6
)
 
(1,785
)
Accounts payable
   
(3,121
)
 
734
 
Accrued employee compensation
   
(2,729
)
 
(1,322
)
Accrued liabilities
   
(697
)
 
(180
)
Current income taxes
   
12,474
   
8,062
 
Deferred revenue
   
(946
)
 
6,044
 
Other current and noncurrent liabilities
   
102
   
215
 
Net cash provided by operating activities
   
43,228
   
30,507
 
               
Cash flows from investing activities:
             
Purchases of property and equipment
   
(3,049
)
 
(1,577
)
Purchases of software
   
(255
)
 
(912
)
Purchases of marketable securities
   
(36,062
)
 
(76,875
)
Sales of marketable securities
   
32,703
   
3,778
 
Acquisition of business
   
(59
)
 
-
 
Net cash used in investing activities
   
(6,722
)
 
(75,586
)
               
Cash flows from financing activities:
             
Proceeds from issuance of common stock
   
589
   
487
 
Proceeds from exercises of stock options
   
7,055
   
7,892
 
Excess tax benefit of stock options exercised 
   
1,506
   
-
 
Purchases of common stock
   
(13,978
)
 
(7,249
)
Payments on debt - financing agreements
   
(2,002
)
 
(4,984
)
Other
   
122
   
397
 
Net cash used in financing activities
   
(6,708
)
 
(3,457
)
               
Effect of exchange rate fluctuations on cash
   
48
   
1,837
 
               
Net increase (decrease) in cash and cash equivalents
   
29,846
   
(46,699
)
Cash and cash equivalents, beginning of period
   
83,693
   
134,198
 
Cash and cash equivalents, end of period
 
$
113,539
 
$
87,499
 
 
 
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 March 31, 2006, and for the three and six months ended March 31, 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. Certain amounts previously reported have been reclassified to conform to the current period presentation.

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 six months ended March 31, 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. The consolidated financial statements at March 31, 2006 and September 30, 2005, and for the three and six months ended March 31, 2006, include amounts acquired from, as well as results of operations of, the acquired business.
 
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 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

5

 
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. 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
March 31,
 
Six Months Ended
March 31,
 
   
2006
 
2005
 
2006
 
2005
 
Software license fees 
 
$
4,057
 
$
5,113
 
$
8,307
 
$
10,065
 
Maintenance fees 
   
1,364
   
1,567
   
2,676
   
3,163
 
Total 
 
$
5,421
 
$
6,680
 
$
10,983
 
$
13,228
 

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. 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.

 
7


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 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.

Accounting for Share-Based Payments Pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 123 (Revised 2004), “Share-Based Payment” (“SFAS No. 123R”)

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, “Share-Based Payment,” 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 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) as the requisite service is rendered on or after that date. 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. Under the modified prospective transition method, the financial statements are unchanged for periods prior to adoption and the pro forma disclosures previously required by SFAS No. 123 for those prior periods will continue to be required to the extent those amounts differ from the amounts in the statement of operations.
 

 
8

 
The Company did not grant any awards pursuant to the 1999 Stock Option Plan during the first six months of fiscal 2006. The Company granted 50,000 and 80,000 stock options, respectively, during the second quarter and first six months of fiscal 2006 pursuant to the 2005 Incentive Plan. With respect to these options, which vest with the passage of time, the fair value of this option grant 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
March 31, 2006
 
Six Months Ended
March 31, 2006
Expected life 
 
        4.0
 
 
 
        4.4
 
Interest rate 
 
4.7%
     
4.6%
 
Volatility 
 
42%
     
42%
 
Dividend yield 
 
     
 

Expected volatilities are based on implied volatilities from traded options on the Company’s common stock, historical volatility of the Company’s common stock, and other factors. The expected term 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 the first six 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”) representing 124,000 shares of the Company’s common stock with a weighted-average grant date fair value of $29.18 per share to various key employees of the Company, using the market price of the Company’s common stock at the time of grant as the fair value per share. 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 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.

Additionally, the discount offered pursuant to the Company’s ESPP discussed above is 15%, which exceeds the 5% noncompensatory guideline in 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.

Share-based compensation expenses recognized under SFAS No. 123R in the second 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, resulting in decreased net income of $1.0 million, or $0.03 per basic share and $0.03 per diluted share. Share-based compensation expenses recognized under SFAS No. 123R in the first six months of fiscal 2006 related to stock options, LTIP Performance Shares, and the ESPP were $2.9 million, with corresponding tax benefits of $1.0 million, resulting in decreased net income of $1.9 million, or $0.05 per basic share and $0.05 per diluted share. No share-based compensation costs were capitalized during the second quarter or first six 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 elected to recognize 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. In accordance with the modified prospective transition method, the Company's consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS No. 123R. However, pro forma disclosures for periods prior to adoption of SFAS No. 123R are included below as part of this footnote.
 
 
9

 
Adoption of SFAS No. 123R also affected the Company’s presentation of cash flows. For the first six months of fiscal 2006, tax benefits in excess of the SFAS No. 123 grant date fair value realized from options exercised during that period reduced cash flows from operating activities by $1.5 million and increased cash flows from financing activities by $1.5 million as compared to amounts that would have been reported had the Company not adopted the new standard.

Other Disclosures

A summary of stock options as of March 31, 2006 and changes during the six 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
   
80,000
   
31.62
             
   Exercised
   
(472,835
)
 
14.93
             
   Cancellations
   
(42,822
)
 
22.52
             
Outstanding at March 31, 2006
   
3,490,561
 
$
17.31
   
7.0
 
$
47,994
 
                           
Exercisable at March 31, 2006
   
2,074,456
 
$
13.79
   
5.7
 
$
35,537
 

All fully-vested stock options as of March 31, 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 upon option exercise. The intrinsic value of options exercised during the first six months of fiscal 2006 was $6.5 million. The Company’s stock awards allow employees to exercise options through cash payment to the Company for the 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.

A summary of nonvested LTIP Performance Shares as of March 31, 2006 and changes during the six 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 March 31, 2006
   
156,000
 
$
29.00
 

As of March 31, 2006, there were unrecognized compensation costs of $9.9 million related to nonvested stock options and $3.4 million related to nonvested LTIP Performance Shares which the Company expects to recognize over weighted-average periods of 2.7 years and 2.5 years, respectively.

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.
 
 
10

 
Prior to October 1, 2005, the Company calculated stock-based compensation pursuant to the disclosure provisions of 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 second quarter and first six months of fiscal 2005 would have approximated the following pro forma amounts (in thousands, except per share amounts):

   
Three Months Ended
March 31, 2005
 
Six Months Ended
March 31, 2005
 
Net income:
             
As reported
 
$
11,193
 
$
24,116
 
Deduct: stock-based employee compensation expense determined under the fair value method for all awards, net of related tax effects
   
(663
)
 
(1,293
)
Add: stock-based employee compensation expense recorded under the intrinsic value method, net of related tax effects
   
76
   
95
 
Pro forma
 
$
10,606
 
$
22,918
 
               
Earnings per share:
             
Basic, as reported
 
$
0.29
 
$
0.64
 
Basic, pro forma
 
$
0.28
 
$
0.60
 
               
Diluted, as reported
 
$
0.29
 
$
0.62
 
Diluted, pro forma
 
$
0.27
 
$
0.59
 

The effects of applying SFAS No. 123 in this pro forma disclosure are not indicative of future amounts.

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, a pricing model acceptable under SFAS No. 123, with the following weighted-average assumptions:

 
Three Months Ended
March 31, 2005
 
Six Months Ended
March 31, 2005
Expected life 
 
        4.1
     
        4.1
 
Interest rate 
 
4.0%
     
4.0%
 
Volatility 
 
46%
     
47%
 
Dividend yield 
 
     
 

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:
 
11


 
Three Months Ended
March 31, 2005
 
Six Months Ended
March 31, 2005
Expected life 
 
        5.5
     
        5.5
 
Interest rate 
 
4.2%
     
4.2%
 
Volatility 
 
46%
     
46%
 
Dividend yield 
 
     
 

During fiscal 2005, pursuant to the Company’s 2005 Incentive Plan, the Company granted LTIP Performance Shares representing 37,000 shares of the Company’s common stock with a grant date fair value of $28.27 per share to various key employees of the Company, using the market price of the Company’s common stock at the time of grant as the fair value per share. None of the LTIP Performance Shares were granted during the second quarter or first six months of fiscal 2005.

4. 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):

   
March 31,
2006
 
Sept. 30,
2005
 
Municipal auction rate notes 
 
$
75,185
 
$
71,825
 
Municipal bonds/notes 
   
997
   
994
 
Marketable securities
 
$
76,182
 
$
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.

5. Goodwill, Software and Other Intangible Assets

Changes in the carrying amount of goodwill during the first six months of fiscal 2006 consisted of additional goodwill of $143,000 related to the acquisition of S2 and a net decrease of $64,000 resulting from foreign currency translation adjustments.

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):

   
March 31,
2006
 
Sept. 30,
2005
 
Software:
             
Internally-developed software
 
$
17,418
 
$
14,916
 
Purchased software
   
40,555
   
43,177
 
     
57,973
   
58,093
 
Less: accumulated amortization
   
(53,698
)
 
(53,163
)
Software, net
 
$
4,275
 
$
4,930
 

 
12


   
March 31,
2006
 
Sept. 30,
2005
 
Other intangible assets:
             
Customer relationships
 
$
14,253
 
$
14,375
 
Purchased contracts
   
3,871
   
3,907
 
Trademarks and tradenames
   
1,400
   
1,400
 
Covenant not to compete
   
1,150
   
1,150
 
     
20,674
   
20,832
 
Less: accumulated amortization
   
(8,193
)
 
(7,259
)
Other intangible assets, net
 
$
12,481
 
$
13,573
 

Amortization of software 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 three years. Software amortization expense recorded in the three and six months ended March 31, 2006 totaled $0.5 million and $0.9 million, respectively. Other intangible assets amortization expense recorded in the three and six months ended March 31, 2006 totaled $0.4 million and $0.9 million, respectively. Based on capitalized intangible assets at March 31, 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 
 
$
831
 
$
870
 
   2007 
   
1,365
   
1,639
 
   2008
   
667
   
1,639
 
   2009 
   
305
   
1,561
 
   2010 
   
275
   
1,502
 
   Thereafter 
   
832
   
5,270
 
  Total 
 
$
4,275
 
$
12,481
 

6. 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 $0.2 million and other reorganization charges of $0.2 million related to the Company’s restructuring of its organization were incurred during the first six months of fiscal 2006. The allocation of net charges incurred during the first six months of fiscal 2006 was as follows: $70,000 in cost of software license fees, $8,000 credit in cost of maintenance and services, $64,000 credit in research and development, $4,000 in selling and marketing, and $395,000 in general and administrative. Cash expenditures related to restructuring and other reorganization charges totaled $1.3 million during the first six 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
   
207
   
616
 
Adjustments to previously-recognized liabilities
   
(219
)
 
-
   
(219
)
Amounts paid during fiscal 2006
   
(1,066
)
 
(207
)
 
(1,273
)
Balance, March 31, 2006
 
$
158
 
$
-
 
$
158
 
 
 
13

 
7. Common Stock, Treasury Stock and Earnings Per Share

Options to purchase 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 March 31, 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 six months ended March 31, 2006 and 2005. Included in common stock are 2,212 penny options as of March 31, 2006 and September 30, 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. During the second quarter of fiscal 2006, the Company repurchased 11,000 shares of its common stock at an average price of $30.45 per share under this stock repurchase program. The maximum approximate remaining dollar value of shares authorized for purchase under the stock repurchase program was $33.0 million as of March 31, 2006.

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 March 31, 2006 and 2005, which amounted to 824,000 and 782,000 shares, respectively, and for the six months ended March 31, 2006 and 2005, which amounted to 794,000 and 782,000 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 March 31, 2006 and 2005 were options to purchase 722,000 shares and 839,000 shares, respectively, and for the six months ended March 31, 2006 and 2005 were options to purchase 773,000 shares and 716,000 shares, respectively, because the stock options were for contingently issuable shares or because their impact would be antidilutive based on current market prices.

8. Comprehensive Income

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

   
Three Months Ended
March 31,
 
Six Months Ended
March 31,
 
   
2006
 
2005
 
2006
 
2005
 
Net income 
 
$
14,986
 
$
11,193
 
$
30,176
 
$
24,116
 
Other comprehensive income (loss):
                         
Foreign currency translation adjustments
   
9
   
16
   
(237
)
 
(73
)
Change in unrealized investment holding loss:
                         
     Unrealized holding gain (loss) arising during the period 
   
4
   
35
   
3
   
(47
)
Comprehensive income 
 
$
14,999
 
$
11,244
 
$
29,942
 
$
23,996
 

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
   
(237
)
 
3
   
(234
)
Balance, March 31, 2006
 
$
(9,392
)
$
(3
)
$
(9,395
)
 
 
14

 
9. 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, it was decided 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.

No single customer accounted for more than 10% of the Company's consolidated revenues during the second quarter or first six months of fiscal 2006 or 2005. Revenues attributable to customers in the United Kingdom accounted for approximately 12.8% and 12.3%, respectively, of the Company’s consolidated revenues during the second quarter and first six months of fiscal 2006. Revenues attributable to customers in each foreign country in which the Company transacts business were less than 10% of the Company’s consolidated revenues during the second quarter and first six months of fiscal 2005.

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
March 31,
 
Six Months Ended
March 31,
 
   
2006
 
2005
 
2006
 
2005
 
Revenues:
                         
Americas
 
$
43,609
 
$
42,746
 
$
87,529
 
$
84,114
 
EMEA
   
37,356
   
25,097
   
71,020
   
56,543
 
Asia/Pacific
   
8,868
   
7,783
   
16,359
   
15,575
 
   
$
89,833
 
$
75,626
 
$
174,908
 
$
156,232
 
                           
Operating income:
                         
Americas
 
$
10,256
 
$
11,188
 
$
18,702
 
$
23,455
 
EMEA
   
8,256
   
2,989
   
13,318
   
10,936
 
Asia/Pacific
   
2,690
   
1,866
   
3,697
   
3,737
 
   
$
21,202
 
$
16,043
 
$
35,717
 
$
38,128
 

 
15

 
10. 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, which the Company estimates to be 35.0% for fiscal 2006. 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 quarter of fiscal 2006, the Company recorded the effects of the refund in its consolidated financial statements, including estimated interest income of $1.8 million and entries to relieve related tax contingency reserves and other accruals relating to the audit in the amount of $3.9 million. In February 2006, the Company received the refund payment, which included additional interest of $0.2 million that was recognized as income in the Company’s fiscal 2006 second quarter operating results.

The effective tax rate for the second quarter of fiscal 2006 was approximately 35.0% as compared to 34.3% for the same period of fiscal 2005. The effective tax rate for the first six months of fiscal 2006 was approximately 24.8% as compared to 37.0% for the same period of fiscal 2005. The improvement in the effective tax rate for the first six months of fiscal 2006, as compared to the same period of fiscal 2005, resulted primarily from the release of tax contingency reserves and other accruals related to the above-noted IRS audit settlement. The effective tax rate for the first six months of fiscal 2006, excluding the effect of the IRS audit settlement, was primarily impacted by the extraterritorial income exclusion, the manufacturing deduction, municipal interest income, a decrease in valuation allowances related to foreign net operating losses, and the differential between the statutory federal tax rate in the U.S. and certain foreign jurisdictions in which the Company operates. The effective tax rate for the first six months of fiscal 2005 was primarily impacted by recognition of research and development credits, the extraterritorial income exclusion, municipal interest income, a decrease in valuation allowances related to foreign net operating losses, an increase in valuation allowances related to foreign withholding taxes, the differential between the statutory federal tax rate in the U.S. and certain foreign jurisdictions in which the Company operates, and the recognition of various tax contingency reserves.

The comparative decrease in the estimated fiscal 2006 effective income tax rate of 35.0%, from 37.0% for fiscal 2005, is attributable primarily to the manufacturing deduction, a decrease in valuation allowances related to foreign withholding taxes, and a decrease in the need for tax contingency reserves offset by an increase related to the phase-out of the extraterritorial income exclusion.

11. 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 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”) alleges 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 seeks unspecified damages, interest, fees, costs and rescission. The class period alleged in the Consolidated Complaint is January 21, 1999 through November 18, 2002. The Company and the 
 
 
16

 
individual defendants filed a motion to dismiss the Consolidated Complaint. 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 February 6, 2004, the Court entered a mediation reference order requiring the parties to mediate before a private mediator. The parties held a mediation session on March 18, 2004, which did not result in a settlement of the matter.
 
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. The parties held a second mediation session on January 5-6, 2006, which did not result in a settlement of the matter.
 
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. The lead plaintiff has opposed the motion and the Court has not yet ruled. 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 representative was filed by the Louisiana District Attorneys Retirement System (“LDARS”). LDARS previously attempted to be named as lead plaintiff in the case. Defendants have opposed the motion. Discovery is continuing.
 
 
 
 
 
 
 
 
 

 

17


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 and changes in the number and type of customers in the financial services industry. As set forth in Note 9 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.

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. For example, in the U.S., debit transactions at the point of sale are growing on an annual basis of over 20%. 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 U.S. 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.
 
 
18


·  
Adoption of open systems technology. In an effort to leverage lower-cost computing technologies and leverage 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, and many regions of the world are working on 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.
 
 
19

 
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 those 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 Company expects that the S2 acquisition will be financially accretive in fiscal 2006, due to a combination of expense reductions, normalization of maintenance fee revenues and continued marketing of S2 products.

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.

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
 
 
20

 
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 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
 
 
21

 
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, historical volatility of the Company’s common stock, and other 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. 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 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 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
 
 
22

 
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.

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 income in the period any such determination was made.

Segment Information

As set forth in Note 9 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
March 31,
 
Six Months Ended
March 31,
 
   
2006
 
2005
 
2006
 
2005
 
Revenues:
                         
Americas
 
$
43,609
 
$
42,746
 
$
87,529
 
$
84,114
 
EMEA
   
37,356
   
25,097
   
71,020
   
56,543
 
Asia/Pacific
   
8,868
   
7,783
   
16,359
   
15,575
 
   
$
89,833
 
$
75,626
 
$
174,908
 
$
156,232
 
                           
Operating income:
                         
Americas
 
$
10,256
 
$
11,188
 
$
18,702
 
$
23,455
 
EMEA
   
8,256
   
2,989
   
13,318
   
10,936
 
Asia/Pacific
   
2,690
   
1,866
   
3,697
   
3,737
 
   
$
21,202
 
$
16,043
 
$
35,717
 
$
38,128
 

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.
 

23

 
 
·  
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 March 31, 2006 and September 30, 2005:

   
March 31, 2006
 
September 30, 2005
 
   
(in millions)
 
(in millions)
 
Americas 
 
$
521
 
$
525
 
EMEA 
   
403
   
383
 
Asia/Pacific 
   
126
   
123
 
   
$
1,050
 
$
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 March 31, 2006 and September 30, 2005:

   
March 31, 2006
 
September 30, 2005
 
   
(in thousands)
 
(in thousands)
 
   
Monthly Recurring
 
Non-Recurring
 
Total
 
Monthly Recurring
 
Non-Recurring
 
Total
 
Americas 
 
$
97,380
 
$
31,520
 
$
128,900
 
$
97,523
 
$
32,343
 
$
129,866
 
EMEA 
   
63,905
   
36,104
   
100,009
   
60,038
   
33,194
   
93,232
 
Asia/Pacific 
   
25,654
   
2,913
   
28,567
   
25,711
   
1,217
   
26,928
 
   
$
186,939
 
$
70,537
 
$
257,476
 
$
183,272
 
$
66,754
 
$
250,026
 

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.
 

 
24


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 March 31,
 
Six Months Ended March 31,
     
2006
 
2005
 
2006
 
2005
 
 
 
Amount
 
% of
Revenue
 
Amount
 
% of
Revenue
 
Amount
 
% of
Revenue
 
Amount
 
% of
Revenue
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Initial license fees (ILFs) 
$
30,834
 
34.3
%
 
$
24,619
 
32.6
%
 
$
56,561
 
32.3
%
 
$
54,152
 
34.7
%
 
Monthly license fees (MLFs) 
 
16,896
 
18.8
 
 
 
18,334
 
24.2
 
 
 
34,561
 
19.8
 
 
 
36,607
 
23.4
 
 
Software license fees 
 
47,730
 
53.1
 
 
 
42,953
 
56.8
 
 
 
91,122
 
52.1
 
 
 
90,759
 
58.1
 
 
Maintenance fees 
 
24,746
 
27.6
 
 
 
22,649
 
29.9
 
 
 
50,064
 
28.6
 
 
 
44,729
 
28.6
 
 
Services 
 
17,357
 
19.3
 
 
 
10,024
 
13.3
 
 
 
33,722
 
19.3
 
 
 
20,744
 
13.3
 
 
 
Total revenues 
 
89,833
 
100.0
 
 
 
75,626
 
100.0
 
 
 
174,908
 
100.0
 
 
 
156,232
 
100.0
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cost of software license fees 
 
7,505
 
8.4
 
 
 
5,725
 
7.6
 
 
 
14,440
 
8.3
 
 
 
11,631
 
7.5
 
 
Cost of maintenance and services 
 
19,056
 
21.2
 
 
 
13,818
 
18.3
 
 
 
39,947
 
22.8
 
 
 
27,654
 
17.7
 
 
Research and development 
 
9,978
 
11.1
 
 
 
10,223
 
13.5
 
 
 
19,730
 
11.3
 
 
 
20,138
 
12.9
 
 
Selling and marketing 
 
16,529
 
18.4
 
 
 
15,368
 
20.3
 
 
 
32,541
 
18.6
 
 
 
30,669
 
19.6
 
 
General and administrative 
 
15,563
 
17.3
 
 
 
14,449
 
19.1
 
 
 
32,533
 
18.6
 
 
 
28,012
 
17.9
 
 
 
Total expenses 
 
68,631
 
76.4
 
 
 
59,583
 
78.8
 
 
 
139,191
 
79.6
 
 
 
118,104
 
75.6
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating income
 
21,202
 
23.6
 
 
 
16,043
 
21.2
 
 
 
35,717
 
20.4
 
 
 
38,128
 
24.4
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other income (expense):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income 
 
1,586
 
1.8
 
 
 
864
 
1.2
 
 
 
4,513
 
2.6
 
 
 
1,448
 
0.9
 
 
Interest expense 
 
(87)
 
(0.1)
 
 
 
(137)
 
(0.2)
 
 
 
(116)
 
(0.1)
 
 
 
(305)
 
(0.2)
 
 
Other, net 
 
354
 
0.4
 
 
 
255
 
0.3
 
 
 
(12)
 
(0.0)
 
 
 
(992)
 
(0.6)
 
 
 
Total other income (expense) 
 
1,853
 
2.1
 
 
 
982
 
1.3
 
 
 
4,385
 
2.5
 
 
 
151
 
0.1
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income before income taxes
 
23,055
 
25.7
 
 
 
17,025
 
22.5
 
 
 
40,102
 
22.9
 
 
 
38,279
 
24.5
 
Income tax provision
 
(8,069)
 
(9.0)
 
 
 
(5,832)
 
(7.7)
 
 
 
(9,926)
 
(5.7)
 
 
 
(14,163)
 
(9.1)
 
Net income
$
14,986
 
16.7
%
 
$
11,193
 
14.8
%
 
$
30,176
 
17.2
%
 
$
24,116
 
15.4
%

Revenues. Total revenues for the second quarter of fiscal 2006 increased $14.2 million, or 18.8%, as compared to the same period of fiscal 2005. The majority of this increase resulted from revenue growth in international markets, primarily in the EMEA region. EMEA revenues increased $12.3 million, or 48.8%, as compared to the same period of fiscal 2005. The three-month increase in total revenues is the result of a $4.8 million, or 11.1%, increase in software license fee revenues, a $2.1 million, or 9.3%, increase in maintenance fee revenues, and a $7.3 million, or 73.2%, increase in services revenues. Total revenues for the first six months of fiscal 2006 increased $18.7 million, or 12.0%, as compared to the same period of fiscal 2005. This six-month increase resulted from revenue growth in international markets, offset by a $4.2 million decrease in U.S. revenues. Six-month EMEA revenues increased $14.5 million, or 25.6%, and revenues generated by international locations within the Americas region increased $7.6 million, or 34.4%, as compared to the same period of fiscal 2005. The six-month increase in total revenues is the result of a $0.4 million, or 0.4%, increase in software license fee revenues, a $5.3 million, or 11.9%, increase in maintenance fee revenues, and a $13.0 million, or 62.6%, increase in services revenues.

The increases in software license fee revenues during the second quarter and first six months of fiscal 2006, as compared to the same periods of fiscal 2005, are primarily due to the completion of several large implementation projects that resulted in software license fee revenue recognition and increased revenues for the Company’s Application Services Suite and Risk Management Suite products. Offsetting the year-to-date comparative increase was completion of a BASE24-es project and an ACI Wholesale Payments System product contract extension that resulted in significant software license fee revenue recognition during the first quarter of fiscal 2005.
 
 
25

 
The increases in maintenance fee revenues during the second quarter and first six months of fiscal 2006, as compared to the same periods of fiscal 2005, are primarily due to growth in the installed base of software products as well as maintenance fee revenues recognized from S2 products during the second quarter and first six months of fiscal 2006. Maintenance revenue from the S2 products recognized in the second quarter and first six months of fiscal 2006 partly reflects the recognition of acquired deferred maintenance amounts which have been reduced to cost, plus a normal profit margin, as required under Financial Accounting Standards Board Emerging Issues Task Force Issue No. 01-03, “Accounting in a Business Combination for Deferred Revenue of an Acquiree.”

The increases in services revenues for the second quarter and first six months of fiscal 2006, as compared to the same periods of fiscal 2005, resulted primarily from recognition of previously-deferred services revenues for several large projects some of which were completed during the second quarter and first six months of fiscal 2006, as well as services revenues recognized from S2 products during the second quarter and first six months of fiscal 2006. For some of the Company’s contracts, including certain S2 contracts, services revenues are being recognized to the extent direct and incremental costs are incurred until such time that project profitability can be estimated. This revenue recognition treatment negatively impacted the margins on services revenues for the second quarter and first six months of fiscal 2006. 

Expenses. Total operating expenses for the second quarter of fiscal 2006 increased $9.0 million, or 15.2%, as compared to the same period of fiscal 2005. Total operating expenses for the first six months of fiscal 2006 increased $21.1 million, or 17.9%, as compared to the same period of fiscal 2005.

Cost of software license fees for the second quarter of fiscal 2006 increased $1.8 million, or 31.1%, as compared to the same period of fiscal 2005. Cost of software license fees for the first six months of fiscal 2006 increased $2.8 million, or 24.2%, as compared to the same period of fiscal 2005. The increases in cost of software license fees during the second quarter and first six months of fiscal 2006, as compared to the same periods of fiscal 2005, were primarily due to additional personnel assigned to support this function following the previously-announced reorganization. In addition, share-based compensation costs of $0.4 million, resulting from adoption of SFAS No. 123R in fiscal 2006, were recognized during the first six months of fiscal 2006.

Cost of maintenance and services for the second quarter of fiscal 2006 increased $5.2 million, or 37.9%, as compared to the same period of fiscal 2005. Cost of maintenance and services for the first six months of fiscal 2006 increased $12.3 million, or 44.5%, as compared to the same period of fiscal 2005. The increases in cost of maintenance and services during the second quarter and first six months of fiscal 2006, as compared to the same periods of fiscal 2005, resulted from costs incurred during the second quarter and first six months of fiscal 2006 of approximately $3.2 million and $7.4 million, respectively, to support the S2 products, and recognition of previously-deferred compensation-related expenses resulting from recognition of several large projects. For these projects, revenues previously were being deferred until acceptance or first production use, and the associated costs, including compensation-related expenses, were being capitalized until the related services revenue was recognized.

R&D costs for the second quarter and first six months of fiscal 2006 were comparable to the same periods of fiscal 2005.

Selling and marketing costs for the second quarter of fiscal 2006 increased $1.2 million, or 7.6%, as compared to the same period of fiscal 2005. Selling and marketing costs for the first six months of fiscal 2006 increased $1.9 million, or 6.1%, as compared to the same period of fiscal 2005. The increases in selling and marketing costs during the second quarter and first six months of fiscal 2006, as compared to the same periods of fiscal 2005, were primarily due to higher sales commissions and other costs resulting from strong sales during the second quarter and first six months of fiscal 2006. In addition, share-based compensation costs of $0.4 million, resulting from adoption of SFAS No. 123R in fiscal 2006, were recognized during the first six months of fiscal 2006.

General and administrative costs for the second quarter of fiscal 2006 increased $1.1 million, or 7.7%, as compared to the same period of fiscal 2005. General and administrative costs for the first six months of fiscal 2006 increased $4.5 million, or 16.1%, as compared to the same period of fiscal 2005. The increase in general and administrative costs during the second quarter of fiscal 2006, as compared to the same period of fiscal 2005, was primarily due to share-based compensation costs of $1.1 million recognized during the second quarter of fiscal 2006 resulting from adoption of SFAS No. 123R in fiscal 2006. The increase in general and administrative costs during the first six months of fiscal 2006, as compared to the same period of fiscal 2005, was primarily due to share-based
 
 
26

 
compensation costs of $2.1 million recognized during the first six months of fiscal 2006 resulting from adoption of SFAS No. 123R, severance costs related to the previously-announced reorganization, additional compensation and benefit costs related to annual merit pay increases and increased costs related to professional services.

Other Income and Expense. Interest income for the second quarter of fiscal 2006 increased $0.7 million as compared to the same period of fiscal 2005. Interest income for the first six months of fiscal 2006 increased $3.1 million as compared to the same period of fiscal 2005. The primary reason for the increase in interest income during the first six months of fiscal 2006, as compared to the same period of fiscal 2005, is attributable to interest income of $2.0 million on a refund of income taxes. The remaining increases in interest income during the second quarter and first six months of fiscal 2006, as compared to the same periods of fiscal 2005, is attributable to increases in interest rates and global consolidation of excess cash amounts into higher yielding investments.

Interest expense for the second quarter of fiscal 2006 decreased $0.1 million as compared to the same period of fiscal 2005. Interest expense for the first six months of fiscal 2006 decreased $0.2 million as compared to the same period of fiscal 2005. Scheduled payments of debt under financing agreements continue to be made, decreasing outstanding debt balances and corresponding interest expense.

Other income and expense consists of foreign currency gains and losses, and other non-operating items. Other income for the second quarter of fiscal 2006 increased $0.1 million as compared to the same period of fiscal 2005. Other expense for the first six months of fiscal 2006 decreased $1.0 million as compared to the same period of fiscal 2005. Comparative changes in other income and expense amounts were primarily attributable to fluctuating currency rates which impacted the amounts of foreign currency gains or losses realized by the Company during the respective periods.

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, which the Company estimates to be 35.0% for fiscal 2006. 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 quarter of fiscal 2006, the Company recorded the effects of the refund in its consolidated financial statements, including estimated interest income of $1.8 million and entries to relieve related tax contingency reserves and other accruals relating to the audit in the amount of $3.9 million. In February 2006, the Company received the refund payment, which included additional interest of $0.2 million that was recognized as income in the Company’s fiscal 2006 second quarter operating results.

The effective tax rate for the second quarter of fiscal 2006 was approximately 35.0% as compared to 34.3% for the same period of fiscal 2005. The effective tax rate for the first six months of fiscal 2006 was approximately 24.8% as compared to 37.0% for the same period of fiscal 2005. The improvement in the effective tax rate for the first six months of fiscal 2006, as compared to the same period of fiscal 2005, resulted primarily from the release of tax contingency reserves and other accruals related to the above-noted IRS audit settlement. The effective tax rate for the first six months of fiscal 2006, excluding the effect of the IRS audit settlement, was primarily impacted by the extraterritorial income exclusion, the manufacturing deduction, municipal interest income, a decrease in valuation allowances related to foreign net operating losses, and the differential between the statutory federal tax rate in the U.S. and certain foreign jurisdictions in which the Company operates. The effective tax rate for the first six months of fiscal 2005 was primarily impacted by recognition of research and development credits, the extraterritorial income exclusion, municipal interest income, a decrease in valuation allowances related to foreign net operating losses, an increase in valuation allowances related to foreign withholding taxes, the differential between the statutory federal tax rate in the U.S. and certain foreign jurisdictions in which the Company operates, and the recognition of various tax contingency reserves.

The comparative decrease in the estimated fiscal 2006 effective income tax rate of 35.0%, from 37.0% for fiscal 2005, is attributable primarily to the manufacturing deduction, a decrease in valuation allowances related to foreign
 
 
27

 
withholding taxes, and a decrease in the need for tax contingency reserves offset by an increase related to the phase-out of the extraterritorial income exclusion.

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. As of March 31, 2006, the Company had net deferred tax assets of $26.1 million (net of a $50.9 million valuation allowance). The Company’s valuation allowance primarily relates to foreign net operating loss carryforwards and, to a lesser extent, foreign tax credit carryforwards, capital loss carryforwards and domestic net operating loss carryforwards. The valuation allowance is based on the extent to which management believes these carryforwards and credits could expire unused due to the Company’s historical or projected losses. The Company analyzes the recoverability of its net deferred tax assets at each reporting period. Because unforeseen factors may affect future taxable income, increases or decreases to the valuation reserve may be required in future periods.

Liquidity and Capital Resources

As of March 31, 2006, the Company's principal sources of liquidity consisted of $189.7 million in cash, cash equivalents and marketable securities. The Company had no bank borrowings outstanding as of March 31, 2006. 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. During the first six months of fiscal 2006, the Company repurchased 488,122 shares of its common stock at an average price of $27.97 per share under this stock repurchase program. The maximum approximate remaining dollar value of shares authorized for purchase under the stock repurchase program was $33.0 million as of March 31, 2006. The Company may also decide to use cash to acquire new products and services or enhance existing products and services through acquisitions of other companies, product lines, technologies and personnel, or through investments in other companies.

The Company's net cash flows provided by operating activities in the first six months of fiscal 2006 amounted to $43.2 million as compared to $30.5 million provided by operating activities during the same period of fiscal 2005. The increase in operating cash flows resulted from receipt of a cash refund of $10.9 million, including interest, in February 2006 related to settlement of the IRS audit of tax years 1997 through 2003, increased net income, including adjustments for non-cash items, and changes in billed and accrued receivables, offset by changes in accounts payable, accrued employee compensation and deferred revenue.

On October 5, 2005, the Company issued a press release announcing a restructuring of its organization. As a result of this restructuring, the Company incurred $1.3 million in restructuring and other reorganization charges during fiscal 2005, of which $0.2 million was paid in fiscal 2005. During the first six months of fiscal 2006, the Company incurred an additional $0.4 million in restructuring and other reorganization charges, net of adjustments to previously-recognized amounts. Cash expenditures related to restructuring and other reorganization charges totaled $1.3 million during the first six months of fiscal 2006. During the remainder of fiscal 2006, the Company expects to incur an additional $1.2 million to $1.8 million in restructuring and other reorganization costs, but also expects that first-year pre-tax savings will more than offset these costs. The Company anticipates that the restructuring will be substantially completed by the end of fiscal 2006.

The Company's net cash flows used in investing activities totaled $6.7 million in the first six months of fiscal 2006 as compared to $75.6 million used in investing activities during the same period of fiscal 2005. During the first six months of fiscal 2006, the Company used cash of $3.4 million to increase its holdings of marketable securities and $3.3 million to purchase software, property and equipment. During the first six months of fiscal 2005, the Company used cash to increase its net holdings of marketable securities by $73.1 million and purchased $2.5 million of software, property and equipment.

The Company's net cash flows used in financing activities totaled $6.7 million in the first six months of fiscal 2006 as compared to $3.5 million used in financing activities during the same period of fiscal 2005. In the first six months of fiscal 2006, the Company used cash of $14.0 million to purchase shares of its common stock under the Company’s stock repurchase program, made payments to third-party financial institutions totaling $2.0 million, and received proceeds of $8.6 million, including corresponding excess tax benefits, from exercises of stock options. In the first six months of fiscal 2005, the Company used cash of $7.2 million to purchase shares of its common stock under the Company’s stock repurchase program, made payments to third-party financial institutions totaling $5.0 million, and
 
 
28

 
received proceeds of $7.9 million from exercises of stock options.

The Company also realized a minimal increase in cash during the first six months of fiscal 2006 compared to a $1.8 million increase in cash during the same period of fiscal 2005 related to foreign exchange rate variances.

The Company believes that its existing sources of liquidity, including cash on hand, marketable securities and cash provided by operating activities, will satisfy the Company's projected liquidity requirements, which primarily consists of working capital requirements, for the foreseeable future.


Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes to the Company's market risk for the six months ended March 31, 2006. The Company conducts business in all parts of the world and is thereby exposed to market risks related to fluctuations in foreign currency exchange rates. The U.S. dollar is the single largest currency in which the Company's revenue contracts are denominated. Thus, any decline in the value of local foreign currencies against the U.S. dollar results in the Company's products and services being more expensive to a potential foreign customer, and in those instances where the Company's goods and services have already been sold, may result in the receivables being more difficult to collect. The Company at times enters into revenue contracts that are denominated in the country’s local currency, principally in Australia, Canada, the United Kingdom and other European countries. This practice serves as a natural hedge to finance the local currency expenses incurred in those locations. The Company has not entered into any foreign currency hedging transactions. The Company does not purchase or hold any derivative financial instruments for the purpose of speculation or arbitrage.

The primary objective of the Company’s cash investment policy is to preserve principal without significantly increasing risk. Based on the Company’s cash investments and interest rates on these investments at March 31, 2006, and if the Company maintained this level of similar cash investments for a period of one year, a hypothetical ten percent increase or decrease in interest rates would increase or decrease interest income by approximately $0.7 million annually.


Item 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

The Company’s management, under the supervision of and with the participation of the Chief Executive Officer and Chief Financial Officer, performed an evaluation of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934 (the “Exchange Act”) as of the end of the period covered by this report. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective, as of the end of the period covered by this report, to provide reasonable assurance that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, completely and accurately, within the time periods specified in Securities and Exchange Commission rules and forms.

Changes in Internal Control Over Financial Reporting

There were no changes in the Company’s internal control over financial reporting that occurred during the second quarter of fiscal 2006 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
 
 


29



PART II - OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

From time to time, the Company is involved in various litigation matters arising in the ordinary course of its business. 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 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”) alleges 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 seeks unspecified damages, interest, fees, costs and rescission. The class period alleged in the Consolidated Complaint is January 21, 1999 through November 18, 2002. The Company and the individual defendants filed a motion to dismiss the Consolidated Complaint. 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 February 6, 2004, the Court entered a mediation reference order requiring the parties to mediate before a private mediator. The parties held a mediation session on March 18, 2004, which did not result in a settlement of the matter.
 
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. The parties held a second mediation session on January 5-6, 2006, which did not result in a settlement of the matter.
 
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. The lead plaintiff has opposed the motion and the Court has not yet ruled. 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 representative was filed by the Louisiana District Attorneys Retirement System (“LDARS”). LDARS previously attempted to be named as lead plaintiff in the case. Defendants have opposed the motion. Discovery is continuing.

Other Litigation - Plus Tecnologia

On August 31, 2001, Plus Tecnologia (“Plus”) filed a complaint in Circuit Court in the Sixth Judicial Circuit for Pinellas County, Florida (the “Florida Court”) against Transaction Systems Architects, Inc., ACI Worldwide Inc., ACI Worldwide (Florida) Inc. n/k/a ACI Worldwide (Texas) LLC, Open Systems Solutions, Inc., the predecessor to ACI Worldwide (Florida) Inc., and ACI Worldwide (Mexico) S.A. de C.V. The complaint alleged breach of contract, breach of non-disclosure agreements, tortious interference with prospective business relationships of Plus and an additional cause of concert of action. Plus claimed various items of damages, including lost profits in excess of $30,000,000, interest, fees, costs and punitive damages.
 
On April 21, 2005, the Company filed a Motion for Sanctions seeking to dismiss the complaint with prejudice and to impose sanctions against Plus alleging that Plus has engaged in improper, unfair, unethical and fraudulent actions. On April 12, 2006, the Florida Court dismissed with prejudice all of Plus’ claims against the Company and all defendants and further found that no liability on the part of the Company or other defendants has ever been found relating to the Plus cause of action. The Florida Court further found that the Company presented a prima facie case of misconduct by Plus. The Florida Court retained jurisdiction for purposes of determining appropriate sanctions against Plus, including entitlement and amount of any attorneys’ fees and costs to be assessed against Plus pursuant to the Company’s pending Motion for Sanctions.

 
30



Item 1A. RISK FACTORS

Except for the risk factors set forth below, there have been no material changes to the risk factors disclosed in Item 1A of the Company’s Form 10-K for the fiscal year ended September 30, 2005 (the “Form 10-K”). Additional risks and uncertainties, including risks and uncertainties not presently known to the Company, or that the Company currently deems immaterial, could also have an adverse effect on the Company’s business, financial condition and/or results of operations. The risk factors set forth below were disclosed in the Form 10-K, but have been updated to provide additional information or updates:

·  
The Company's backlog estimates are based on management’s assessment of the customer contracts that exist as of the date the estimates are made, as well as revenues from assumed contract renewals, to the extent that the Company believes that recognition of the related revenue will occur within the corresponding backlog period. A number of factors could result in actual revenues being less than the amounts reflected in backlog. 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 their industries or geographic locations, or the Company may experience delays in the development or delivery of products or services specified in customer contracts. Actual renewal rates and amounts may differ from historical experiences used to estimate backlog amounts. 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 a 12-month or 60-month period.

 
·
The Company is subject to income taxes, as well as non-income based taxes, in the United States and in various foreign jurisdictions. Significant judgment is required in determining the Company’s worldwide provision for income taxes and other tax liabilities. In addition, the Company has benefited from, and expects to continue to benefit from, implemented tax-saving strategies. The Company believes that implemented tax-saving strategies comply with applicable tax law. However, taxing authorities could disagree with the Company’s positions. If the taxing authorities decided to challenge any of the Company’s tax positions and were successful in such challenges, the Company’s financial condition and/or results of operations could be adversely affected.

The Company’s tax positions in its federal income tax returns for tax years subsequent to fiscal 2001 have not been fully examined by the IRS. The Company believes that its tax positions comply with applicable tax law. However, the IRS could challenge any of those positions and issue adjustments that could adversely affect the Company’s financial condition and/or results of operations.

Three of the Company’s foreign subsidiaries are the subject of tax examinations by the local taxing authorities. Other foreign subsidiaries could face challenges from various foreign tax authorities. It is not certain that the local authorities will accept the Company’s tax positions. The Company believes its tax positions comply with applicable tax law and intends to vigorously defend its positions. However, differing positions on certain issues could be upheld by foreign tax authorities, which could adversely affect the Company’s financial condition and/or results of operations.
 
 
 

 

31


Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Issuer Purchases of Equity Securities

The following table provides information regarding the Company’s repurchases of its common stock during the second quarter of fiscal 2006: 

 
 
 
 
 
 
 
Period
 
 
 
 
 
Total
Number of Shares Purchased
 
 
 
 
 
 
Average
Price Paid
per Share
 
Total
Number of Shares Purchased
as Part of Publicly Announced Program
 
Maximum Approximate
Dollar Value
of Shares that
May Yet Be Purchased
Under the
Program
 
January 1 through January 31, 2006
   
-
   
-
   
-
 
$ 33,334,000
February 1 through February 28, 2006
   
10,723
   
$ 30.45
   
10,723
 
$ 33,007,000
March 1 through March 31, 2006
   
-
   
-
   
-
 
$ 33,007,000
Total (1)
   
10,723
   
$ 30.45
   
10,723
   
_______________________________________
(1) 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 million of its Common Stock, and that it intends to use existing cash and cash equivalents to fund these repurchases. There is no guarantee as to the exact number of shares that will be repurchased by the Company. Repurchased shares are returned to the status of authorized but unissued shares of Common Stock. In March 2005, the Company’s Board of Directors approved a plan under Rule 10b5-1 of the Securities Exchange Act of 1934 to facilitate the repurchase of shares of Common Stock under the existing stock repurchase program. Under the Company’s Rule 10b5-1 plan, the Company has delegated authority over the timing and amount of repurchases to an independent broker who does not have access to inside information about the Company. Rule 10b5-1 allows the Company, through the independent broker, to purchase Company shares at times when the Company ordinarily would not be in the market because of self-imposed trading blackout periods, such as the time immediately preceding the end of the fiscal quarter through a period three business days following the Company’s quarterly earnings release. During the second quarter of fiscal 2006, all shares were purchased in open-market transactions.


Item 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.


Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The Company’s Annual Meeting of Stockholders was held on March 7, 2006. The matters voted upon at such meeting and the number of shares cast for, against or withheld, and abstained are as follows:

1.  
Election of directors to hold office until the next Annual Meeting of Stockholders:

Nominee
 
For
 
Withheld
 
Roger K. Alexander
 
32,503,763
 
   161,521
 
John D. Curtis
 
32,462,887
 
   202,397
 
Philip G. Heasley
 
32,541,423
 
   123,861
 
Jim D. Kever
 
32,484,606
 
   180,678
 
Harlan F. Seymour
 
32,459,608
 
   205,676
 
John E. Stokely
 
29,308,051
 
3,357,233
 
 
 
 
32

 
2.  
Proposal to ratify the appointment of KPMG LLP as the Company’s independent auditors for fiscal 2006:

For: 32,176,125
Against: 477,478
Abstain: 11,681
Broker Non-Vote: - 0 -


Item 5. OTHER INFORMATION

Not applicable.


Item 6. EXHIBITS

Exhibit
No.
 
Description
10.1
 
ACI Holding, Inc. 1994 Stock Option Plan, as amended
10.2
 
Transaction Systems Architects, Inc. 1996 Stock Option Plan, as amended
10.3
 
Transaction Systems Architects, Inc. 1997 Management Stock Option Plan, as amended
10.4
 
Transaction Systems Architects, Inc. 1999 Stock Option Plan, as amended
10.5
 
MessagingDirect Ltd. Amended and Restated Employee Share Option Plan, as amended
10.6
 
Transaction Systems Architects, Inc. 2000 Non-Employee Director Stock Option Plan, as amended
10.7
 
Transaction Systems Architects, Inc. 2002 Non-Employee Director Stock Option Plan, as amended
31.1
 
Certification of Chief Executive Officer pursuant to SEC Rule 13a-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
 
Certification of Chief Financial Officer pursuant to SEC Rule 13a-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
*
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
*
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
_______________________________________
* This certification is not deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section. Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates it by reference.

 
 
 
 

 
33


SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


 
TRANSACTION SYSTEMS ARCHITECTS, INC.
(Registrant)
Date: May 10, 2006
By:
/s/ DAVID R. BANKHEAD
   
David R. Bankhead
   
Senior Vice President,
Chief Financial Officer and Treasurer
(principal financial officer)

 
 
 
 
 
 
 
 
 
 
 
 
 

 
34


 
EXHIBIT INDEX

Exhibit
No.
 
Description
10.1
 
ACI Holding, Inc. 1994 Stock Option Plan, as amended
10.2
 
Transaction Systems Architects, Inc. 1996 Stock Option Plan, as amended
10.3
 
Transaction Systems Architects, Inc. 1997 Management Stock Option Plan, as amended
10.4
 
Transaction Systems Architects, Inc. 1999 Stock Option Plan, as amended
10.5
 
MessagingDirect Ltd. Amended and Restated Employee Share Option Plan, as amended
10.6
 
Transaction Systems Architects, Inc. 2000 Non-Employee Director Stock Option Plan, as amended
10.7
 
Transaction Systems Architects, Inc. 2002 Non-Employee Director Stock Option Plan, as amended
31.1
 
Certification of Chief Executive Officer pursuant to SEC Rule 13a-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
 
Certification of Chief Financial Officer pursuant to SEC Rule 13a-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
*
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
*
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
_______________________________________
* This certification is not deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section. Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates it by reference.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
35