Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

(Mark One)

 

x

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

 

 

 

For the quarterly period ended June 30, 2008

 

 

 

or

 

 

o

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

 

 

 

For the transition period from

 

Commission File Number 0-25346

 


 

ACI WORLDWIDE, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

47-0772104

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification No.)

 

 

 

120 Broadway, Suite 3350
New York, New York 10271

 

(646) 348-6700

(Address of principal executive offices,
including zip code)

 

(Registrant’s telephone number,
including area code)

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes    x       No    o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

Smaller reporting company o

 

 

(Do not check if a smaller
reporting company)

 

 

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

 

Yes  o    No x

 

As of August 8, 2008, there were 34,428,009 shares of the registrant’s common stock outstanding.

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

 

 

Page

PART I – FINANCIAL INFORMATION

 

Item 1.

Financial Statements

3

 

Consolidated Balance Sheets as of June 30, 2008, December 31, 2007 and September 30, 2007

3

 

Consolidated Statements of Operations for the three and six months ended June 30, 2008 and 2007

4

 

Consolidated Statements of Cash Flows for the six months ended June 30, 2008 and 2007

5

 

Notes to Consolidated Financial Statements

6

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

24

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

41

Item 4.

Controls and Procedures

42

 

 

 

PART II – OTHER INFORMATION

 

Item 1.

Legal Proceedings

42

Item 1A.

Risk Factors

43

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

43

Item 3.

Defaults Upon Senior Securities

44

Item 4.

Submission of Matters to a Vote of Security Holders

44

Item 5.

Other Information

44

Item 6.

Exhibits

45

 

 

 

Signature

46

Exhibit Index

47

 

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Table of Contents

 

ACI WORLDWIDE, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)

 

 

 

June 30,

 

December 31,

 

September 30,

 

 

 

2008

 

2007

 

2007

 

 

 

(unaudited)

 

(unaudited)

 

 

 

ASSETS

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

98,193

 

$

97,011

 

$

60,794

 

Billed receivables, net of allowances of $2,218, $1,723, and $2,041, respectively

 

88,208

 

87,932

 

70,384

 

Accrued receivables

 

15,371

 

11,132

 

11,955

 

Deferred income taxes

 

5,747

 

5,374

 

7,088

 

Recoverable income taxes

 

7,284

 

6,033

 

3,852

 

Prepaid expenses

 

11,131

 

9,803

 

10,572

 

Other current assets

 

9,322

 

8,399

 

7,233

 

Total current assets

 

235,256

 

225,684

 

171,878

 

 

 

 

 

 

 

 

 

Property, plant and equipment, net

 

20,400

 

19,503

 

19,356

 

Software, net

 

31,155

 

31,430

 

31,764

 

Goodwill

 

210,175

 

206,770

 

205,715

 

Other intangible assets, net

 

35,368

 

38,088

 

39,685

 

Deferred income taxes

 

32,541

 

31,283

 

24,315

 

Other assets

 

17,609

 

17,700

 

14,028

 

TOTAL ASSETS

 

$

582,504

 

$

570,458

 

$

506,741

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

Accounts payable

 

$

12,524

 

$

16,351

 

$

14,677

 

Accrued employee compensation

 

24,948

 

22,659

 

22,625

 

Deferred revenue

 

121,119

 

115,519

 

97,042

 

Income taxes payable

 

 

 

2,251

 

Alliance agreement liability

 

7,147

 

9,331

 

 

Accrued and other current liabilities

 

23,264

 

22,992

 

17,925

 

Total current liabilities

 

189,002

 

186,852

 

154,520

 

 

 

 

 

 

 

 

 

Deferred revenue

 

23,147

 

27,253

 

30,280

 

Note payable under credit facility

 

75,000

 

75,000

 

75,000

 

Deferred income taxes

 

2,851

 

3,245

 

3,265

 

Alliance agreement noncurrent liability

 

40,226

 

 

 

Other noncurrent liabilities

 

34,693

 

37,069

 

18,664

 

Total liabilities

 

364,919

 

329,419

 

281,729

 

 

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

 

 

Preferred stock , $0.01 par value; 5,000,000 shares authorized; no shares issued and outstanding at June 30, 2008, December 31, 2007 and September 30, 2007

 

 

 

 

Common stock; $0.005 par value; 70,000,000 shares authorized; 40,821,516 shares issued at June 30, 2008, December 31, 2007, and September 30, 2007

 

204

 

204

 

204

 

Common stock warrants

 

24,003

 

24,003

 

 

Treasury stock, at cost, 6,415,341, 5,144,947, and 5,115,367 shares outstanding at June 30, 2008, December 31, 2007 and September 30, 2007, respectively

 

(160,473

)

(140,320

)

(140,340

)

Additional paid-in capital

 

308,139

 

311,108

 

312,642

 

Retained earnings

 

45,254

 

47,886

 

53,226

 

Accumulated other comprehensive income (loss)

 

458

 

(1,842

)

(720

)

Total stockholders’ equity

 

217,585

 

241,039

 

225,012

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

 

$

582,504

 

$

570,458

 

$

506,741

 

 

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

 

3



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ACI WORLDWIDE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited and in thousands, except per share amounts)

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

Software license fees

 

$

38,214

 

$

40,920

 

$

77,312

 

$

79,444

 

Maintenance fees

 

32,867

 

31,287

 

64,340

 

61,188

 

Services

 

38,138

 

25,902

 

60,158

 

47,425

 

Total revenues

 

109,219

 

98,109

 

201,810

 

188,057

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Cost of software license fees

 

11,966

 

9,932

 

24,457

 

21,125

 

Cost of maintenance and services

 

36,044

 

26,789

 

64,673

 

50,140

 

Research and development

 

12,694

 

13,422

 

25,247

 

25,463

 

Selling and marketing

 

22,741

 

16,894

 

39,491

 

33,693

 

General and administrative

 

24,515

 

26,190

 

47,195

 

52,543

 

Total expenses

 

107,960

 

93,227

 

201,063

 

182,964

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

1,259

 

4,882

 

747

 

5,093

 

 

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

703

 

940

 

1,296

 

1,954

 

Interest expense

 

(1,038

)

(1,431

)

(2,404

)

(3,028

)

Other, net

 

2,333

 

(1,533

)

2,143

 

(1,870

)

Total other income (expense)

 

1,998

 

(2,024

)

1,035

 

(2,944

)

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

3,257

 

2,858

 

1,782

 

2,149

 

Income tax expense

 

2,429

 

5,581

 

4,414

 

5,286

 

Net income (loss)

 

$

828

 

$

(2,723

)

$

(2,632

)

$

(3,137

)

 

 

 

 

 

 

 

 

 

 

Earnings (loss) per share information

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding

 

 

 

 

 

 

 

 

 

Basic

 

34,133

 

37,075

 

34,649

 

37,118

 

Diluted

 

34,903

 

37,075

 

34,649

 

37,118

 

 

 

 

 

 

 

 

 

 

 

Earnings (loss) per share

 

 

 

 

 

 

 

 

 

Basic

 

$

0.02

 

$

(0.07

)

$

(0.08

)

$

(0.08

)

Diluted

 

$

0.02

 

$

(0.07

)

$

(0.08

)

$

(0.08

)

 

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

 

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ACI WORLDWIDE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited and in thousands)

 

 

 

For the Six Months Ended June 30,

 

 

 

2008

 

2007

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(2,632

)

$

(3,137

)

Adjustments to reconcile net loss to net cash flows from operating activities

 

 

 

 

 

Depreciation

 

3,174

 

2,976

 

Amortization

 

7,741

 

7,379

 

Tax expense of intellectual property shift

 

1,180

 

956

 

Amortization of debt financing costs

 

168

 

168

 

Gain on reversal of asset retirement obligation

 

(949

)

 

Loss on disposal of assets

 

236

 

13

 

Change in fair value of interest rate swaps

 

754

 

 

Deferred income taxes

 

(1,465

)

(2,826

)

Stock-based compensation expense

 

5,165

 

3,046

 

Tax benefit of stock options exercised and cash settled

 

109

 

734

 

Changes in operating assets and liabilities, net of impact of acquisitions:

 

 

 

 

 

Billed and accrued receivables, net

 

(1,211

)

(4,830

)

Other current assets

 

(1,136

)

(898

)

Other assets

 

(1,334

)

(425

)

Accounts payable

 

(4,079

)

(346

)

Accrued employee compensation

 

1,761

 

5,909

 

Proceeds from alliance agreement

 

37,487

 

 

Accrued liabilities

 

(1,373

)

182

 

Current income taxes

 

(1,363

)

(273

)

Deferred revenue

 

731

 

18,677

 

Other current and noncurrent liabilities

 

141

 

(66

)

Net cash flows from operating activities

 

43,105

 

27,239

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of property and equipment

 

(4,619

)

(2,047

)

Purchases of software and distribution rights

 

(3,984

)

(479

)

Alliance technical enablement expenditures

 

(2,445

)

 

Proceeds from alliance agreement

 

1,246

 

 

Acquisition of businesses, net of cash acquired

 

(20

)

(10,730

)

Other

 

 

6

 

Net cash flows from investing activities

 

(9,822

)

(13,250

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of common stock

 

1,042

 

 

Proceeds from exercises of stock options

 

787

 

 

Excess tax benefit of stock options exercised

 

62

 

 

Purchases of common stock

 

(30,064

)

(14,865

)

Payments on debt and capital leases

 

(1,904

)

(915

)

Net cash flows from financing activities

 

(30,077

)

(15,780

)

 

 

 

 

 

 

Effect of exchange rate fluctuations on cash

 

(2,024

)

1,856

 

Net increase in cash and cash equivalents

 

1,182

 

65

 

Cash and cash equivalents, beginning of period

 

97,011

 

89,900

 

Cash and cash equivalents, end of period

 

$

98,193

 

$

89,965

 

 

 

 

 

 

 

Supplemental cash flow information

 

 

 

 

 

Income taxes paid, net

 

$

6,752

 

$

6,882

 

Interest paid

 

$

2,584

 

$

2,544

 

 

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

 

5


 


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ACI WORLDWIDE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited and in thousands, except per share amounts)

 

1.  Consolidated Financial Statements

 

The unaudited consolidated financial statements include the accounts of ACI Worldwide, Inc. (“the Company”) and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated. The consolidated financial statements at June 30, 2008 and December 31, 2007, and for the three and six months ended June 30, 2008 and 2007, are unaudited and reflect all adjustments of a normal recurring nature, except as otherwise disclosed herein, which are, in the opinion of management, necessary for a fair presentation, in all material respects, of the financial position and operating results for the interim periods.

 

The consolidated financial statements contained herein should be read in conjunction with the consolidated financial statements and notes thereto, together with management’s discussion and analysis of financial condition and results of operations, contained in the Company’s annual report on Form 10-K for the fiscal year ended September 30, 2007, as amended by the Form 10-K/A for the same period filed March 4, 2008.

 

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.

 

Change in Fiscal Year End

 

Effective January 1, 2008, the Company changed its fiscal year end from September 30 to December 31.  The Company’s new fiscal year commenced January 1, 2008 and will end on December 31, 2008.  This quarterly report on Form 10-Q compares the financial position as of June 30, 2008 to December 31, 2007 and September 30, 2007 and the results of operations for the three and six months ended June 30, 2008 with the results of operations for the three and six months ended June 30, 2007.  The Company changed its fiscal year end to align its sales contracting and delivery processes with its customers and to allow for more effective communication with the capital markets and investment community by being consistent with its peer group.

 

Acquisitions

 

Visual Web Solutions, Inc.

 

On February 7, 2007, the Company acquired Visual Web Solutions, Inc. (“Visual Web”), a provider of international trade finance and web-based cash management solutions, primarily to financial institutions in the Asia/Pacific region.  These solutions complement and have been integrated with the Company’s U.S.-centric cash management and online banking solutions to create a more complete international offering.  Visual Web had wholly-owned subsidiaries in Singapore for sales and customer support and in Bangalore, India for product development and services.

 

The consolidated financial statements as of June 30, 2007 and for the six months then ended include amounts acquired from, as well as the results of operations of, Visual Web from February 7, 2007 forward.  The consolidated financial statements as of June 30, 2008, December 31, 2007, and September 30, 2007, and for the three and six months ended June 30, 2008 include amounts acquired from, as well as the results of operations of, Visual Web.

 

The aggregate purchase price of Visual Web, including direct costs of the acquisition, was $8.3 million, net of $1.1 million of cash acquired.  Under the terms of the acquisition, the parties established a cash escrow arrangement in which $1.1 million of the cash consideration paid at closing is held in escrow as security for tax and other contingencies.  The allocation of the purchase price to specific assets and liabilities was based, in part, upon outside appraisals of the fair value of certain assets.

 

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Stratasoft Sdn Bhd

 

On April 2, 2007, the Company acquired Stratasoft Sdn Bhd (“Stratasoft”), a Malaysian-based provider of electronic payment solutions.  Prior to the acquisition, Stratasoft had been a distributor of our OCM24 product within the Malaysian market since 1995. This acquisition compliments the Company’s strategy to move to a direct sales model in selected markets in Asia.

 

The consolidated financial statements as of June 30, 2008, December 31, 2007, and September 30, 2007, and for the three and six months ended June 30, 2008, include amounts acquired from, as well as the results of operations of, Stratasoft.

 

The aggregate purchase price of Stratasoft, including direct costs of the acquisition, was $2.5 million, net of $0.7 million of cash acquired.  The allocation of the purchase price to specific assets and liabilities was based, in part, upon outside appraisals of the fair value of certain assets.

 

The Company will pay an additional aggregate amount of up to $0.6 million (subject to foreign currency fluctuations) to the sellers if Stratasoft achieves certain financial targets set forth in the purchase agreement for the period ended December 31, 2007 and the period ending December 31, 2008.  During the six months ended June 30, 2008, the Company completed the assessment for the period ended December 31, 2007 and determined that Stratasoft did not meet the financial targets set forth in the purchase agreement.

 

Under the terms of the acquisition, the parties established a cash escrow arrangement in which $0.5 million of the cash consideration paid at closing is held in escrow as security for tax and other contingencies.

 

Lease Termination

 

During the six months ended June 30, 2008, the Company terminated the lease for one of its facilities in Watford, England.  Pursuant to the termination agreement, the Company paid a termination fee of approximately $0.9 million that was recorded in general and administrative expenses in the accompanying consolidated statement of operations for the six months ended June 30, 2008.  Further under the termination agreement, the Company was relieved of its contractual obligations with respect to the restoration of facilities back to their original condition.  As a result, the Company recognized a gain of approximately $1.0 million related to the relief from this liability, which is also recorded in general and administrative expenses in the accompanying consolidated statement of operations.  At June 30, 2008, December 31, 2007 and September 30, 2007, the Company had contractual obligations with respect to the restoration of leased facilities of $1.6 million, $2.5 million and $2.6 million, respectively, recorded in other liabilities in the accompanying consolidated balance sheets.

 

Recently Issued Accounting Standards

 

In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 141(R), Business Combinations (“SFAS 141(R)”), which replaces SFAS 141.  SFAS 141(R) establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any controlling interest; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is to be applied prospectively to business combinations for which the acquisition date is on or after an entity’s fiscal year that begins after December 15, 2008. The Company will assess the impact of SFAS 141(R) if and when a future acquisition occurs.

 

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51 (“SFAS 160”).  SFAS 160 establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Specifically, this statement requires the recognition of a noncontrolling interest (minority interest) as equity in the consolidated financial statements and separate from the parent’s equity. The amount of net income (loss) attributable to the noncontrolling interest will be included in consolidated net income (loss) on the face of the statement of operations. SFAS 160 clarifies that changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains it controlling financial interest. In addition, this statement requires that a parent recognize a gain or loss in net income (loss) when a subsidiary is deconsolidated. Such gain or loss will be measured using the fair value of the noncontrolling equity investment on the deconsolidation date. SFAS 160 also includes expanded disclosure requirements regarding the interests of the parent and its noncontrolling interest.  SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is

 

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prohibited. The Company is currently evaluating the impact, if any, the adoption of SFAS 160 will have on its consolidated financial statements.

 

On March 19, 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, (“SFAS 161”). SFAS 161 amends FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, (“SFAS 133”) and was issued in response to concerns and criticisms about the lack of adequate disclosure of derivative instruments and hedging activities.  SFAS 161 requires (i) qualitative disclosures regarding the objectives and strategies for using derivative instruments and engaging in hedging activities in the context of an entity’s overall risk exposure, (ii) quantitative disclosures in tabular format of the fair values of derivative instruments and their gains and losses, and (iii) disclosures about credit-risk related contingent features in derivative instruments.  SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, but early application is encouraged.  The Company is currently evaluating the impact, if any, the adoption of SFAS 161 will have on its consolidated financial statements.

 

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 97-2”), SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition With Respect to Certain Transactions (“SOP 98-9”), and Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin (“SAB”) 101, Revenue Recognition in Financial Statements, as codified 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 post contract 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 element.

 

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 (“ARB No. 45”), and the relevant guidance provided by SOP 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts (“SOP 81-1”). Accounting for services delivered over time (generally in excess of twelve months) under ARB No. 45 and SOP 81-1 is referred to as contract accounting. Under contract accounting, the Company generally uses the percentage-of-completion method. Under the percentage-of-completion method, the Company records revenue for the software license fee and services over the development and implementation period, with the percentage of completion 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 takes into consideration 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.  If it is determined that a loss will result from the performance of a contract, the entire amount of the loss is recognized in the period in which it is determined that a loss will result.

 

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.

 

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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 reference to stated renewals with 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 stated 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.

 

For software license arrangements in which the Company permits the customer to receive or exchange for 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 has the right to change or alternate its use of currently licensed products, revenue is recognized upon delivery of the first copy of all of the licensed products, 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 licenses, provided all other revenue recognition criteria have been met.

 

Certain of the Company’s software license arrangements include PCS terms that fail to achieve VSOE of fair value due to non-substantive renewal periods, or contain a range of possible PCS renewal amounts that is not sufficiently narrow to establish VSOE of fair value. For these arrangements, VSOE of fair value of PCS does not exist and revenues are therefore recognized ratably over the contractually specified 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 (in thousands):

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Software license fees

 

$

4,270

 

$

2,496

 

$

7,497

 

$

5,177

 

Maintenance fees

 

1,350

 

1,172

 

2,602

 

2,133

 

Services

 

1,499

 

1,084

 

2,757

 

2,245

 

Total

 

$

7,119

 

$

4,752

 

$

12,856

 

$

9,555

 

 

Maintenance Fees. The Company typically enters into multi-year time-based software license arrangements that vary in length but are generally five years.  These arrangements include an initial (bundled) PCS term of one or two years with subsequent renewals for additional years within the initial license period.  For arrangements in which the Company looks to substantive renewal rates

 

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to evidence VSOE of fair value of PCS and in which the PCS renewal rate and term are substantive, VSOE of fair value of PCS is determined by reference to the stated renewal rate.  For these arrangements, PCS revenues are recognized ratably over the PCS 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 or when the range of possible PCS renewal amounts is not sufficiently narrow), the Company recognizes revenue for the entire arrangement ratably over the PCS term.

 

For those arrangements that meet the criteria to be accounted for under contract accounting, the Company determines whether VSOE of fair value exists for the PCS element.  For those situations in which VSOE of fair value exists for the PCS element, PCS is accounted for separately and the balance of the arrangement is accounted for under ARB No. 45 and the relevant guidance provided by SOP 81-1.  For those arrangements in which VSOE of fair value does not exist for the PCS element, revenue is recognized to the extent direct and incremental costs are incurred until such time as the services are complete.  Once services are complete, all remaining revenue is then recognized ratably over the remaining PCS period.

 

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.

 

Hosting.  The Company’s hosting-related arrangements contain multiple products and services.  As these arrangements generally do not contain a contractual right to take possession of the software at anytime during the hosting period without significant penalty, the Company applies the separation provisions of Emerging Issues Task Force (EITF) 00-21, Revenue Arrangements with Multiple Deliverables.  The Company uses the relative fair value method of revenue recognition to allocate the total consideration derived from the arrangement to each of the elements.  Any up-front fees allocated to the hosting services are recognized over the estimated life of the hosting relationship.  Professional services revenues are recognized as the services are performed when the services have stand-alone value and over the estimated life of the hosting relationship when the services do not have stand-alone value.

 

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 agreements for revenue recognition purposes.  The Company evaluates the facts and circumstances related to each situation in order to reach appropriate conclusions regarding whether such arrangements are related or separate.  The conclusions reached can impact the timing of revenue recognition related to those arrangements.

 

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

 

Employee Stock Purchase Plan

 

Under the Company’s 1999 Employee Stock Purchase Plan, as amended (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. Shares issued under the ESPP during the six months ended June 30, 2008 totaled 54,449.  No shares were issued under the ESPP during the six months ended June 30, 2007, as the Company was not current with its filings with the SEC.

 

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Accounting for Share-Based Payments Pursuant to SFAS 123(R)

 

The Company adopted SFAS No. 123(R), Share-Based Payment (“SFAS 123(R)”), 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 APB Opinion No. 25, and requires instead that such transactions be accounted for using a fair-value-based method. SFAS 123(R) 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 Staff Accounting Bulletin (“SAB 107”), which does not modify any of SFAS 123(R)’s conclusions or requirements, but rather includes recognition, measurement and disclosure guidance for companies as they implement SFAS 123(R).

 

Upon adoption of SFAS 123(R), all of the Company’s existing share-based compensation awards were determined to be equity classified awards. A portion of these options were reclassified to liability classification as they were subsequently cash settled.  Under the modified prospective transition method, the Company is required to recognize noncash compensation costs for the portion of share-based awards that are outstanding as of October 1, 2005 for which the requisite service has not been rendered (i.e., nonvested awards). These compensation costs are based on the grant date fair value of those awards as calculated for pro forma disclosures under SFAS 123. The Company is recognizing compensation costs related to the nonvested portion of those awards in the financial statements from the SFAS 123(R) adoption date through the end of the requisite service period.

 

A summary of stock options is as follows:

 

 

 

Number of
Shares

 

Weighted-
Average
Exercise
Price ($)

 

Weighted-
Average
Remaining
Contractual
Term (Years)

 

Aggregate
Intrinsic Value of
In-the-Money
Options ($)

 

Outstanding, September 30, 2007

 

3,708,431

 

$

22.35

 

 

 

 

 

Granted

 

 

 

 

 

 

 

Exercised

 

(51,160

)

10.75

 

 

 

 

 

Cancelled/Forfeited/Expired

 

(66,946

)

27.39

 

 

 

 

 

Outstanding, December 31, 2007

 

3,590,325

 

22.43

 

 

 

 

 

Granted

 

437,000

 

16.86

 

 

 

 

 

Exercised

 

(77,424

)

10.18

 

 

 

 

 

Cancelled/Forfeited/Expired

 

(174,994

)

26.01

 

 

 

 

 

Outstanding, June 30, 2008

 

3,774,907

 

$

21.87

 

6.70

 

$

7,395,603

 

 

 

 

 

 

 

 

 

 

 

Exercisable, June 30, 2008

 

1,984,293

 

$

17.99

 

5.30

 

$

7,010,483

 

 

The weighted-average grant date fair value of stock options granted during the six months ended June 30, 2008 and 2007 was $9.25 and $17.75, respectively.  The Company issued treasury shares for the exercise of stock options during the six months ended June 30, 2008 and 2007.  The total intrinsic value of stock options exercised during the six months ended June 30, 2008 was $0.6 million.  There were no stock option exercises during the six months ended June 30, 2007 due to the suspension of option exercises because the Company was not current with its filings with the SEC.

 

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The fair value of options granted during the three and six months ended June 30, 2008 and 2007 was estimated on the date of grant using the Black-Scholes option-pricing model, a pricing model acceptable under SFAS 123(R), with the following assumptions:

 

 

 

Three Months Ended

 

Six Months Ended

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30, 2008

 

June 30, 2008

 

June 30, 2007

 

June 30, 2007

 

 

 

 

 

 

 

 

 

 

 

Expected life (years)

 

5.50

 

6.15

 

5.30

 

5.30

 

Interest rate

 

3.5

%

3.2

%

5.0

%

5.0

%

Volatility

 

49.5

%

54.6

%

51.0

%

51.0

%

Dividend yield

 

 

 

 

 

 

Expected volatilities are based on the Company’s historical common stock volatility derived from historical stock price data for historical periods commensurate with the options’ expected life. 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 Company used the simplified method for determining the expected life as permitted under SAB 110, Topic 14, Share-Based Payment. The simplified method was used as the historical data did not provide a reasonable basis upon which to estimate the expected term. This is due to the extended period during which individuals were unable to exercise options while the Company was not current with its filings with the SEC. The risk-free interest rate is based on the implied yield currently available on United States Treasury zero coupon issues with a term equal to the expected term at the date of grant of the options. The expected dividend yield is zero as the Company has historically paid no dividends and does not anticipate dividends to be paid in the future.

 

During the six months ended June 30, 2007, the Company granted long-term incentive program performance share awards (“LTIP Performance Shares”) pursuant to the Company’s 2005 Equity and Performance Incentive Plan, as amended (the “2005 Incentive Plan”) representing 174,947 shares (based on a target of 100%) of the Company’s common stock with a weighted-average grant date fair value of $34.25 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.  The Company did not grant any LTIP Performance Shares during the six months ended June 30, 2008.   A summary of nonvested LTIP Performance Shares is as follows:

 

Nonvested LTIP Performance Shares

 

Number of
Shares at
Expected
Attainment

 

Weighted-
Average Grant
Date Fair
Value

 

Nonvested at September 30, 2007

 

312,117

 

$

31.95

 

Granted

 

 

 

Vested

 

 

 

Change in expected attainment for fiscal 2005 and 2006 grants

 

(132,110

)

29.00

 

Forfeited or expired

 

(5,060

)

29.10

 

Nonvested at December 31, 2007

 

174,947

 

34.25

 

Granted

 

 

 

Vested

 

 

 

Forfeited or expired

 

(15,333

)

34.30

 

Nonvested at June 30, 2008

 

159,614

 

$

34.25

 

 

These LTIP Performance Shares are earned, if at all, based upon the achievement, over a specified period that must not be less than one year and is typically a three-year period  (the “Performance Period”), of performance goals related to (i) the compound annual growth over the Performance Period in the Company’s 60-month backlog as determined and defined by the Company, (ii) the compound annual growth over the Performance Period in the diluted earnings per share as reported in the Company’s consolidated financial statements, and (iii) the compound annual growth over the Performance Period in the total revenues as reported in the Company’s consolidated financial statements. In no event will any of the LTIP Performance Shares become earned if the Company’s earnings per share is below a predetermined minimum threshold level at the conclusion of the Performance Period. Assuming achievement of the predetermined minimum earnings per share threshold level, up to 150% of the

 

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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.

 

Through September 30, 2007, the Company had accrued compensation costs assuming an attainment level of 110% for the awards granted in fiscal 2005 and 2006.  During the three months ended December 31, 2007, the Company changed the expected attainment to 0% based upon revised forecasted diluted earnings per share, which the Company does not expect will achieve the predetermined earnings per share minimum threshold level required for the LTIP Performance Shares granted in fiscal 2005 and 2006 to be earned.  As the performance goals were considered improbable of achievement, the Company reversed compensation costs related to the awards granted in fiscal 2005 and 2006 during the three months ended December 31, 2007.

 

Based on forecasts for the performance period of the awards granted during the fiscal year ended September 30, 2007, management currently believes that an achievement level of 100% will be attained for those awards.

 

During the six months ended June 30, 2008, pursuant to the Company’s 2005 Incentive Plan, the Company granted restricted share awards (“RSAs”).  These awards have requisite service periods of four years and vest in increments of 25% on the anniversary dates of the grants. Under each arrangement, stock is issued without direct cost to the employee. The Company estimates the fair value of the RSAs based upon the market price of the Company’s stock at the date of grant. The RSA grants provide for the payment of dividends on the Company’s common stock, if any, to the participant during the requisite service period (vesting period) and the participant has voting rights for each share of common stock. The Company recognizes compensation expense for RSAs on a straight-line basis over the requisite service period.

 

A summary of nonvested RSAs as of June 30, 2008 and changes during the period are as follows:

 

 

 

Number of

 

 

 

 

 

Restricted

 

Weighted-Average Grant

 

Nonvested Restricted Share Awards

 

Share Awards

 

Date Fair Value

 

Nonvested at December 31, 2007

 

 

$

 

Granted

 

237,500

 

16.17

 

Vested

 

 

 

Forfeited or expired

 

 

 

Nonvested at June 30, 2008

 

237,500

 

$

16.17

 

 

As of June 30, 2008, there were unrecognized compensation costs of $14.7 million related to nonvested stock options, $2.2 million related to nonvested LTIP Performance Shares, and $2.2 million related to nonvested RSAs, which the Company expects to recognize over weighted-average periods of 2.6 years, 1.5 years and 3.4 years, respectively.

 

The Company recorded stock-based compensation expense in accordance with SFAS 123(R) for the three months ended June 30, 2008 and 2007 related to stock options, LTIP Performance Shares, RSAs, and the ESPP of $2.6 million and $1.4 million, respectively, with corresponding tax benefits of $0.9 million and $0.5 million, respectively.  The Company recorded stock-based compensation expense in accordance with SFAS 123(R) for the six months ended June 30, 2008 and 2007 related to stock options, LTIP Performance Shares, RSAs, and the ESPP of $5.2 million and $3.1 million, respectively, with corresponding tax benefits of $1.9 million and $1.1 million, respectively.   Tax benefits in excess of the option’s grant date fair value under SFAS 123(R) are classified as financing cash flows.  No stock-based compensation costs were capitalized during the six months ended June 30, 2008 and 2007. Estimated forfeiture rates, stratified by employee classification, have been included as part of the Company’s calculations of compensation costs. The Company recognizes compensation costs for stock option awards which vest with the passage of time with only service conditions on a straight-line basis over the requisite service period.

 

Cash received from option exercises for the three months ended June 30, 2008 was $0.4 million.  The actual tax benefit realized for the tax deductions from option exercises totaled $0.1 million for the three months ended June 30, 2008.  Cash received from option exercises for the six months ended June 30, 2008 was $0.8 million.  The actual tax benefit realized for the tax deductions from option exercises totaled $0.3 million for the six months ended June 30, 2008. There were no option exercises during the six months ended June 30, 2007 due to the suspension of stock option exercises during the period because the Company was not current with its filings with the SEC.

 

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During the three months ended December 31, 2007, the Company reclassified 31,393 vested options from equity classification to liability classification, as these options were expected to cash settle subsequent to December 31, 2007 due to the suspension of option exercises because the Company was not current with its filings with the SEC.  As a result, the Company recorded a liability of approximately $0.1 million and recorded compensation expense of $0.1 million in the three months ended December 31, 2007. This liability was paid during the six months ended June 30, 2008.  As of June 30, 2008, the Company was current with its filings with the SEC and, therefore, all outstanding options were classified as equity.

 

4. Goodwill

 

Changes in the carrying amount of goodwill attributable to each reportable operating segment, consisting primarily of foreign currency translation adjustments, were as follows (in thousands):

 

 

 

Goodwill

 

Balance, September 30, 2007

 

$

205,715

 

Foreign currency translation adjustments

 

628

 

Adjustments - S2 (1)

 

13

 

Adjustments - Visual Web (2)

 

414

 

Balance, December 31, 2007

 

206,770

 

Foreign currency translation adjustments

 

3,388

 

Adjustments - S2 (3)

 

17

 

Balance, June 30, 2008

 

$

210,175

 

 


(1)

Adjustment to S2 Systems, Inc. acquisition relates to settlement of escrow balances in accordance with the purchase agreement.

(2)

Visual Web purchase accounting adjustment relates to an adjustment to deferred tax balances.

(3)

Adjustment to S2 Systems, Inc. acquisition relates to a contingency payment made in accordance with the purchase agreement.

 

5.  Software and Other Intangible Assets

 

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

 

 

 

June 30,

 

December 31,

 

September 30,

 

 

 

2008

 

2007

 

2007

 

Internally-developed software

 

$

13,738

 

$

13,299

 

$

13,302

 

Purchased software

 

86,392

 

82,410

 

80,836

 

 

 

100,130

 

95,709

 

94,138

 

Less: accumulated amortization

 

(68,975

)

(64,279

)

(62,374

)

Software, net

 

$

31,155

 

$

31,430

 

$

31,764

 

 

At June 30, 2008, the software net book value includes the following software purchased through acquisitions which is being marketed for external sale:  $1.6 million of S2 Systems, Inc. purchased software, $3.6 million of eps Electronic Payment Systems AG purchased software, $15.9 million of P&H Solutions, Inc. purchased software and $1.0 million of Visual Web purchased software.   The remaining software net book value of $9.1 million is comprised of various software that has been acquired or developed for internal use.

 

Quarterly amortization of acquired software marketed for external sale 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 to six years. Software amortization expense recorded in the three months ended June 30, 2008 and 2007 totaled $2.4 million and $2.1 million, respectively.  Software amortization expense recorded in the six months ended June 30, 2008 and 2007 totaled $4.5 million and $4.1 million, respectively.  These software amortization expense amounts are reflected in cost of software license fees in the consolidated statements of operations.

 

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

 

 

 

June 30,

 

December 31,

 

September 30,

 

 

 

2008

 

2007

 

2007

 

Customer relationships

 

$

41,166

 

$

40,538

 

$

40,488

 

Purchased contracts

 

11,632

 

11,593

 

11,643

 

Trademarks and tradenames

 

2,336

 

2,266

 

2,246

 

Covenant not to compete

 

1,560

 

1,546

 

1,531

 

 

 

56,694

 

55,943

 

55,908

 

Less: accumulated amortization

 

(21,326

)

(17,855

)

(16,223

)

Other intangible assets, net

 

$

35,368

 

$

38,088

 

$

39,685

 

 

Other intangible assets amortization expense recorded in the three months ended June 30, 2008 and 2007 totaled $1.6 million and $1.7 million, respectively.  Other intangible assets amortization expense recorded in the six months ended June 30, 2008 and 2007 totaled $3.3 million for each period.

 

Based on capitalized software and intangible assets at June 30, 2008, estimated amortization expense for future fiscal years is as follows (in thousands):

 

Fiscal Year Ending December 31,

 

Software
Amortization

 

Other
Intangible
Assets
Amortization

 

Remainder of 2008

 

$

4,955

 

$

3,254

 

2009

 

9,321

 

6,359

 

2010

 

8,155

 

6,314

 

2011

 

5,547

 

5,960

 

2012

 

2,799

 

4,891

 

Thereafter

 

378

 

8,590

 

Total

 

$

31,155

 

$

35,368

 

 

6.  Derivative Instruments and Hedging Activities

 

The Company maintains an interest-rate risk-management strategy that uses derivative instruments to mitigate the risk of variability in future cash flows (and related interest expense) associated with currently outstanding and forecasted floating rate bank borrowings due to changes in the benchmark interest rate, the London Inter-Bank Offer Rate (“LIBOR”).

 

At June 30, 2008, the Company had $75 million of outstanding variable-rate borrowings under a 5-year $150 million revolving facility that matures on September 29, 2011. The variable-rate benchmark is 3-month LIBOR.  During the fiscal year ended September 30, 2007, the Company entered into two interest-rate swaps to convert its existing and forecasted variable-rate borrowing needs to fixed rates.

 

Although the Company believes that these interest rate swaps will mitigate the risk of variability in future cash flows associated with existing and forecasted variable rate borrowings during the term of the swaps, neither swap qualifies for hedge accounting. Accordingly, the change in the aggregate fair value liability of the interest rate swaps for the three and six month periods ended June 30, 2008 of a decrease of $2.9 million and an increase of $0.8 million, respectively, is reflected as expense in other income (expense), net in the accompanying consolidated statements of operations.

 

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Changes in the fair value of the interest rate swaps were as follows (in thousands):

 

 

 

Asset

 

 

 

(Liability)

 

Beginning fair value, September 30, 2007

 

$

(2,077

)

Loss recognized in earnings

 

(2,475

)

Fair value, December 31, 2007

 

(4,552

)

Net settlement payments

 

152

 

Loss recognized in earnings

 

(754

)

Ending fair value, June 30, 2008

 

$

(5,154

)

 

As of June 30, 2008, the $5.2 million fair value liability is recorded as $3.4 million and $1.8 million in other current liabilities and other noncurrent liabilities, respectively, on the accompanying consolidated balance sheet.

 

Net settlements are measured monthly and paid quarterly.  The net settlements are recorded in other income (expense) in the accompanying consolidated statements of operations.  Included in the $5.2 million fair value at June 30, 2008, is approximately $0.8 million of net settlement obligations paid by the Company subsequent to June 30, 2008.

 

Subsequent to June 30, 2008, events in the global credit markets have impacted the expectation of near-term variable borrowing rates. As a result, the Company has experienced a positive impact to the fair value liability of its interest rate swaps. During July 2008, the fair value liability has decreased approximately $0.4 million from a balance of $5.2 million as of June 30, 2008 to $4.8 million as of July 31, 2008.

 

7.  Fair Value Financial Instruments

 

Effective January 1, 2008, the Company adopted the provisions of SFAS No. 157, Fair Value Measurements (“SFAS 157”), for financial assets and financial liabilities. In accordance with Financial Accounting Standards Board Staff Position No. 157-2, Effective Date of FASB Statement No. 157, the Company will delay application of SFAS 157 for non-financial assets and non-financial liabilities, until January 1, 2009. SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements.

 

SFAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.  SFAS 157 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 

·                  Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

 

·                  Level 2 Inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

 

·                  Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

 

Derivatives. Derivatives are reported at fair value utilizing Level 2 inputs. The Company utilizes valuation models prepared by a third-party with observable market data inputs to estimate fair value of its interest rate swaps.

 

Commons Stock Warrants.  Common stock warrants are reported at fair value utilizing Level 2 inputs.  The Company utilized a valuation model prepared by a third-party with observable market data inputs to estimate fair value of the common stock warrants.

 

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The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of June 30, 2008, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (in thousands):

 

 

 

 

 

Fair Value Measurements at Reporting
Date Using

 

 

 

 

 

Quoted Prices

 

 

 

 

 

 

 

 

 

in Active

 

Significant

 

 

 

 

 

 

 

Markets for

 

Other

 

Significant

 

 

 

 

 

Identical

 

Observable

 

Unobservable

 

 

 

June 30,

 

Assets

 

Inputs

 

Inputs

 

Description

 

2008

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

 

 

 

 

 

 

 

 

 

 

Derivative liabilities

 

$

5,154

 

$

 

$

5,154

 

$

 

Common stock warrants

 

$

24,003

 

$

 

$

24,003

 

$

 

 

Certain non-financial assets and non-financial liabilities measured at fair value on a recurring basis include reporting units measured at fair value in the first step of a goodwill impairment test. Certain non-financial assets measured at fair value on a non-recurring basis include non-financial assets and non-financial liabilities measured at fair value in the second step of a goodwill impairment test, as well as intangible assets and other non-financial long-lived assets measured at fair value for impairment assessment. As stated above, SFAS 157 will be applicable to these fair value measurements beginning January 1, 2009.

 

The Company pays interest quarterly on its long-term revolving credit facility based upon the LIBOR rate plus a margin ranging from 0.625% to 1.375%, the margin being dependent upon the Company’s total leverage ratio at the end of the quarter.  At June 30, 2008, the fair value of the Company’s long-term revolving credit facility approximates its carrying value.

 

8.  Corporate Restructuring and Other Reorganization Charges

 

Changes in the liability for corporate restructuring charges were as follows (in thousands):

 

 

 

Termination
Benefits

 

Balance, September 30, 2007

 

$

2,726

 

Additional restructuring charges incurred

 

477

 

Amounts paid during the period

 

(1,829

)

Other

 

23

 

Balance, December 31, 2007

 

1,397

 

Additional restructuring charges incurred

 

275

 

Amounts paid during the period

 

(1,636

)

Other

 

54

 

Balance, June 30, 2008

 

$

90

 

 

Other includes the impact of foreign currency translation.

 

At June 30, 2008, December 31, 2007 and September 30, 2007, the liabilities were classified as short-term in accrued employee compensation in the accompanying consolidated balance sheets.  See Note 16, “International Business Machines Corporation Information Technology Outsourcing Agreement”.

 

9.  Common Stock and Earnings (Loss) Per Share

 

In December 2004, the Company announced that the board of directors approved a stock repurchase program authorizing the Company, from time to time as market and business conditions warrant, to acquire up to $80.0 million of its common stock.  In May 2006, the Company’s board of directors approved an increase of $30.0 million to the stock repurchase program, bringing the total of the approved plan to $110.0 million.  In March 2007, the Company’s board of directors approved an increase of $100 million to the current repurchase authorization, bringing the total authorization to $210 million.  Under the program to date, the

 

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Company has purchased approximately 6,049,484 shares for approximately $154 million.  The maximum remaining dollar value of shares authorized for purchase under the stock repurchase program was approximately $56 million as of June 30, 2008.  Purchases will be made from time to time as market and business conditions warrant, in open market, negotiated or block transactions, subject to applicable laws, rules and regulations.

 

Earnings (loss) per share is computed in accordance with SFAS No. 128, Earnings per Share.  Basic earnings (loss) per share is computed on the basis of weighted average outstanding common shares.  Diluted earnings (loss) per share is computed on the basis of basic weighted average outstanding common shares adjusted for the dilutive effect of stock options and other outstanding dilutive securities.  The following table reconciles the average share amounts used to compute both basic and diluted earnings (loss) per share (in thousands):

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

 

Weighted average share outstanding:

 

 

 

 

 

 

 

 

 

Basic weighted average shares outstanding

 

34,133

 

37,075

 

34,649

 

37,118

 

Add: Dilutive effect of stock options, restricted stock awards and other dilutive securities

 

770

 

 

 

 

Diluted weighted average shares outstanding

 

34,903

 

37,075

 

34,649

 

37,118

 

 

For the three months ended June 30, 2008, 4.4 million options to purchase shares, contingently issuable shares, and common stock warrants were excluded from the diluted net income per share computation as their effect would be anti-dilutive.  For the three months ended June 30, 2007, 4.4 million options to purchase shares and contingently issuable shares were excluded from the diluted net income (loss) per share computation due to the net loss.  For the six months ended June 30, 2008 and 2007, 7.1 million and 4.4 million, respectively, options to purchase shares, restricted share awards, contingently issuable shares, and common stock warrants were excluded from the diluted net income (loss) per share computation due to the net loss.

 

10.  Other Income/Expense

 

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

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

 

Foreign currency transactions gains (losses)

 

$

(737

)

$

(1,500

)

$

2,922

 

$

(1,772

)

Change in fair value of interest rate swap

 

2,935

 

 

(754

)

 

Other

 

135

 

(33

)

(25

)

(98

)

Total

 

$

2,333

 

$

(1,533

)

$

2,143

 

$

(1,870

)

 

11.  Comprehensive Income (Loss)

 

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

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

828

 

$

(2,723

)

$

(2,632

)

$

(3,137

)

Foreign currency translation adjustments

 

818

 

2,614

 

2,300

 

3,209

 

Comprehensive income (loss)

 

$

1,646

 

$

(109

)

$

(332

)

$

72

 

 

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Accumulated other comprehensive income (loss) included in the Company’s consolidated balance sheets represents the accumulated foreign currency translation adjustment.  Since the undistributed earnings of the Company’s foreign subsidiaries are considered to be indefinitely reinvested, the components of accumulated other comprehensive income (loss) have not been tax effected.

 

12.  Segment Information

 

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 (loss), for the geographic regions of the Americas, Europe/Middle East/Africa (“EMEA”) and Asia/Pacific. 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.  As such, the Company has concluded that its three geographic regions are its reportable operating segments.

 

The Company’s chief operating decision makers review financial information presented on a consolidated basis, accompanied by disaggregated information about revenues and operating income by geographical region.

 

The Company allocated segment support expenses such as global product delivery, business operations and management based upon percentage of revenue per segment.  Corporate costs are allocated as a percentage of the headcount by segment.  The prior period amounts for operating income (loss) have been reclassified to conform to current period presentation, which reflect a change in the allocation of certain costs related to acquired businesses across the reportable operating segments versus solely in the region in which the acquired business was located in when acquired.  The following are revenues and operating income (loss) for the periods indicated (in thousands):

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Revenues:

 

 

 

 

 

 

 

 

 

Americas

 

$

52,523

 

$

52,253

 

$

96,537

 

$

104,875

 

EMEA

 

46,923

 

36,548

 

84,231

 

65,294

 

Asia/Pacific

 

9,773

 

9,308

 

21,042

 

17,888

 

 

 

$

109,219

 

$

98,109

 

$

201,810

 

$

188,057

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss):

 

 

 

 

 

 

 

 

 

Americas

 

$

1,431

 

$

7,633

 

$

2,769

 

$

14,958

 

EMEA

 

835

 

(3,510

)

(1,346

)

(11,865

)

Asia/Pacific

 

(1,007

)

759

 

(676

)

2,000

 

 

 

$

1,259

 

$

4,882

 

$

747

 

$

5,093

 

 

No single customer accounted for more than 10% of the Company’s consolidated revenues during the three or six months ended June 30, 2008 or 2007.  Aggregate revenues attributable to customers in the United Kingdom accounted for 17.8% and 4.2% of the Company’s consolidated revenues during the three months ended June 30, 2008 and 2007, respectively.  Aggregate revenues attributable to customers in the United Kingdom accounted for 14.9% and 7.6% of the Company’s consolidated revenues during the six months ended June 30, 2008 and 2007, respectively.  Aggregate revenues attributable to customers in Canada accounted for 5.4% and 12.0% of the Company’s consolidated revenues during the six months ended June 30, 2008 and 2007, respectively.

 

13.  Income Taxes

 

The effective tax rate for the three months ended June 30, 2008 and 2007 is 74.6% and 195.3%, respectively.  The effective tax rate for the six months ended June 30, 2008 and 2007 is 247.7% and 246.0%, respectively.  The effective tax rate in all four periods are higher than the U.S. effective rate of 35% due to the low level of income before taxes and the impact of the Company’s inability to recognize income tax benefits during the period as a result of losses sustained in certain tax jurisdictions where the future utilization of the losses are uncertain.  This was offset by income in tax jurisdictions in which the Company

 

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accrues tax expense and by the recognition of tax expense associated with the transfer of certain intellectual property rights from U.S. to non-U.S. entities.

 

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 (“FIN 48”).  The Company adopted the provisions of FIN 48 effective October 1, 2007.  FIN 48 prescribes a recognition threshold and measurement attribute for the recognition and measurement of tax positions taken or expected to be taken in a tax return and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. As a result of the implementation of FIN 48, the Company recognized a decrease to retained earnings of $3.3 million, which included at October 1, 2007 an increase of $2.7 million in net unrecognized tax benefits.  In addition, reclassification in balance sheet accounts as required by FIN 48 resulted in an increase in noncurrent deferred income tax assets of $4.3 million, an increase in other long term assets of $1.5 million and an increase in other long term liabilities of $16.2 million.  As of the date of adoption, the Company’s gross unrecognized tax benefits totaled $14.8 million.  Of this amount, $9.0 million represents the net unrecognized tax benefits that, if recognized, would favorably impact the effective income tax rate.  During the six months ended June 30, 2008, approximately $0.5 million of liability was added to the unrecognized tax benefit balance.

 

The Company files income tax returns in the U.S. federal jurisdiction, various state and local jurisdictions, and many foreign jurisdictions.  The U.S., United Kingdom and Canada are the main taxing jurisdictions in which the Company operates.  A number of years may elapse before an uncertain tax position is audited and finally resolved.  While it is often difficult to predict the final outcome or the timing of resolution of any particular uncertain tax position, the Company believes that the accruals for income taxes reflect the most probable outcome.  The Company will adjust these accruals, as well as the related interest, in light of changing facts and circumstances.  The years open for audit varies depending on the tax jurisdiction.  In the U.S., the Company’s tax returns for years following fiscal year 2003 are open for audit.  In the UK, the Company’s tax returns for the years following 2002 are open for audit, while in Canada, the Company’s tax returns for years following 1999 are open for audit.

 

The Internal Revenue Service is currently auditing the Company’s fiscal year 2005 and 2006 income tax returns.  The Company’s United Kingdom and Canada income tax returns covering fiscal years 2003 through 2005 and 2000 through 2004, respectively, are also under audit by the applicable tax authorities.  The Company believes it is reasonably possible that the total amount of unrecognized tax benefits will decrease within the next 12 months between $3.0 million and $6.0 million, due to settlement of various audits.

 

The Company accrues interest related to uncertain tax positions in interest expense or interest income and recognizes penalties related to uncertain tax positions in other income or other expense.  As of June 30, 2008, $1.5 million is accrued for the payment of interest and penalties related to income tax liabilities.

 

14.  Contingencies

 

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 previously alleged that during the purported class period, the Company and the named defendants misrepresented the Company’s historical financial condition, results of operations and its future prospects, and failed to disclose facts that could have indicated an impending decline in the Company’s revenues. That Complaint also alleged that, prior to August 2002, the purported truth regarding the Company’s financial condition had not been disclosed to the market.  The Company and the individual defendants initially filed a motion to dismiss the lawsuit. In response, on December 15, 2003, the Court dismissed, without prejudice, Gregory Derkacht, the Company’s former president and chief executive officer, as a defendant, but denied the motion to dismiss with respect to the remaining defendants, including the Company.

 

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

 

On January 27, 2006, the Company and the individual defendants filed a motion for judgment on the pleadings, seeking a dismissal of the lead plaintiff and certain other class members, as well as a limitation on damages based upon plaintiffs’ inability to establish loss causation with respect to a large portion of their claims.  On February 6, 2006, additional class representative Roger M. Wally filed a motion to withdraw as a class representative and class member. On April 21, 2006, and based upon the pending motion for judgment, a motion to intervene as a class representative was filed by the Louisiana District Attorneys Retirement System (“LDARS”). LDARS previously attempted to be named as lead plaintiff in the case.  On July 5, 2006, the Magistrate denied LDARS’ motion to intervene, which LDARS appealed to the District Judge.

 

On May 17, 2006, the Court denied the motion for judgment on the pleadings as being moot based upon the Court’s granting lead plaintiff leave to file a Third Amended Complaint (“Third Complaint”), which it did on May 31, 2006.  The Third Complaint alleges the same misrepresentations as described above, while simultaneously alleging that the purported truth about the Company’s financial condition was being disclosed throughout that time, commencing in April 1999.  The Third Complaint sought unspecified damages, interest, fees, and costs.

 

On June 14, 2006, the Company and the individual defendants filed a motion to dismiss the Third Complaint pursuant to Rules 8 and 12 of the Federal Rules of Civil Procedure.  Lead Plaintiff opposed the motion.  Prior to any ruling on the motion to dismiss, on November 7, 2006, the parties entered into a Stipulation of Settlement for purposes of settling all of the claims in the Class Action Litigation, with no admissions of wrongdoing by the Company or any individual defendant.  The settlement provides for an aggregate cash payment of $24.5 million of which, net of insurance, the Company contributed approximately $8.5 million.  The settlement was approved by the Court on March 2, 2007 and the Court ordered the case dismissed with prejudice against the Company and the individual defendants.

 

On March 27, 2007, James J. Hayes, a class member, filed a notice of appeal with the United States Court of Appeals for the Eighth Circuit appealing the Court’s order.  The Company responded to this appeal in accordance with the Court of Appeals’ orders and procedures.  The appeal has not yet been decided.

 

15.  International Business Machines Corporation Alliance

 

On December 16, 2007, the Company entered into an Alliance Agreement (“Alliance”) with International Business Machines Corporation (“IBM”) relating to joint marketing and optimization of the Company’s electronic payments application software and IBM’s middleware and hardware platforms, tools and services. On March 17, 2008, the Company and IBM entered into Amendment No. 1 to the Alliance (“Amendment No.1” and included hereafter in all references to the “Alliance”), which changed the timing of certain payments to be made by IBM.  Under the terms of the Alliance, each party will retain ownership of its respective intellectual property and will independently determine product offering pricing to customers. In connection with the formation of the Alliance, the Company granted warrants to IBM to purchase up to 1,427,035 shares of the Company’s common stock at a price of $27.50 per share and up to 1,427,035 shares of the Company’s common stock at a price of $33.00 per share. The warrants are exercisable for five years.

 

Under the terms of the Alliance, on December 16, 2007, IBM paid the Company an initial non-refundable payment of $33.3 million in consideration for the estimated fair value of the warrants described above. The fair value of the warrants granted, as subsequently determined by an independent third party appraiser, is approximately $24.0 million and is recorded as common stock warrants in the accompanying consolidated balance sheet as of June 30, 2008 and December 31, 2007. The remaining balance of $9.3 million is related to prepaid incentives and other obligations and is recorded in the Alliance agreement liability in the accompanying consolidated balance sheet as of December 31, 2007.

 

During the six months ended June 30, 2008, the Company received an additional payment from IBM of $37.3 million per Amendment No. 1.  This payment has been recorded in the Alliance agreement liability in the accompanying consolidated balance sheet as of June 30, 2008.  This amount represents a prepayment of funding for technical enablement milestones and incentive payments to be earned under the Alliance and related agreements and, accordingly, a portion of this payment is subject to refund by the Company to IBM under certain circumstances.  As of June 30, 2008, $20.7 million is refundable subject to achievement of future milestones.

 

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The future costs incurred by the Company related to internally developed software associated with the technical enablement milestones will be capitalized in accordance with SFAS No. 86, Accounting for Costs of Computer Software to be Sold, Leased, or Otherwise Marketed (“SFAS 86”), when the resulting product reaches technological feasibility. Prior to reaching technological feasibility, the costs will be expensed as incurred. The Company will receive partial reimbursement from IBM for expenditures incurred if certain technical enablement milestones and delivery dates specified in the Alliance are met. Reimbursements from IBM for expenditures determined to be direct and incremental to satisfying the technical enablement milestones will be used to offset the amounts expensed or capitalized as described above but not in excess of non-refundable cash received or receivable.  During the three and six months ended June 30, 2008, the Company incurred $1.8 million and $2.9 million, respectively, of costs related to fulfillment of the technical enablement milestones.  The reimbursement of these costs was recorded as a reduction of the Alliance agreement liability and a reduction in capitalizable costs under SFAS 86 in the accompanying consolidated balance sheet as of June 30, 2008, and a reduction of operating expenses in the accompanying consolidated statements of operations for the three and six months ended June 30, 2008.

 

Also, during the three and six months ended June 30, 2008, the Company reached certain technical enablement milestones and has recognized an increase in the Alliance agreement liability of $3.4 million and $3.6 million, respectively.  Of the $3.6 million, approximately $1.4 million has been collected and the remaining $2.2 million is recorded in billed receivables in the accompanying consolidated balance sheet as of June 30, 2008.

 

Changes in the Alliance agreement liability were as follows (in thousands):

 

 

 

Alliance
Agreement
Liability

 

Balance, September 30, 2007

 

$

 

IBM payment

 

33,334

 

Common stock warrants

 

(24,003

)

Balance, December 31, 2007

 

9,331

 

IBM payment

 

37,333

 

Technical enablement milestones

 

3,600

 

Costs related to fulfillment of technical enablement milestones

 

(2,891

)

Balance, June 30, 2008

 

$

47,373

 

 

Of the $47.4 million Alliance agreement liability, $7.2 million is short-term and $40.2 million is long-term in the accompanying consolidated balance sheet as of June 30, 2008.

 

IBM will pay the Company additional amounts upon meeting certain prescribed technical enablement obligations and incentives payable upon IBM recognizing revenue from end-user customers as a result of the Alliance.  The revenue related to the incentive payments will be deferred until the Company has reached substantial completion of the technical enablement milestones.  Subsequent to reaching substantial completion, revenue will be recognized as sales incentives are earned.

 

The stated initial term of the Alliance is five years, subject to extension for successive two year terms if not previously terminated by either party and subject to earlier termination for cause.

 

16.  International Business Machines Corporation Information Technology Outsourcing Agreement

 

On March 17, 2008, the Company entered into a Master Services Agreement (“Outsourcing Agreement”) with IBM to outsource the Company’s internal information technology (“IT”) environment to IBM. Under the terms of the Outsourcing Agreement, IBM will provide the Company with global IT infrastructure services including the following services, which services are currently provided by the Company: cross functional delivery management services, asset management services, help desk services, end user services, server system management services, storage management services, data network services, enterprise security management services and disaster recovery/business continuity plans (collectively, the “IT Services”). The Company will retain responsibility for its security policy management and on-demand business operations.

 

The initial term of the Outsourcing Agreement is seven years, commencing on March 17, 2008. The Company has the right to extend the Outsourcing Agreement for one additional one-year term unless otherwise terminated in accordance with the terms of the Outsourcing Agreement. Under the Outsourcing Agreement, the Company retains the right to terminate the agreement

 

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both for cause and for its convenience. However, upon any termination of the Outsourcing Agreement by the Company for any reason (other than for material breach by IBM), the Company will be required to pay a termination charge to IBM, which charge may be material.

 

The Company will pay IBM for the IT Services through a combination of fixed and variable charges, with the variable charges fluctuating based on the Company’s actual need for such services as well as the applicable service levels and statements of work. Based on the currently projected usage of these IT Services, the Company expects to pay $116 million to IBM in service fees and project costs over the initial seven-year term.

 

In addition, IBM will provide the Company with certain transition services required to transition the Company’s IT operations embodied in the IT Services in accordance with a mutually agreed upon transition plan (the “Transition Services”). The Company currently expects the Transition Services to be completed approximately 18 months after the effective date of the Outsourcing Agreement and to pay IBM approximately $8 million for the Transition Services over a period of five years.   These Transition Services will be recognized as incurred based on the capital or expense nature of the cost.  The Company has expensed approximately $2.5 million for Transition Services during the three months ended June 30, 2008 that are included in general and administrative expenses in the accompanying consolidated statement of operations.  Of the $2.5 million recognized during the three months ended June 30, 2008, approximately $0.1 million is included in accounts payable, $0.7 million is included in other noncurrent liabilities and $1.7 million is included in other liabilities in the accompanying consolidated balance sheet at June 30, 2008.  The Company incurred an additional $0.4 million of staff augmentation costs related to the Transition Services during the three months ended June 30, 2008 that are included in general and administrative expenses in the accompanying consolidated statement of operations.

 

The Outsourcing Agreement has performance standards and minimum services levels that IBM must meet or exceed. If IBM fails to meet a given performance standard, the Company would, in certain circumstances, receive a credit against the charges otherwise due.

 

Additionally, the Company has the right to periodically perform benchmark studies to determine whether IBM’s price and performance are consistent with the then current market. The Company has the right to conduct such benchmark studies, at its cost, beginning in the second year of the Outsourcing Agreement.

 

As a result of the Outsourcing Agreement, 16 employees of the Company became employees of IBM and an additional 62 positions were eliminated by the Company.  In connection with these actions, the Company will incur approximately $1.9 million to $2.3 million of termination costs.  During the three and six month periods ended June 30, 2008, $0.9 million and $1.3 million, respectively, of termination costs were recognized in general and administrative expense in the accompanying consolidated statements of operations.  The charges, by segment, were as follows for the three months ended June 30, 2008:  $0.7 million in the Americas segment, $0.1 million in the EMEA segment, and $0.1 million in the Asia Pacific segment.  The charges, by segment, were as follows for the six months ended June 30, 2008:  $1.1 million in the Americas segment, $0.1 million in the EMEA segment, and $0.1 million in the Asia Pacific segment.  The remainder of the costs will be recognized over the employees remaining service periods during the third quarter of fiscal year 2008.

 

As of June 30, 2008, $1.3 million is accrued in accrued employee compensation for these termination costs in the accompanying consolidated balance sheet.  The Company anticipates that these amounts will be paid by the end of fiscal 2009.  No amounts were paid during the six months ended June 30, 2008.

 

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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 anticipates,” “we believe,” “we anticipate,” “we expect,” “we plan,” “we will,” “we are well positioned,” 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, as well as statements related to expected financial and other benefits from our recent acquisition of Visual Web Solutions, Inc., and Stratasoft Sdn Bhd and those related to our organizational restructuring activities. 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 document may turn out to be incorrect. They may be based on inaccurate assumptions or may not account for known or unknown risks and uncertainties. Consequently, no forward-looking statement is guaranteed, and our actual future results may vary materially from the results expressed or implied in our forward-looking statements. The cautionary statements in this report expressly qualify all of our forward-looking statements. In addition, we are not obligated, and do not intend, to update any of our forward-looking statements at any time unless an update is required by applicable securities laws. 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 Item 1A in the section entitled “Risk Factors — Factors That May Affect Our Future Results or The Market Price of Our Common Stock.”

 

The following discussion should be read together with our financial statements and related notes contained in this report and with the financial statements and related notes and Management’s Discussion & Analysis in our Annual Report on Form 10-K for the fiscal year ended September 30, 2007, as amended by the Form 10-K/A for the same period filed March 4, 2008, the Transition Report on Form 10-Q for the three months ended December 31, 2007, as amended by the Form 10-Q/A for the same period filed March 4, 2008, and the Quarterly Report on Form 10-Q for the three months ended March 31, 2008 filed May 9, 2008.  Results for the six months ended June 30, 2008, are not necessarily indicative of results that may be attained in the future.

 

Trademarks and Service Marks

 

ACI, the ACI logo, BASE24, ON/2, OpeN/2, ENGUARD, Network Express, PaymentWare and CO-ach, among others, are registered trademarks and/or registered service marks of ACI Worldwide, Inc., or one of its subsidiaries, in the United States and/or other countries. BASE24-eps, ACI Retail Commerce Server, NET24, Commerce Gateway, Smart Chip Manager, Proactive Risk Manager, PRM, ICE, WebGate, SafeTGate, DataWise, ACI Wholesale Payment System, ACI Money Transfer System or MTS, ACI Enterprise Banker, ACI Payments Manager, ACI Card Management System, ACI Dispute Management System, and WPS, among others, have pending registrations or are common-law trademarks and/or service marks of ACI Worldwide, Inc., or one of its subsidiaries, in the United States and/or other countries. Other parties’ marks referred to in this report are the property of their respective owners.

 

Change in Fiscal Year End

 

Effective January 1, 2008, the Company changed its fiscal year end from September 30 to December 31.  The Company’s new fiscal year commenced January 1, 2008 and will end on December 31, 2008.  This quarterly report on Form 10-Q compares the financial position as of June 30, 2008, to December 31, 2007 and September 30, 2007, and the results of operations for the three and six months ended June 30, 2008 with the results of operations for the three and six months ended June 30, 2007.  The Company changed its fiscal year end to align its sales contracting and delivery processes with its customers and to allow for more effective communication with the capital markets and investment community by being consistent with its peer group.

 

Overview

 

We develop, market, install and support a broad line of software products and services primarily focused on facilitating electronic payments. In addition to our own products, we distribute, or act as a sales agent for, software developed by third parties. Our 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 its sales force with independent reseller and/or distributor networks. Our products and services are used principally by financial institutions, retailers and electronic payment processors, both in domestic and international markets. Accordingly, our business and operating results are influenced by trends

 

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such as information technology spending levels, economic changes in the financial markets, the growth rate of the electronic payments industry, mandated regulatory changes, and changes in the number and type of customers in the financial services industry. Our products are marketed under the ACI Worldwide brand.

 

We derive a majority of our revenues from non-domestic operations and believe our greatest opportunities for growth exist largely in international markets. Refining our global infrastructure is a critical component of driving our growth. We have launched a globalization strategy intended to streamline our supply chain and provide low-cost centers of expertise to support a growing international customer base. A subsidiary in Ireland serves as the focal point for certain international product development and commercialization efforts. This subsidiary oversees remote software development operations in Romania and elsewhere and manages certain of our intellectual property rights.  We are also taking a direct selling and support strategy in certain countries where historically we have used third-party distributors to represent our products, in an effort to develop closer relationships with our customers and develop a stronger overall position in those countries.  Our principal executive offices are located in New York state to manage our global infrastructure more strategically.

 

Through a service called ACI On Demand, we host our payment systems and sell them as a service to banks, retailers and processors as an alternative to customers managing their ACI software in-house.

 

We are maturing many of our retail payment engines.  These products were developed or acquired by ACI over several years and include BASE24, TRANS24-eft, ON/2, OpeN/2 and ASx.  Our strategy is to help customers migrate to our next-generation BASE24-eps solution as we discontinue standard support for previous products. This will allow customers to take advantage of our newest technology and allow ACI to more efficiently focus R&D investment.

 

Key trends that currently impact our 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. We commissioned an industry study that determined that electronic payment volumes are expected to grow at approximately 13% per year from 2004 through 2009, with varying growth rates based on the type of payment and part of the world. We leverage 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 to existing customers.

 

·                  Increasing competition.  The electronic payments market is highly competitive and subject to rapid change. Our competition comes from in-house information technology departments, third-party electronic payment processors and third-party software companies located both within and outside of the United States. Many of these companies are significantly larger than we are and have significantly greater financial, technical and marketing resources. As electronic payment transaction volumes increase, third-party processors tend to provide competition to our solutions, particularly among customers that do not seek to differentiate their electronic payment offerings. As consolidation in the financial services industry continues, we anticipate 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 serve to make these systems obsolete, creating opportunities for us to replace aging software with newer and more advanced products.

 

·                  Adoption of open systems technology.  In an effort to leverage lower-cost computing technologies and current technology staffing and resources, many financial institutions, retailers and electronic payment processors are seeking to transition their systems from proprietary technologies to open technologies such as Windows, UNIX and Linux. Our 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. We continue to see opportunity to offer our fraud detection solutions to help customers manage the growing levels of electronic payment fraud and compliance activity.

 

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·                  Adoption of smart card 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 EMV standard for issuing and processing debit and credit card transactions has emerged as the global standard, with many regions throughout the world working on 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 ATMs and POS devices). We are working with many customers around the world to facilitate EMV deployments, leveraging several of our solutions.

 

·                  Single Euro Payments Area (“SEPA”) and Faster Payments Mandates.  The SEPA and Faster Payments initiatives, primarily focused on the European Economic Community and the United Kingdom, are designed to facilitate lower costs for cross-border payments and reduce timeframes for settling electronic payment transactions.  Our retail and wholesale banking solutions provide key functions that help financial institutions address these mandated regulations.

 

·                  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 smaller number of existing and potential customers for our products and services. Consolidation of two of our customers could result in reduced revenues if the combined entity were to negotiate greater volume discounts or discontinue use of certain of our products. Additionally, if a non-customer and a customer combine and the combined entity in turn decides to forego future use of our products, our revenue would decline. Conversely, we could benefit from the combination of a non-customer and a customer when the combined entity continues use of our products and, as a larger combined entity, increases its demand for our products and services. We tend to focus on larger financial institutions as customers, often resulting in our 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. We believe 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. Our organizational structure is, 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 us, 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 we are and have significantly greater financial, technical and marketing resources.

 

Several other factors related to our business may have a significant impact on our 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 we 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 our products often cause revenue related to sales generated in one period to be deferred and recognized in later periods. For arrangements in which services revenue is deferred, related direct and incremental costs may also be deferred. Additionally, while the majority of our contracts are denominated in the United States dollar, a substantial portion of our sales are made, and some of our 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 recognition of gains or losses for that period.  Also during the year ended September 30, 2007, we entered into two interest rate swaps with a commercial bank whereby we pay a fixed rate of 5.375% and 4.90% and receive a floating rate indexed to the three-month LIBOR from the counterparty on a notional amount of $75 million and forecasted borrowings of $50 million, respectively.  Fluctuations in interest rates in a given period may result in the recognition of gains or losses for that period.

 

We continue to seek ways to grow through both organic sources and acquisitions. We continually look for potential acquisitions designed to improve our solutions breadth or provide access to new markets. As part of our strategy, we seek

 

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acquisition candidates that are strategic, capable of being integrated into our operating environment, and financially accretive to our financial performance.

 

International Business Machines Corporation Alliance

 

On December 16, 2007, we entered into an Alliance Agreement (“Alliance”) with International Business Machines Corporation (“IBM”) relating to joint marketing and optimization of our electronic payments application software and IBM’s middleware and hardware platforms, tools and services. On March 17, 2008, the Company and IBM entered into Amendment No. 1 to the Alliance (“Amendment No. 1” and included hereafter in all references to the “Alliance”), which changed the timing of certain payments to be made by IBM.  Under the terms of the Alliance, each party will retain ownership of its respective intellectual property and will independently determine product offering pricing to customers. In connection with the formation of the Alliance, we granted warrants to IBM to purchase up to 1,427,035 shares of our common stock at a price of $27.50 per share and up to 1,427,035 shares of our common stock at a price of $33.00 per share. The warrants are exercisable for five years.

 

The stated initial term of the Alliance is five years, subject to extension for successive two-year terms if not previously terminated by either party and subject to earlier termination for cause.

 

During the six months ended June 30, 2008, we received a second payment from IBM of $37.3 million per the Alliance.  This payment has been recorded in the Alliance agreement liability in the accompanying consolidated balance sheet as of June 30, 2008.  This amount represents a prepayment of funding for technical enablement milestones and incentive payments to be earned under the Alliance and related agreements, and accordingly a portion of this payment is subject to refund by us to IBM under certain circumstances.  As of June 30, 2008, $20.7 million is refundable subject to achievement of future milestones.

 

International Business Machines Corporation Outsourcing Agreement

 

On March 17, 2008, we entered into a Master Services Agreement (“Outsourcing Agreement”) with IBM to outsource our internal information technology (“IT”) environment to IBM. Under the terms of the Outsourcing Agreement, IBM will provide us with global IT infrastructure services including the following services, which services are currently provided by our employees: cross functional delivery management services, asset management services, help desk services, end user services, server system management services, storage management services, data network services, enterprise security management services and disaster recovery/business continuity plans (collectively, the “IT Services”). We will retain responsibility for our security policy management and on-demand business operations.

 

The initial term of the Outsourcing Agreement is seven years, commencing on March 17, 2008. We have the right to extend the Outsourcing Agreement for one additional one-year term unless otherwise terminated in accordance with the terms of the Outsourcing Agreement. Under the Outsourcing Agreement, we retain the right to terminate the agreement both for cause and for its convenience. However, upon any termination of the Outsourcing Agreement by us for any reason (other than for material breach by IBM), we will be required to pay a termination charge to IBM, which charge may be material.

 

We will pay IBM for the IT Services through a combination of fixed and variable charges, with the variable charges fluctuating based on our actual need for such services as well as the applicable service levels and statements of work. Based on the currently projected usage of these IT Services, we expect to pay $116 million to IBM in service fees and project costs over the initial seven-year term.

 

In addition, IBM will provide us with certain transition services required to transition our IT operations embodied in the IT Services in accordance with a mutually agreed upon transition plan (the “Transition Services”). We currently expect the Transition Services to be completed approximately 18 months after the effective date of the Outsourcing Agreement and to pay IBM approximately $8 million for the Transition Services over a period of five years. We have recorded approximately $2.5 million of expense for Transition Services during the three months ended June 30, 2008 that are included in general and administrative expenses in the accompanying consolidated statement of operations.  We expect to recognize the majority of the remaining approximately $5.5 million of expense for Transition Services during the three months ended September 30, 2008.  We incurred an additional $0.4 million of staff augmentation costs related to the Transition Services during the three months ended June 30, 2008 that are included in general and administrative expenses in the accompanying consolidated statement of operations.

 

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To protect our expectations regarding IBM’s performance, the Outsourcing Agreement has performance standards and minimum services levels that IBM must meet or exceed. If IBM fails to meet a given performance standard, we would, in certain circumstances, receive a credit against the charges otherwise due.

 

Additionally, to assure that the charges under the Outsourcing Agreement do not become significantly higher than the market rate for such services, we have the right to periodically perform benchmark studies to determine whether IBM’s price and performance are consistent with the then current market. We have the right to conduct such benchmark studies, at its cost, beginning in the second year of the Outsourcing Agreement.

 

As a result of the Outsourcing Agreement, 16 of our employees became employees of IBM and another 62 positions were eliminated.

 

Acquisitions

 

On February 7, 2007, we acquired Visual Web Solutions, Inc. (“Visual Web”).  Visual Web markets trade finance and web-based cash management solutions, primarily to financial institutions in the Asia/Pacific region.  Visual Web had sales and customer support office in Singapore, and a product development facility in Bangalore, India.  The aggregate purchase price of Visual Web, including direct costs of the acquisition, was $8.3 million, net of $1.1 million of cash acquired

 

On April 2, 2007, we acquired Stratasoft Sdn. Bhd. (“Stratasoft”).  Stratasoft was a Kuala Lumpur based company focused on the provision of mainframe based payments systems to the Malaysian market.  Prior to the acquisition, Stratasoft had been a distributor of our OCM24 product within the Malaysian market since 1995.  The aggregate purchase price of Stratasoft, including direct costs of the acquisition, was $2.5 million, net of $0.7 million of cash acquired.

 

Backlog

 

Included in backlog estimates 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 we believe recognition of the related revenue will occur within the corresponding backlog period.  We have historically included assumed renewals in backlog estimates based upon automatic renewal provisions in the executed contract and our historic experience with customer renewal rates.

 

Our 60-month backlog estimate 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 our historical experiences.

·                       Non-recurring license arrangements are assumed to renew as recurring revenue streams.

·                       Foreign currency exchange rates are assumed to remain constant over the 60-month backlog period for those contracts stated in currencies other than the U.S. dollar.

·                       Our pricing policies and practices are assumed to remain constant over the 60-month backlog period.

 

In computing our 60-month backlog estimate, 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 our markets and/or customers is not reflected in the computation of our 60-month backlog estimate.

 

For the three months ended December 31, 2007, we completed a comprehensive review of the assumptions used and data required in computing our backlog estimates.  The 60-month and 12-month backlog estimates set forth below for the period ended September 30, 2007 have been revised to reflect these adjustments.  The revisions resulted in an increase in the 60-month backlog estimate of $14 million and a decrease in the 12-month backlog estimate of $2.5 million, the majority of which is monthly recurring revenue for the period ended September 30, 2007.

 

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The review identified two categories of adjustments which are reflected in the above revision:

 

·                  Adjustments due to inaccurate or incomplete data resulting in a historical over-statement of previously reported backlog estimates, and

·                  Adjustments required to conform with the recently adopted backlog policy resulting in a historical under-statement of previously reported backlog estimates.

 

While this review is complete and we do not expect further adjustments to previously reported backlog estimates, we continue to review the processes, procedures, tools, and assumptions used in preparing backlog estimates.

 

In addition, we also completed a review of our customer renewal experience over the 12-month period ended December 31, 2007. The impact of this review resulted in a revision to the renewal assumptions used in computing the 60-month and 12-month backlog estimates.  We expect to perform an annual review of customer renewal experience.  In the event a revision to renewal assumptions is determined to be necessary, prior periods will be adjusted for comparability purposes.

 

The following table sets forth our 60-month backlog estimate, by geographic region, as of June 30, 2008, March 31, 2008, December 31, 2007 and September 30, 2007 (in millions):

 

 

 

June 30, 2008

 

March 31,
2008

 

December 31,
2007

 

September 30,
2007

 

Americas

 

$

737

 

$

724

 

$

733

 

$

717

 

EMEA

 

533

 

522

 

504

 

489

 

Asia/Pacific

 

157

 

151

 

143

 

135

 

Total

 

$

1,427

 

$

1,397

 

$

1,380

 

$

1,341

 

 

We also estimate 12-month backlog, segregated between monthly recurring and non-recurring revenues, using a methodology consistent with the 60-month backlog estimate.  Monthly recurring revenues include all monthly license fees, maintenance fees and processing services fees.  Non-recurring revenues include other software license fees and services.  Amounts included in our 12-month backlog estimate 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 our 12-month backlog estimate, by geographic region, as of June 30, 2008, March 31, 2008, December 31, 2007 and September 30, 2007 (in millions):

 

 

 

June 30, 2008

 

March 31, 2008

 

 

 

Monthly
Recurring

 

Non-
Recurring

 

Total

 

Monthly
Recurring

 

Non-
Recurring

 

Total

 

Americas

 

$

135

 

$

32

 

$

167

 

$

132

 

$

35

 

$

167

 

EMEA

 

79

 

53

 

132

 

76

 

68

 

144

 

Asia/Pacific

 

28

 

12

 

40

 

27

 

9

 

36

 

Total

 

$

242

 

$

97

 

$

339

 

$

235

 

$

112

 

$

347

 

 

 

 

December 31, 2007

 

September 30, 2007

 

 

 

Monthly
Recurring

 

Non-

Recurring

 

Total

 

Monthly
Recurring

 

Non-
Recurring

 

Total

 

Americas

 

$

130

 

$

30

 

$

160

 

$

125

 

$

34

 

$

159

 

EMEA

 

73

 

66

 

139

 

70

 

66

 

136

 

Asia/Pacific

 

26

 

11

 

37

 

25

 

8

 

33

 

Total

 

$

229

 

$

107

 

$

336

 

$

220

 

$

108

 

$

328

 

 

Estimates of future financial results are inherently unreliable. Our backlog estimates require substantial judgment and are based on a number of assumptions as described above. These assumptions may turn out to be inaccurate or wrong, including for reasons outside of management’s control. For example, our 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 we 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

 

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can be no assurance that amounts included in backlog estimates will actually generate the specified revenues or that the actual revenues will be generated within the corresponding 12-month or 60-month period.  Additionally, because backlog estimates are operating metrics, the estimates are not subject to the same level of internal review or controls as a GAAP financial measure.

 

RESULTS OF OPERATIONS

 

The following table presents the consolidated statements of operations as well as the percentage relationship to total revenues of items included in our Consolidated Statements of Operations (amounts in thousands):

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30.

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

Amount

 

% of
Total
Revenue

 

Amount

 

% of
Total
Revenue

 

Amount

 

% of
Total
Revenue

 

Amount

 

% of
Total
Revenue

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Initial license fees (ILFs)

 

$

20,422

 

18.7

%

$

25,379

 

25.9

%

$

42,681

 

21.1

%

$

48,639

 

25.9

%

Monthly license fees (MLFs)

 

17,792

 

16.3

%

15,541

 

15.8

%

34,631

 

17.2

%

30,805

 

16.4

%

Software license fees

 

38,214

 

35.0

%

40,920

 

41.7

%

77,312

 

38.3

%

79,444

 

42.2

%

Maintenance fees

 

32,867

 

30.1

%

31,287

 

31.9

%

64,340

 

31.9

%

61,188

 

32.5

%

Services

 

38,138

 

34.9

%

25,902

 

26.4

%

60,158

 

29.8

%

47,425

 

25.2

%

Total revenues

 

109,219

 

100.0

%

98,109

 

100.0

%

201,810

 

100.0

%

188,057

 

100.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of software licenses fees

 

11,966

 

11.0

%

9,932

 

10.1

%

24,457

 

12.1

%

21,125

 

11.2

%

Cost of maintenance and services

 

36,044

 

33.0

%

26,789

 

27.3

%

64,673

 

32.0

%

50,140

 

26.7

%

Research and development

 

12,694

 

11.6

%

13,422

 

13.7

%

25,247

 

12.5

%

25,463

 

13.5

%

Selling and marketing

 

22,741

 

20.8

%

16,894

 

17.2

%

39,491

 

19.6

%

33,693

 

17.9

%

General and administrative

 

24,515

 

22.4

%

26,190

 

26.7

%

47,195

 

23.4

%

52,543

 

27.9

%

Total expenses

 

107,960

 

98.8

%

93,227

 

95.0

%

201,063

 

99.6

%

182,964

 

97.3

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

1,259

 

1.2

%

4,882

 

5.0

%

747

 

0.4

%

5,093

 

2.7

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

703

 

0.6

%

940

 

1.0

%

1,296

 

0.6

%

1,954

 

1.0

%

Interest expense

 

(1,038

)

-1.0

%

(1,431

)

-1.5

%

(2,404

)

-1.2

%

(3,028

)

-1.6

%

Other, net

 

2,333

 

2.1

%

(1,533

)

-1.6

%

2,143

 

1.1

%

(1,870

)

-1.0

%

Total other income (expense)

 

1,998

 

1.8

%

(2,024

)

-2.1

%

1,035

 

0.5

%

(2,944

)

-1.6

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) before income taxes

 

3,257

 

3.0

%

2,858

 

2.9

%

1,782

 

0.9

%

2,149

 

1.1

%

Income tax expense

 

2,429

 

2.2

%

5,581

 

5.7

%

4,414

 

2.2

%

5,286

 

2.8

%

Net income (loss)

 

$

828

 

0.8

%

$

(2,723

)

-2.8

%

$

(2,632

)

-1.3

%

$

(3,137

)

-1.7

%

 

Three Month Period Ended June 30, 2008 Compared to Three Month Period Ended June 30, 2007

 

Revenues

 

Total revenues for the three months ended June 30, 2008 increased $11.1 million, or 11.3%, compared to the same period of 2007 as a result of a $12.2 million, or 47.2%, increase in services revenues and a $1.6 million, or 5.1%, increase in maintenance fee revenues offset by a $2.7 million, or 6.6%, decline in software license fee revenues.

 

During the three months ended June 30, 2008, we recognized $13.5 million of revenues associated with certain Faster Payments implementations in the United Kingdom.  Of this amount, approximately $4.5 million is reflected in initial license fee revenue and approximately $9.0 million is reported as services revenue.

 

License Fee Revenues

 

Customers purchase the right to license ACI software for the term of their agreement, generally 60 months.  Within these agreements are specified capacity limits typically measured based on transaction volumes.  ACI employs measurement tools that monitor the number of transactions processed by customers and if contractually specified limits are exceeded, additional fees are

 

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charged for the overage.  Capacity overages may occur at varying times throughout the term of the agreement depending on the product, the size of the customer, and the significance of customer transaction volume growth.  Depending on specific circumstances, multiple overages or no overages may occur during the term of the agreement.

 

Initial License Fee (ILF) Revenue

 

ILF revenue includes license and capacity revenues that do not recur on a monthly or quarterly basis.  Included in ILF revenues are license and capacity fees that are recognizable at the inception of the arrangement and license and capacity fees that are recognizable at interim points during the term of the arrangement, including those that are recognizable annually, due to negotiated customer payment terms.  The decrease in ILF revenues during the three months ended June 30, 2008 compared to the same period in 2007, is primarily due to revenue from significant capacity increase and term renewals events within the three months ended June 30, 2007 that did not repeat in the current period.  This decrease was partially offset by $4.5 million of ILF revenues associated with Faster Payments implementations in the United Kingdom that were recognized during the three months ended June 30, 2008.

 

Monthly License Fee (MLF) Revenue

 

MLF revenues are license and capacity revenues that are paid up-front but recognized as revenue ratably over an extended period and license and capacity revenues that are paid in monthly or quarterly increments due to negotiated customer payment terms.  The increase in MLF revenues during the three months ended June 30, 2008, as compared to the same period of 2007, is primarily due to an increase in the amount of paid up-front revenue that is recognized ratably and capacity overages during the current period payable monthly or quarterly by customers in the Americas reportable operating segment.

 

Maintenance Fee Revenue

 

Maintenance fee revenue includes standard and enhanced maintenance or any post contract support fees received from customers for the provision of product support services.  The increase in maintenance fee revenues during the three months ended June 30, 2008, compared to the same period of 2007 is primarily a result of an increase in the number of customers that achieved live status, primarily in the EMEA and Asia-Pacific operating segments, subsequent to June 30, 2007.

 

Services Revenue

 

Services revenues include fees earned through implementation services, professional services and processing services.  Implementation services include product installations, product upgrades, customer specific modifications (“CSMs”) and product education.  Professional services include business consultancy, technical consultancy, on site support services, CSMs, product education, and testing services.  Processing services include hosting, on-demand, and facilities management services.

 

Services revenue increased $12.2 million, or 47.2%, primarily as a result of $9.0 million of revenues associated with Faster Payments implementations in the EMEA reportable operating segment and a large multi-product implementation in the Americas operating segment.

 

Expenses

 

Total operating expenses for the three months ended June 30, 2008 increased $14.7 million, or 15.8%, compared to the same period of 2007 as a result of a $9.3 million, or 34.5%, increase in cost of maintenance and services, a $5.8 million, or 34.6% increase in cost of selling and marketing, a $2.0 million, or 20.5%, increase in cost of software license fees, offset by a $1.7 million, or 6.4%, decrease in general and administrative costs and a $0.7 million, or 5.4%, decrease in research and development costs.

 

Cost of Software License Fees

 

Cost of software license fees represents the costs associated with maintaining software products that have already been developed.  Software license fee costs include human resource costs and other incidental costs for maintaining software products as well as the amortization of previously capitalized internally developed and acquired software costs.  Examples of this include product management, documentation, publications and education.

 

The cost of software license fees for the three months ended June 30, 2008, increased compared to the same period of 2007 as a result of higher personnel and related costs of $2.6 million reallocated from certain business functions (primarily research and development, services, and sales and marketing) to invest in the Global Product Management function and to support the fulfillment of the technical enablement milestones under the Alliance and other development work.  Additionally, cost of software license fees expense increased $0.4 million resulting from an increase in depreciation and amortization.  These increases were partially offset by $0.9 million of reimbursement from IBM for certain expenditures determined to be direct and incremental to satisfying the technical enablement milestones under the Alliance and are recorded as a reduction of cost of software license fees.

 

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Cost of Maintenance and Services

 

Cost of maintenance and services includes costs to provide hosting services and both the costs of maintaining our software products at customer sites as well as the service costs required to deliver, install and support software at customer sites.  Maintenance costs include the efforts associated with providing the customer with upgrades, 24-hour helpdesk, post go-live (remote) support and production-type support for software that was previously installed at a customer location.  Service costs include human resource costs and other incidental costs such as travel and training required for both pre go-live and post go-live support.  Such efforts include project management, delivery, product customization and implementation, installation support, consulting, configuration, and on-site support.

 

Cost of maintenance and services for the three months ended June 30, 2008 increased compared to the same period of 2007, as a result of higher personnel and related costs of $7.7 million primarily to support the implementation services for the increase in large complex multi-product installations.  Costs of maintenance and services also increased as a result of the recognition of $2.4 million of previously deferred expenses associated with the completion of certain Faster Payments implementations in the EMEA reportable operating segment and a large multi-product implementation in the Americas operating segment offset by a $1.3 million additional deferral of implementation costs for various products currently being installed. Additionally, cost of maintenance and services increased $0.3 million for the three months June 30, 2008 as a result of an increase in distributor commission expense compared to the same period on 2007.

 

Research and Development

 

Research and development (“R&D”) expenses are primarily human resource costs related to the creation of new products as well as improvements made to existing products.  Continued R&D effort on existing products addresses issues, if any, related to regulatory requirements and processing mandates as well as compatibility with new operating system releases and generations of hardware.

 

R&D expense for the three months ended June 30, 2008 decreased as compared to the same period of 2007, as a result of $0.8 million of reimbursement from IBM for certain expenditures determined to be direct and incremental to satisfying the technical enablement milestones under the Alliance and are recorded as a reduction of R&D expense.

 

Selling and Marketing

 

Selling and marketing includes both the costs related to selling our products to current and prospective customers as well as the costs related to promoting the Company, its products and the research efforts required to measure customers’ future needs and satisfaction levels.  Selling costs are primarily the human resource and travel costs related to the effort expended to license our products and services to current and potential clients within defined territories and/or industries as well as the management of the overall relationship with customer accounts.  Selling costs also include the costs associated with assisting distributors in their efforts to sell our products and services in their respective local markets.  Marketing costs include costs needed to promote the Company and its products as well as perform or acquire market research to help us better understand what products our customers are looking for in the future.  Marketing costs also include the costs associated with measuring customers’ opinions toward the Company, our products and personnel.

 

Selling and marketing expense for the three months ended June 30, 2008, increased $5.8 million compared to the same period of 2007 as a result of $3.3 million in personnel and related costs and $0.4 million in advertising and promotional expenses to support the 2008 sales plan and Alliance joint sales and marketing initiatives. Additionally, commissions expense increased $1.5 million in the three months ended June 30, 2008, compared to the same period in 2007 as a result of higher sales and a change in the mix of sales to more high value sales of new customer accounts and new applications.

 

General and Administrative

 

General and administrative expenses are primarily human resource costs including executive salaries and benefits, personnel administration costs, and the costs of staff support functions such as legal, administrative, human resources and finance and accounting.

 

General and administrative expense for the three months ended June 30, 2008 decreased $1.7 million compared to the same period of 2007.  Included in the three months ended June 30, 2007, with no corresponding amount during the same period in 2008, were $4.7 million of expenses related to the historical stock option review and $1.2 million of severance related expenses.  Included in the three months ended June 30, 2008, with no corresponding amounts during the same period in 2007, were $2.9 million of expenses for Transition Services incurred and $0.9 million of severance incurred related to the IBM Outsourcing

 

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Agreement.  The remaining increase is primarily the result of an increase in bad debt expense of $0.6 million in the three months ended June 30, 2008 compared to the same period in 2007.

 

Other Income and Expense

 

Other income and expense includes interest income and expense, foreign currency gains and losses, and other non-operating items.  Fluctuating currency rates impacted the three months ended June 30, 2008 by $0.7 million in net foreign currency losses, compared to $1.5 million in net losses during the same period in 2007.  A $2.9 million gain on change in fair value of interest rate swaps was incurred during the three months ended June 30, 2008 with no corresponding amount in the same period of 2007.  Interest income for the three months ended June 30, 2008 decreased $0.2 million or 25.2% as compared to the corresponding period of 2007 as a result of lower interest rates.  Interest expense decreased $0.4 million or 27.5% for the three months ended June 30, 2008 compared to the corresponding period of 2007 as a result of lower interest rates.

 

Income Taxes

 

The effective tax rate for the three months ended June 30, 2008 and 2007 is 74.6% and 195.3%, respectively.  The effective tax rate in both periods are higher than the U.S. effective rate of 35% due to the low level of income before taxes and the impact of the Company’s inability to recognize income tax benefits during the period as a result of losses sustained in certain tax jurisdictions where the future utilization of the losses are uncertain.  This was offset by income in tax jurisdictions in which we accrues tax expense and by the recognition of tax expense associated with the transfer of certain intellectual property rights from U.S. to non-U.S. entities.

 

Six Month Period Ended June 30, 2008 Compared to Six Month Period Ended June 30, 2007

 

Revenues

 

Total revenues for the six months ended June 30, 2008, increased $13.8 million, or 7.3%, compared to the same period of 2007 as a result of a $12.7 million, or 26.8%, increase in services revenues and a $3.2 million, or 5.2%, increase in maintenance fee revenues offset by a $2.1 million, or 2.7%, decrease in software license fee revenues.

 

During the six months ended June 30, 2008, the Company recognized $13.5 million of revenues associated with certain Faster Payments implementations in the United Kingdom.  Of this amount, approximately $4.5 million is reflected in ILF revenues and approximately $9.0 million is reported as services revenue.

 

Initial License Fee (ILF) Revenue

 

The decrease in ILF revenues during the six months ended June 30, 2008, compared to the same period in 2007 is primarily due to revenue from significant capacity increase and term renewal events for the six months ended June 30, 2007 that did not repeat in the current period.  This was offset by $4.5 million of ILF revenues associated with Faster Payments implementations in the United Kingdom that were recognized during the six months ended June 30, 2008.

 

Monthly License Fee (MLF) Rev