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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2003
Commission File Number 0-25346
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TRANSACTION SYSTEMS ARCHITECTS, INC.
(Exact name of registrant as specified in its charter)
Delaware 47-0772104
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
224 South 108th Avenue (402) 334-5101
Omaha, Nebraska 68154 (Registrant's telephone number,
(Address of principal executive offices, including area code)
including zip code)
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes x No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes x No
--- ---
As of January 30, 2004, there were 38,195,054 shares of the registrant's Class A
Common Stock, par value $.005 per share, outstanding (excluding 1,476,145 shares
held as Treasury Stock, and including 5,248 options to purchase shares of the
registrant's Class A Common Stock at an exercise price of one cent per share).
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TABLE OF CONTENTS
Page
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements....................................................................... 1
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...... 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk................................. 23
Item 4. Controls and Procedures.................................................................... 23
PART II - OTHER INFORMATION
Items 1, 2, 3, 4 and 5. Not Applicable.
Item 6. Exhibits and Reports on Form 8-K........................................................... 24
Signature............................................................................................ 25
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PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Page
----
Condensed Consolidated Balance Sheets as of December 31, 2003 and September 30, 2003................... 2
Condensed Consolidated Statements of Operations for the three months ended December 31, 2003 and 2002.. 3
Condensed Consolidated Statements of Cash Flows for the three months ended December 31, 2003 and 2002.. 4
Notes to Condensed Consolidated Financial Statements................................................... 5
1
TRANSACTION SYSTEMS ARCHITECTS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
December 31, September 30,
2003 2003
------------ -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents.................................................. $ 125,684 $ 113,986
Marketable securities...................................................... 1,155 1,296
Billed receivables, net of allowances of $5,211 and 4,037, respectively.... 42,812 42,225
Accrued receivables........................................................ 15,284 9,592
Recoverable income taxes................................................... 9,631 11,985
Deferred income taxes, net................................................. 8,716 10,316
Other...................................................................... 4,048 5,104
---------- ----------
Total current assets..................................................... 207,330 194,504
Property and equipment, net.................................................. 8,883 9,405
Software, net................................................................ 1,923 2,319
Goodwill, net................................................................ 46,603 46,425
Deferred income taxes, net................................................... 9,846 9,638
Other........................................................................ 1,457 1,609
---------- ----------
Total assets............................................................. $ 276,042 $ 263,900
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of debt - financing agreements............................. $ 14,034 $ 15,493
Accounts payable........................................................... 4,932 6,965
Accrued employee compensation.............................................. 9,461 9,822
Accrued liabilities........................................................ 11,829 9,714
Deferred revenue........................................................... 75,616 70,798
Other...................................................................... 438 628
---------- ----------
Total current liabilities................................................ 116,310 113,420
Debt - financing agreements.................................................. 5,671 9,444
Deferred revenue............................................................. 16,126 17,689
Other........................................................................ 646 473
---------- ----------
Total liabilities........................................................ 138,753 141,026
Contingencies (Note 8)
Stockholders' equity:
Class A Common Stock, $.005 par value; 50,000,000 shares authorized;
38,159,554 and 37,660,731 shares issued at December 31, 2003 and
September 30, 2003, respectively........................................... 191 188
Treasury stock, at cost, 1,476,145 shares.................................... (35,258) (35,258)
Additional paid-in capital................................................... 242,086 235,767
Accumulated deficit.......................................................... (59,561) (69,602)
Accumulated other comprehensive loss, net.................................... (10,169) (8,221)
---------- ----------
Total stockholders' equity............................................... 137,289 122,874
---------- ----------
Total liabilities and stockholders' equity............................... $ 276,042 $ 263,900
========== ==========
The accompanying notes are an integral part of the
condensed consolidated financial statements.
2
TRANSACTION SYSTEMS ARCHITECTS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited and in thousands, except per share amounts)
Three Months Ended
December 31,
--------------------------
2003 2002
---------- ----------
Revenues:
Software license fees...................................................... $ 41,233 $ 31,330
Maintenance fees........................................................... 21,313 18,604
Services................................................................... 11,471 12,555
---------- ----------
Total revenues........................................................... 74,017 62,489
Expenses:
Cost of software license fees.............................................. 6,639 5,939
Cost of maintenance and services........................................... 14,979 14,808
Research and development................................................... 9,433 7,950
Selling and marketing...................................................... 13,790 13,736
General and administrative................................................. 13,668 12,583
---------- ----------
Total expenses........................................................... 58,509 55,016
---------- ----------
Operating income............................................................. 15,508 7,473
---------- ----------
Other income (expense):
Interest income............................................................ 523 310
Interest expense........................................................... (531) (956)
Other, net................................................................. 2,205 (1,139)
---------- ----------
Total other income (expense)............................................. 2,197 (1,785)
---------- ----------
Income before income taxes................................................... 17,705 5,688
Income tax provision......................................................... (7,664) (2,693)
---------- ----------
Net income................................................................... $ 10,041 $ 2,995
========== ==========
Earnings per share information:
Weighted average shares outstanding:
Basic.................................................................... 36,382 35,437
========== ==========
Diluted.................................................................. 37,641 35,550
========== ==========
Earnings per share:
Basic.................................................................... $ 0.28 $ 0.08
========== ==========
Diluted.................................................................. $ 0.27 $ 0.08
========== ==========
The accompanying notes are an integral part of the
condensed consolidated financial statements.
3
TRANSACTION SYSTEMS ARCHITECTS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited and in thousands)
Three Months Ended
December 31,
--------------------------
2003 2002
---------- ----------
Cash flows from operating activities:
Net income................................................................. $ 10,041 $ 2,995
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation............................................................. 1,087 1,312
Amortization............................................................. 712 1,265
Deferred income taxes.................................................... 3,203 715
Changes in operating assets and liabilities:
Billed and accrued receivables, net.................................... (4,627) (12,497)
Other current and noncurrent assets.................................... (1,512) (1,311)
Accounts payable....................................................... (2,306) (134)
Current income taxes................................................... 2,354 (2,712)
Deferred revenue....................................................... 1,202 15,390
Other current and noncurrent liabilities............................... 945 (425)
---------- ----------
Net cash provided by operating activities............................ 11,099 4,598
---------- ----------
Cash flows from investing activities:
Purchases of property and equipment, net................................... (439) (591)
Purchases of software and distribution rights.............................. (98) (32)
Proceeds from sales of marketable securities............................... 220 174
---------- ----------
Net cash used in investing activities................................ (317) (449)
---------- ----------
Cash flows from financing activities:
Proceeds from issuance of Class A Common Stock............................. 232 273
Proceeds from sale and exercise of stock options........................... 4,481 6
Payments on debt - financing agreements.................................... (5,232) (4,637)
Other...................................................................... (197) (248)
---------- ----------
Net cash used in financing activities................................ (716) (4,606)
---------- ----------
Effect of exchange rate fluctuations on cash................................. 1,632 685
---------- ----------
Net increase in cash and cash equivalents.................................... 11,698 228
Cash and cash equivalents, beginning of period............................... 113,986 87,894
---------- ----------
Cash and cash equivalents, end of period..................................... $ 125,684 $ 88,122
========== ==========
The accompanying notes are an integral part of the
condensed consolidated financial statements.
4
TRANSACTION SYSTEMS ARCHITECTS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Nature of Business
Transaction Systems Architects, Inc., a Delaware corporation, and its
subsidiaries (collectively referred to as "TSA" or the "Company"), develop,
market, install and support a broad line of software products and services
primarily focused on facilitating electronic payments and electronic commerce.
In addition to its own products, the Company distributes, or acts as a sales
agent for, software developed by third parties. These products and services are
used principally by financial institutions, retailers and electronic-payment
processors, both in domestic and international markets.
Condensed Consolidated Financial Statements
The condensed consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany balances
and transactions have been eliminated. The condensed consolidated financial
statements at December 31, 2003, and for the three months ended December 31,
2003 and 2002, are unaudited and reflect all adjustments (consisting only of
normal recurring adjustments) which are, in the opinion of management, necessary
for a fair presentation of the financial position and operating results for the
interim periods.
The condensed 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, 2003. The results of
operations for the three months ended December 31, 2003 are not necessarily
indicative of the results that may be achieved for the entire fiscal year ending
September 30, 2004.
Use of Estimates in Preparation of Condensed Consolidated Financial Statements
The preparation of the condensed 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 condensed consolidated financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Revenue Recognition, Accrued Receivables and Deferred Revenue
Software License Fees. The Company recognizes software license fee revenue
in accordance with American Institute of Certified Public Accountants ("AICPA")
Statement of Position ("SOP") 97-2, "Software Revenue Recognition," SOP 98-9,
"Modification of SOP 97-2, Software Revenue Recognition With Respect to Certain
Transactions," and Securities and Exchange Commission ("SEC") Staff Accounting
Bulletin ("SAB") 101, "Revenue Recognition in Financial Statements." For
software license arrangements for which services rendered are not considered
essential to the functionality of the software, the Company recognizes revenue
upon delivery, provided (1) there is persuasive evidence of an arrangement, (2)
collection of the fee is considered probable, and (3) the fee is fixed or
determinable. In most arrangements, vendor-specific objective evidence ("VSOE")
of fair value does not exist for the license element; therefore, the Company
uses the residual method under SOP 98-9 to determine the amount of revenue to be
allocated to the license element. Under SOP 98-9, the fair value of all
undelivered elements, such as postcontract customer support (maintenance or
"PCS") or other products or services, is deferred and subsequently recognized as
the products are delivered or the services are performed, with the residual
difference between the total arrangement fee and revenues allocated to
undelivered elements being allocated to the delivered element.
When a software license arrangement includes services to provide
significant production, modification, or customization of software, those
services are not separable from the software and are accounted for in accordance
with Accounting Research Bulletin ("ARB") No. 45, "Long-Term Construction-Type
Contracts," and the relevant guidance provided by SOP 81-1, "Accounting for
Performance of Construction-Type and Certain Production-Type Contracts."
Accounting for services delivered over time (generally in excess of twelve
months)
5
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 under
the contract, which are used in current percentage-complete computations,
exclude amounts due under extended payment terms. In certain cases, the Company
provides its customers with extended terms where payment is deferred beyond when
the services are rendered. Because the Company is unable to demonstrate a
history of enforcing payment terms under such arrangements without granting
concessions, the Company excludes revenues due on extended payment terms from
its current percentage-of-completion computation because it cannot be presumed
that those fees are fixed or determinable.
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 to 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 to revenue recognition have been met. In making the determination of
collectibility, the Company considers the creditworthiness of the customer,
economic conditions in the customer's industry and geographic location, and
general economic conditions.
SOP 97-2 requires the seller of software that includes PCS to establish
VSOE of fair value of the undelivered element of the contract in order to
account separately for the PCS revenue. For certain of the Company's products,
VSOE of the fair value of PCS is determined by a consistent pricing of PCS and
PCS renewals as a percentage of the software license fees. In other products,
the Company determines VSOE by reference to contractual renewals, when the
renewal terms are substantive. In those cases where VSOE of the fair value of
PCS is determined by reference to contractual renewals, the Company considers
factors such as whether the period of the initial PCS term is relatively long
when compared to the term of the software license or whether the PCS renewal
rate is significantly below the Company's normal pricing practices.
Certain of the Company's software arrangements (primarily those in the
Asia/Pacific region) include payment terms that are enforceable only upon the
passage of time or customer acceptance. For software license arrangements in
which the Company's ability to enforce payment terms depends on customer
acceptance provisions, software license fee revenue is recognized upon the
earlier of the point at which (1) the customer accepts the software products or
(2) the acceptance provisions lapse.
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 vary their software mix, including the right to receive unspecified future
software products during the software license term, the Company recognizes
revenue ratably over the license term, provided all other revenue recognition
criteria have been met. For software license arrangements in which the customer
is charged variable software license fees based on usage of the product, the
Company recognizes revenue as usage occurs over the term of the licenses,
provided all other revenue recognition criteria have been met.
Maintenance Fees. Revenues for PCS are recognized ratably over the
maintenance term specified in the contract. In arrangements where VSOE of fair
value of PCS cannot be determined (for example, a time-based software license
with a duration of one year or less), the Company recognizes revenue for the
entire arrangement ratably over the PCS term.
6
Services. Revenues from arrangements to provide professional services on a
time and materials basis are recognized as the related services are performed.
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 to revenue recognition have not been met.
Stock-Based Compensation Plans
The Company accounts for its stock-based compensation plans under the
intrinsic value method in accordance with APB Opinion No. 25, "Accounting for
Stock Issued to Employees," and follows the disclosure provisions of SFAS No.
123, "Accounting for Stock-Based Compensation," as amended by SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure." The
Company calculates stock-based compensation pursuant to the disclosure
provisions of SFAS No. 123 using the straight-line method over the vesting
period of the option. Had compensation cost for the Company's stock-based
compensation plans been determined based on the fair value at the grant date of
the stock options awarded under those plans, consistent with the fair value
method of SFAS No. 123, the Company's net income and earnings per share for the
three months ended December 31, 2003 and 2002 would have approximated the
following pro forma amounts (in thousands, except per share amounts):
Three Months Ended
December 31,
--------------------
2003 2002
-------- --------
Net income:
As reported............................................. $ 10,041 $ 2,995
Deduct: stock-based employee compensation expense
determined under fair value based method for all
awards, net of related tax effects.................... (618) (1,539)
Add: stock-based employee compensation expense
recorded under intrinsic value based method,
net of related tax effects............................ 19 -
-------- --------
Pro forma............................................... $ 9,442 $ 1,456
======== ========
Earnings per share:
Basic, as reported...................................... $ 0.28 $ 0.08
======== ========
Basic, pro forma........................................ $ 0.26 $ 0.04
======== ========
Diluted, as reported.................................... $ 0.27 $ 0.08
======== ========
Diluted, pro forma...................................... $ 0.25 $ 0.04
======== ========
The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option-pricing model, a pricing model acceptable under
SFAS No. 123, with the following weighted-average assumptions:
Three Months Ended
December 31,
--------------------
2003 2002
-------- --------
Expected life............................................. 4.2 6.0
Interest rate............................................. 2.8% 3.2%
Volatility................................................ 85% 45%
Dividend yield............................................ -- --
7
The effects of applying SFAS No. 123 in this pro forma disclosure are not
indicative of future amounts. Additional future awards are anticipated.
Recent Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. ("FIN") 46, "Consolidation of Variable Interest
Entities, an Interpretation of Accounting Research Bulletin No. 51." In December
2003, the FASB issued a revised version of FIN 46, which incorporated a number
of changes to the prior version. In FIN 46, the FASB concluded that the voting
interest approach is not always effective in identifying controlling financial
interest. FIN 46 provides guidance for determining whether an entity lacks
sufficient equity or its equity holders lack adequate decision-making ability.
These entities, variable interest entities ("VIEs"), are evaluated for
consolidation. Variable interests are ownership, contractual or other interests
in a VIE that change with changes in the VIE's net assets. The party with the
majority of the variability in gains or losses of the VIE is the VIE's primary
beneficiary, and is required to consolidate the VIE. The adoption of FIN 46, as
revised, did not impact the Company's financial position or results of
operations.
In December 2003, SAB 104, "Revenue Recognition," was issued which
supercedes SAB 101, "Revenue Recognition in Financial Statements." The primary
purpose of SAB 104 is to rescind accounting guidance contained in SAB 101
related to multiple element revenue arrangements, superceded as a result of
the issuance of the FASB's Emerging Issues Task Force ("EITF") Issue No.
00-21, "Accounting for Revenue Arrangements with Multiple Deliverables."
Additionally, SAB 104 rescinds the SEC's "Revenue Recognition in Financial
Statements Frequently Asked Questions and Answers" (the "FAQ") issued with SAB
101 that had been codified in SEC Topic 13, "Revenue Recognition." Selected
portions of the FAQ have been incorporated into SAB 104. While the wording of
SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue
recognition principles of SAB 101 remain largely unchanged by the issuance of
SAB 104. The adoption of SAB 104 had no impact on the Company's financial
position or results of operations.
2. Goodwill and Software
Changes to the carrying amount of goodwill during the three months ended
December 31, 2003 resulted only from foreign currency translation adjustments.
The gross carrying amount and accumulated amortization of the Company's
intangible assets that are subject to amortization at each balance sheet date,
consisting only of software, are as follows (in thousands):
Dec. 31, Sept. 30,
2003 2003
-------- ---------
Internally-developed software...................... $ 15,906 $ 15,725
Purchased software................................. 44,671 44,186
-------- --------
60,577 59,911
Less: accumulated amortization..................... (58,654) (57,592)
-------- --------
Software, net...................................... $ 1,923 $ 2,319
======== ========
Amortization of software is computed using the greater of the ratio of
current revenues to total estimated revenues expected to be derived from the
software or the straight-line method over an estimated useful life of three
years. Software amortization expense recorded in the three months ended December
31, 2003 was $0.5 million. Based on capitalized software at December 31, 2003,
and assuming no impairment of these software assets, estimated amortization
expense for the remainder of fiscal 2004 and in succeeding fiscal years is as
follows (in thousands):
2004............................................................ $1,310
2005............................................................ 408
2006............................................................ 150
2007............................................................ 37
Thereafter...................................................... 18
8
3. Corporate Restructuring Charges and Asset Impairment Losses
During fiscal 2001, the Company closed, or significantly reduced the size
of, certain product development organizations and geographic sales offices,
resulting in restructuring charges and asset impairment losses. The following
table shows activity related to these exit activities since September 30, 2003
(in thousands):
Lease
Obligations
-----------
Balance, September 30, 2003.................................. $ 681
Amounts paid year-to-date during fiscal 2004................. (53)
-------
Balance, December 31, 2003................................... $ 628
=======
The liability for lease obligations relates to the abandonment or reduction
of office facilities with lease terms ending on various dates through March
2005, net of expected third-party purchases or sub-leases, and an estimated
lease termination loss for the corporate aircraft. The Company continues to seek
subleases for certain of the properties as well as an exit to the corporate
aircraft lease. The final settlement of these obligations may result in
adjustments to these liabilities.
During fiscal 2003, the Company reduced the size of certain product
development organizations, resulting in severance-related restructuring charges.
The following table shows activity related to these exit activities since
September 30, 2003 (in thousands):
Termination
Benefits
-----------
Balance, September 30, 2003.................................. $ 1,771
Amounts paid year-to-date during fiscal 2004................. (329)
Adjustments to previously-recognized liabilities............. (137)
-------
Balance, December 31, 2003................................... $ 1,305
=======
The liability remaining at December 31, 2003 is expected to be settled
during the remainder of fiscal 2004.
4. Common Stock and Earnings Per Share
Options to purchase shares of Class A Common Stock ("Common Stock") at an
exercise price of one cent per share, received by shareholders of
MessagingDirect Ltd. ("MDL") as part of its acquisition by the Company during
fiscal 2001, that have not yet been converted into Common Stock are included in
Class A Common Stock for presentation purposes on the December 31, 2003 and
September 30, 2003 consolidated balance sheets, and are included in common
shares outstanding for earnings per share ("EPS") computations for the three
months ended December 31, 2003 and 2002. Included in Common Stock are 5,248 and
6,248 MDL options, respectively, as of December 31, 2003 and September 30, 2003.
EPS has been computed in accordance with SFAS No. 128, "Earnings Per
Share." Basic EPS is calculated by dividing net income available to common
stockholders (the numerator) by the weighted average number of common shares
outstanding during the period (the denominator). Diluted EPS is computed by
dividing net income available to common stockholders by the weighted average
number of common shares outstanding during the period, adjusted for the dilutive
effect of any outstanding dilutive securities (the denominator). The difference
between the basic and diluted EPS denominators for the three months ended
December 31, 2003 and 2002, which amounted to approximately 1,259,000 and
113,000 shares, respectively, were due to the dilutive effect of the Company's
outstanding stock options using the treasury stock method. Weighted average
shares from stock options of 806,000 and 5,213,000 were excluded from the
computations of diluted EPS for the three months ended December 31, 2003 and
2002, respectively, because the exercise prices of the stock options were
greater than the average market price of the Company's common shares.
9
5. Comprehensive Income/Loss
The Company's components of other comprehensive income/loss were as follows
(in thousands):
Three Months Ended
December 31,
--------------------
2003 2002
-------- --------
Net income............................................ $ 10,041 $ 2,995
Other comprehensive income (loss):
Foreign currency translation adjustments............ (2,037) (455)
Change in unrealized investment holding loss:
Unrealized holding gain (loss) arising
during the period............................... 79 (433)
Reclassification adjustment for loss included
in net income .................................. 10 37
-------- --------
Comprehensive income.................................. $ 8,093 $ 2,144
======== ========
The Company's components of accumulated other comprehensive income/loss at
each balance sheet date were as follows (in thousands):
Foreign Unrealized Accumulated
Currency Investment Other
Translation Holding Comprehensive
Adjustments Loss Income (Loss)
----------- ----------- -------------
Balance, September 30, 2003........................... $ (8,020) $ (201) $ (8,221)
Fiscal 2004 year-to-date activity..................... (2,037) 89 (1,948)
----------- ----------- -----------
Balance, December 31, 2003............................ $ (10,057) $ (112) $ (10,169)
=========== =========== ===========
6. Segment Information
The Company has three operating segments, referred to as business units.
These three business units are ACI Worldwide, Insession Technologies and
IntraNet. ACI Worldwide products represent the Company's largest product line
and include its most mature and well-established applications, which are used
primarily by financial institutions, retailers and e-payment processors. Its
products are used to route and process transactions for automated teller machine
networks; process transactions from point-of-sale devices, wireless devices and
the Internet; control fraud and money laundering; authorize checks; establish
frequent shopper programs; automate transaction settlement, card management and
claims processing; and issue and manage multi-functional applications on smart
cards. Insession Technologies products facilitate communication, data movement,
monitoring of systems, and business process automation across computing systems
involving mainframes, distributed computing networks and the Internet. IntraNet
products offer high value payments processing, bulk payments processing, global
messaging and continuous link settlement processing.
The Company's chief operating decision maker, together with other senior
management personnel, reviews financial information presented on a consolidated
basis, accompanied by disaggregated information about revenues and operating
income by business unit. The Company does not track assets by business unit.
Most of the Company's products are sold and supported through distribution
networks covering the geographic regions of the Americas,
Europe/Middle East/Africa and Asia/Pacific. No single customer accounted for
more than 10% of the Company's consolidated revenues during the three months
ended December 31, 2003 or 2002.
10
The following are revenues and operating income for these business units
for the periods indicated (in thousands):
Three Months Ended
December 31,
--------------------
2003 2002
-------- --------
Revenues:
ACI Worldwide................................ $ 57,716 $ 45,606
Insession Technologies....................... 8,450 7,000
IntraNet..................................... 7,851 9,883
-------- --------
$ 74,017 $ 62,489
======== ========
Operating income:
ACI Worldwide................................ $ 12,100 $ 4,910
Insession Technologies....................... 1,813 849
IntraNet..................................... 1,595 1,714
-------- --------
$ 15,508 $ 7,473
======== ========
7. Income Taxes
The effective tax rate for the three months ended December 31, 2003 was
approximately 43.3% as compared to 47.3% for the same period of fiscal 2002. The
effective tax rate for the first quarter of fiscal 2004 was primarily impacted
by non-recognition of tax benefits for operating losses in certain foreign
locations. The Company has not recognized the tax benefit of these operating
losses because it is likely that all or a portion of the operating losses will
not be realized. The effective tax rate for the first quarter of fiscal 2003 was
primarily impacted by non-recognition of tax benefits for operating losses in
certain foreign locations and recognition of a valuation allowance for foreign
tax credits. The improvement in the effective tax rate for the first three
months of fiscal 2004, as compared to the same period of fiscal 2003, resulted
primarily from recognition of research and development credits, extraterritorial
income exclusion benefits and expected utilization of foreign tax credits.
8. Contingencies
Legal Proceedings
From time to time, the Company is involved in litigation relating to claims
arising out of its operations. Other than as described below, the Company is not
currently a party to any legal proceedings, the adverse outcome of which,
individually or in the aggregate, would 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 individual named defendants. The suits were
filed in connection with the Company's restatement of its prior consolidated
financial statements. The two complaints are Desert Orchid Partners v. the
Company, et al. and Nancy Rosen v. the Company, et al. Pursuant to a Court
order, the two suits were consolidated and, also in accordance with the Court
order, the Court-designated lead plaintiff, Genesee County Employees' Retirement
System, filed a First Amended Consolidated Class Action Complaint on June 30,
2003 (the "Consolidated Complaint"). The lead plaintiff alleges violations of
Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5
thereunder, on the grounds that certain of the Company's Exchange Act reports
and press releases contained untrue statements of material facts, or omitted to
state facts necessary to make the statements therein not misleading, with regard
to the Company's revenues and expenses during the purported class period. The
Consolidated Complaint alleges that during the purported class period, the
Company and the named defendants misrepresented the Company's historical
financial condition, results of operations and its future prospects, and failed
to disclose facts that could have indicated an impending decline in the
Company's revenues. The lead plaintiff is seeking unspecified damages, interest,
fees, costs and rescission. The class period stated in the Consolidated
Complaint is January 21, 1999 through November 18, 2002. The Company and the
11
individual defendants filed a motion to dismiss the Consolidated Complaint,
which the lead plaintiff opposed. On November 20, 2003, the Court heard oral
arguments on the defendants' motion to dismiss. On December 15, 2003,
the Court issued its order granting in part, and denying in part, the motion to
dismiss. In particular, the Court dismissed, without prejudice, Gregory
Derkacht as a defendant. The Court denied the motion to dismiss with respect
to the remaining defendants, including the Company. The Company and the other
defendants filed an answer to the Consolidated Complaint on January 21, 2004.
On February 6, 2004, the Court entered a Mediation Reference Order requiring
the parties to mediate before a private mediator, and the parties have agreed
to commence mediation on March 18, 2004.
Derivative Litigation. On January 10, 2003, Samuel Naito filed the suit of
"Samuel Naito, Derivatively on behalf of nominal defendant Transaction Systems
Architects, Inc. v. Roger K. Alexander, Gregory D. Derkacht, Gregory J. Duman,
Larry G. Fendley, Jim D. Kever, and Charles E. Noell, III and Transaction
Systems Architects, Inc." in the State District Court in Douglas County,
Nebraska (the "Naito matter"). The suit is a shareholder derivative action that
generally alleges that the named individuals breached their fiduciary duties of
loyalty and good faith owed to the Company and its shareholders by causing the
Company to conduct its business in an unsafe, imprudent and unlawful manner,
resulting in damage to the Company. More specifically, the plaintiff alleges
that the individual defendants, and particularly the members of the Company's
audit committee, failed to implement and maintain an adequate internal
accounting control system that would have enabled the Company to discover
irregularities in its accounting procedures with regard to certain transactions
prior to August 2002, thus violating their fiduciary duties of loyalty and good
faith, generally accepted accounting principles and the Company's audit
committee charter. The plaintiff seeks to recover an unspecified amount of money
damages allegedly sustained by the Company as a result of the individual
defendants' alleged breaches of fiduciary duties, as well as the plaintiff's
costs and disbursements related to the suit.
On January 24, 2003, Michael Russiello filed the suit of "Michael
Russiello, Derivatively on behalf of nominal defendant Transaction Systems
Architects, Inc. v. Roger K. Alexander, Gregory D. Derkacht, Gregory J. Duman,
Larry G. Fendley, Jim D. Kever, and Charles E. Noell, III and Transaction
Systems Architects, Inc." in the State District Court in Douglas County,
Nebraska (the "Russiello matter"). The suit is a shareholder derivative action
involving allegations similar to those in the Naito matter. The plaintiff seeks
to recover an unspecified amount of money damages allegedly sustained by the
Company as a result of the individual defendants' alleged breaches of fiduciary
duties, as well as the plaintiff's costs and disbursements related to the suit.
The Company filed a motion to dismiss in the Naito matter on February 14,
2003, and a motion to dismiss in the Russiello matter on February 21, 2003. A
hearing was scheduled on those motions for March 14, 2003. Just prior to that
date, plaintiffs' counsel requested that the derivative lawsuits be stayed
pending a determination of an anticipated motion to dismiss to be filed in the
class action lawsuits when and if service of process is achieved. The Company,
by and through its counsel, agreed to that stay. As a result, no other
defendants have been served and no discovery has been commenced. The Company has
not determined what effect the Court's ruling in the class action litigation
will have on the Naito or Russiello matters.
Securities and Exchange Commission Investigation. In connection with the
Company's restatement of its prior consolidated financial statements, the
Company has been in contact with the SEC Enforcement Division. On December 9,
2002, certain of the Company's officers and external legal counsel held a
telephone conference with representatives of the SEC Enforcement Division. The
Company had a follow-up meeting with the SEC Enforcement Division on March 14,
2003. At this meeting, the SEC representatives asked questions about the
restatement. The SEC Enforcement Division also requested that the Company
provide additional written information regarding the restatement. The Company
supplied this information on March 21, 2003. On August 8, 2003, the Company was
informed that the SEC Enforcement Division has issued a formal order of private
investigation in connection with the Company's restatement of its prior
consolidated financial statements. The Company intends to cooperate fully with
the SEC with respect to this investigation.
12
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," "the
Company believes," "the Company anticipates," "the Company expects," "the
Company plans," "the Company will," and words and phrases of similar impact, and
include, but are not limited to, statements regarding operations, business
strategy and business environment. 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 wrong. 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 the Company's actual future results
may vary materially from the results expressed or implied in the Company's
forward-looking statements. The cautionary statements in this report expressly
qualify all of the Company's forward-looking statements. In addition, the
Company disclaims any obligation to update any of its 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
below in the section entitled "Factors That May Affect the Company's Future
Results or the Market Price of the Company's Common Stock."
Overview
The Company develops, markets, installs and supports a broad line of
software products and services primarily focused on facilitating electronic
payments and electronic commerce. In addition to its own products, the Company
distributes, or acts as a sales agent for, software developed by third parties.
These products and services are used principally by financial institutions,
retailers and electronic-payment processors, both in domestic and international
markets. Accordingly, the Company's business and operating results are
influenced by trends such as information technology spending levels and the
growth rate of the electronic payments industry. Most of the Company's products
are sold and supported through distribution networks covering three geographic
regions - the Americas, Europe/Middle East/Africa ("EMEA") and Asia/Pacific.
Each distribution network has its own sales force and supplements this with
independent reseller and/or distributor networks.
Several factors related to the Company's business may have a significant
impact on its operating results from quarterly to quarter. For example, the
accounting rules governing the timing of revenue recognition in the software
industry are complex, and it can be difficult to estimate when the Company will
recognize revenue generated by a given transaction. Factors such as the maturity
of the product sold, the creditworthiness of the customer, and delays in
delivery or acceptance of the Company's products can cause sales generated in
one period to be deferred and recognized as revenue in later periods. In
addition, while the Company's revenue contracts are generally denominated in
U.S. dollars, a substantial portion of its sales are made, and some of its
expenses are incurred, in the local currency of countries other than the U.S.
Fluctuations in currency exchange rates in a given period may result in the
Company's recognition of non-recurring gain or loss for that period. The Company
is engaged in an ongoing evaluation of its tax position and implementation of
strategies to reduce its effective tax rate. The Company's degree of success in
this regard, and the acceptance by taxing authorities of the Company's tax
positions, could cause its effective tax rate, and its results of operations, to
fluctuate from period to period.
Business Units
The Company's products and services are currently organized within three
operating segments, referred to as business units - ACI Worldwide, Insession
Technologies and IntraNet. 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 business unit.
13
The following are revenues and operating income for these business units
for the periods indicated (in thousands):
Three Months Ended
December 31,
--------------------
2003 2002
-------- --------
Revenues:
ACI Worldwide................................ $ 57,716 $ 45,606
Insession Technologies....................... 8,450 7,000
IntraNet..................................... 7,851 9,883
-------- --------
$ 74,017 $ 62,489
======== ========
Operating income:
ACI Worldwide................................ $ 12,100 $ 4,910
Insession Technologies....................... 1,813 849
IntraNet..................................... 1,595 1,714
-------- --------
$ 15,508 $ 7,473
======== ========
Backlog
Included in backlog are all software license fees, maintenance fees and
services specified in executed contracts to the extent that the Company believes
that recognition of the related revenue will occur within the next twelve
months. Recurring backlog includes all monthly license fees, maintenance fees
and facilities management fees. Non-recurring backlog includes other software
license fees and services.
The following table sets forth the Company's recurring and non-recurring
backlog, by business unit, as of December 31, 2003 (in thousands):
Non-
Recurring Recurring Total
--------- --------- ---------
ACI Worldwide.......................... $ 132,223 $ 50,907 $ 183,130
Insession Technologies................. 20,724 6,817 27,541
IntraNet, Inc.......................... 13,287 7,828 21,115
--------- --------- ---------
$ 166,234 $ 65,552 $ 231,786
========= ========= =========
Customers may request that their contracts be renegotiated or terminated
due to a number of factors, including mergers, changes in their financial
condition, or general changes in economic conditions in the customer's industry
or geographic location, or the Company may experience delays in the development
or delivery of products or services specified in customer contracts.
Accordingly, there can be no assurance that contracts included in recurring or
non-recurring backlog will actually generate the specified revenues or that the
actual revenues will be generated within a twelve-month period.
Critical Accounting Policies and Estimates
This disclosure is based upon the Company's consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial
statements requires that the Company make estimates and assumptions that affect
the reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. The Company bases its estimates
on historical experience and other assumptions that are believed to be proper
and reasonable under the circumstances. The Company continually evaluates the
appropriateness of its estimates and assumptions, including those related to
revenue recognition, provision for doubtful accounts, fair value of investments,
fair value of goodwill and software, useful lives of intangible and fixed
assets, income taxes, and contingencies and litigation, among others. Actual
results could differ from those estimates.
14
The Company believes that there are several accounting policies that are
critical to understanding the Company's historical and future performance, as
these policies affect the reported amounts of revenue and the more significant
areas involving management's judgments and estimates. These critical policies,
and the Company's procedures related to these policies, are described in detail
below.
Revenue Recognition, Accrued Receivables and Deferred Revenue
Software License Fees. The Company recognizes software license fee revenue
in accordance with American Institute of Certified Public Accountants ("AICPA")
Statement of Position ("SOP") 97-2, "Software Revenue Recognition," SOP 98-9,
"Modification of SOP 97-2, Software Revenue Recognition With Respect to Certain
Transactions," and Securities and Exchange Commission ("SEC") Staff Accounting
Bulletin ("SAB") 101, "Revenue Recognition in Financial Statements." For
software license arrangements for which services rendered are not considered
essential to the functionality of the software, the Company recognizes revenue
upon delivery, provided (1) there is persuasive evidence of an arrangement, (2)
collection of the fee is considered probable, and (3) the fee is fixed or
determinable. In most arrangements, vendor-specific objective evidence ("VSOE")
of fair value does not exist for the license element; therefore, the Company
uses the residual method under SOP 98-9 to determine the amount of revenue to be
allocated to the license element. Under SOP 98-9, the fair value of all
undelivered elements, such as postcontract customer support (maintenance or
"PCS") or other products or services, is deferred and subsequently recognized as
the products are delivered or the services are performed, with the residual
difference between the total arrangement fee and revenues allocated to
undelivered elements being allocated to the delivered element.
When a software license arrangement includes services to provide
significant production, modification, or customization of software, those
services are not separable from the software and are accounted for in accordance
with Accounting Research Bulletin ("ARB") No. 45, "Long-Term Construction-Type
Contracts," and the relevant guidance provided by SOP 81-1, "Accounting for
Performance of Construction-Type and Certain Production-Type Contracts."
Accounting for services delivered over time (generally in excess of twelve
months) under ARB No. 45 and SOP 81-1 is referred to as contract accounting.
Under contract accounting, the Company generally uses the
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 under
the contract, which are used in current percentage-complete computations,
exclude amounts due under extended payment terms. In certain cases, the Company
provides its customers with extended terms where payment is deferred beyond when
the services are rendered. Because the Company is unable to demonstrate a
history of enforcing payment terms under such arrangements without granting
concessions, the Company excludes revenues due on extended payment terms from
its current percentage-of-completion computation because it cannot be presumed
that those fees are fixed or determinable.
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 to 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 to revenue recognition have been met. In making the determination of
collectibility, the Company considers the creditworthiness of the customer,
economic conditions in the customer's industry and geographic location, and
general economic conditions.
SOP 97-2 requires the seller of software that includes PCS to establish
VSOE of fair value of the undelivered element of the contract in order to
account separately for the PCS revenue. For certain of the Company's products,
VSOE of the fair value of PCS is determined by a consistent pricing of PCS and
PCS renewals as a percentage of the software license fees. In other products,
the Company determines VSOE by reference to contractual renewals, when the
renewal terms are substantive. In those cases where VSOE of the fair value of
PCS is determined by reference to contractual renewals, the Company considers
factors such as whether the period of the initial PCS term is relatively long
when compared to the term of the software license or whether the PCS renewal
rate is significantly below the Company's normal pricing practices.
15
Certain of the Company's software arrangements (primarily those in the
Asia/Pacific region) include payment terms that are enforceable only upon the
passage of time or customer acceptance. For software license arrangements in
which the Company's ability to enforce payment terms depends on customer
acceptance provisions, software license fee revenue is recognized upon the
earlier of the point at which (1) the customer accepts the software products or
(2) the acceptance provisions lapse.
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 vary their software mix, including the right to receive unspecified future
software products during the software license term, the Company recognizes
revenue ratably over the license term, provided all other revenue recognition
criteria have been met. For software license arrangements in which the customer
is charged variable software license fees based on usage of the product, the
Company recognizes revenue as usage occurs over the term of the licenses,
provided all other revenue recognition criteria have been met.
Maintenance Fees. Revenues for PCS are recognized ratably over the
maintenance term specified in the contract. In arrangements where VSOE of fair
value of PCS cannot be determined (for example, a time-based software license
with a duration of one year or less), the Company recognizes revenue for the
entire arrangement ratably over the PCS term.
Services. Revenues from arrangements to provide professional services on a
time and materials basis are recognized as the related services are performed.
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 to revenue recognition have not been met.
Provision for Doubtful Accounts
The Company maintains a general allowance for doubtful accounts based on
its historical experience, along with additional customer-specific allowances.
The Company regularly monitors credit risk exposures in its accounts receivable.
In estimating the necessary level of its allowance for doubtful accounts,
management considers the aging of its accounts receivable, the creditworthiness
of the Company's customers, economic conditions within the customer's industry,
and general economic conditions, among other factors. Should any of these
factors change, the estimates made by management will also change, which in turn
impacts the level of the Company's future provision for doubtful accounts.
Specifically, if the financial condition of the Company's customers were to
deteriorate, affecting their ability to make payments, additional
customer-specific provision for doubtful accounts may be required. Also, should
deterioration occur in general economic conditions, or within a particular
industry or region in which the Company has a number of customers, an additional
provision for doubtful accounts may be recorded to reserve for potential future
losses.
Impairment of Goodwill
In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets,"
which the Company adopted effective October 1, 2001, goodwill is no longer
amortized, but is tested for impairment at the reporting unit level at least
annually utilizing a two-step methodology. The initial step requires the Company
to determine the fair value of each reporting unit and compare it to the
carrying value, including goodwill, of such reporting unit. If the fair value
exceeds
16
the carrying value, no impairment loss is to be recognized. However, if the
carrying value of the reporting unit exceeds its fair value, the goodwill of
this unit may be impaired. The amount of impairment, if any, is then measured in
the second step. For impairment testing purposes, the Company has utilized the
services of an independent consultant to perform valuations of the Company's
reporting units that contained goodwill.
Capitalized Software
Software consists of internally-developed software and purchased software.
The Company capitalizes costs related to certain internally-developed software
when the resulting products reach technological feasibility. Technological
feasibility is determined upon completion of a detailed program design or
internal specification. The internal specification establishes that the product
can be produced to meet its design specifications including functions, features
and technical performance requirements. Purchased software consists of software
to be marketed externally that was acquired primarily as the result of a
business acquisition and costs of computer software obtained for internal use
that were capitalized.
Amortization of internally-developed software costs begins when the
products are available for licensing to customers and is computed separately for
each product as the greater of (a) the ratio of current gross revenue for the
product to the total of current and anticipated gross revenue for the product or
(b) the straight-line method over three years. Due to competitive pressures, it
may be possible that the anticipated gross revenue or remaining estimated
economic life of the software products will be reduced significantly. As a
result, the carrying amount of the software product may be reduced accordingly.
Amortization of purchased software is generally computed using the straight-line
method over its estimated useful life of approximately three years.
Accounting for Income Taxes
Accounting for income taxes requires significant judgments in the
development of estimates used in income tax calculations. Such judgments
include, but are not limited to, the likelihood the Company would realize the
benefits of net operating loss carryforwards and/or foreign tax credits, the
adequacy of valuation allowances, and the rates used to measure transactions
with foreign subsidiaries. As part of the process of preparing the Company's
consolidated financial statements, the Company is required to estimate its
income taxes in each of the jurisdictions in which the Company operates. The
judgments and estimates used are subject to challenge by domestic and foreign
taxing authorities. It is possible that either domestic or foreign taxing
authorities could challenge those judgments and estimates and draw conclusions
that would cause the Company to incur tax liabilities in excess of, or realize
benefits less than, those currently recorded. Changes in the geographical mix or
estimated amount of annual pretax income could impact the Company's overall
effective tax rate.
To the extent recovery of deferred tax assets is not likely based on
estimation of future taxable income in each jurisdiction, the Company records a
valuation allowance to reduce its deferred tax assets to the amount that is more
likely than not to be realized. Although the Company has considered future
taxable income along with prudent and feasible tax planning strategies in
assessing the need for the valuation allowance, if the Company should determine
that it would not be able to realize all or part of its deferred tax assets in
the future, an adjustment to deferred tax assets would be charged to income in
the period any such determination was made. Likewise, in the event the Company
was able to realize its deferred tax assets in the future in excess of the net
recorded amount, an adjustment to deferred tax assets would increase income in
the period any such determination was made.
17
Results of Operations
The following table sets forth certain financial data and the percentage of
total revenues of the Company for the periods indicated (in thousands):
Three Months Ended December 31,
--------------------------------------
2003 2002
----------------- -----------------
% of % of
Amount Revenue Amount Revenue
-------- ------- -------- -------
Revenues:
Initial license fees (ILFs)................ $ 20,198 27.3% $ 11,243 18.0%
Monthly license fees (MLFs)................ 21,035 28.4 20,087 32.1
-------- ------- -------- -------
Software license fees...................... 41,233 55.7 31,330 50.1
Maintenance fees........................... 21,313 28.8 18,604 29.8
Services................................... 11,471 15.5 12,555 20.1
-------- ------- -------- -------
Total revenues........................... 74,017 100.0 62,489 100.0
-------- ------- -------- -------
Expenses:
Cost of software license fees.............. 6,639 9.0 5,939 9.5
Cost of maintenance and services........... 14,979 20.2 14,808 23.7
Research and development................... 9,433 12.7 7,950 12.7
Selling and marketing...................... 13,790 18.6 13,736 22.0
General and administrative................. 13,668 18.5 12,583 20.1
-------- ------- -------- -------
Total expenses........................... 58,509 79.1 55,016 88.0
-------- ------- -------- -------
Operating income............................. 15,508 20.9 7,473 12.0
-------- ------- -------- -------
Other income (expense):
Interest income............................ 523 0.7 310 0.5
Interest expense........................... (531) (0.7) (956) (1.6)
Other, net................................. 2,205 3.0 (1,139) (1.8)
-------- ------- -------- -------
Total other income (expense)............. 2,197 3.0 (1,785) (2.9)
-------- ------- -------- -------
Income before income taxes................... 17,705 23.9 5,688 9.1
Income tax provision......................... (7,664) (10.3) (2,693) (4.3)
-------- ------- -------- -------
Net income................................... $ 10,041 13.6% $ 2,995 4.8%
======== ======= ======== =======
Revenues. Total revenues for the first quarter of fiscal 2004 increased
$11.5 million, or 18.4%, as compared to the same period of fiscal 2003. The
three-month increase is the result of a $9.9 million, or 31.6%, increase in
software license fee revenues and a $2.7 million, or 14.6%, increase in
maintenance fee revenues, offset by a $1.1 million, or 8.6%, decrease in
services revenues.
For the first quarter of fiscal 2004, as compared to the same period of
fiscal 2003, ACI Worldwide's software license fee revenues increased by $10.1
million, a substantial portion of which was due to a significant license
renewal in the EMEA region, increased revenues from the Company's fraud
detection product and a number of capacity increases. Insession Technologies'
software license fee revenues were $0.8 million higher for the first quarter
of fiscal 2004, as compared to the same period of fiscal 2003, due to increased
activity related to its data center management enhancement products. For the
first quarter of fiscal 2004, as compared to the same period of fiscal 2003,
IntraNet's software license fee revenues decreased by $1.0 million, primarily
due to a decline in the number of customers migrating from the Digital
VAX-based Money Transfer System ("MTS") product to the RS6000-based MTS product.
The increase in maintenance fee revenues is primarily due to growth in the
installed base of software products within the ACI Worldwide business unit.
For the first quarter of fiscal 2004, as compared to the same period of
fiscal 2003, within the ACI Worldwide
18
business unit, there was a shift in
services work from the Company's more established products to its newer
BASE24-es product and its Payments Management products. As a result of this
shift to newer products, absent other factors, the Company initially experiences
an increase in deferred revenues and a corresponding decrease in revenues due to
differences in the timing of revenue recognition for the respective products.
Additionally, IntraNet's services revenues decreased due to a decline in the
number of customers migrating from the Digital VAX-based MTS product to the
RS6000-based MTS product.
Expenses. Total operating expenses for the first quarter of fiscal 2004
increased $3.5 million, or 6.3%, as compared to the same period of fiscal 2003.
Cost of software license fees for the first quarter of fiscal 2004
increased $0.7 million, or 11.8%, as compared to the same period of fiscal 2003.
The increase in cost of software license fees was due primarily to increased
distributor and product royalty costs of approximately $1.2 million, with a
lesser offsetting reduction in salaries resulting from a shift of certain
personnel to research and development ("R&D") activities in the latter part of
fiscal 2003.
Cost of maintenance and services for the first quarter of fiscal 2004
increased $0.2 million, or 1.2%, as compared to the same period of fiscal 2003.
The increase in costs to perform maintenance and services activities
corresponded to an increase in the related combined revenues. These comparative
cost increases were offset by a reduction in salaries resulting from a shift of
certain personnel to R&D activities in the latter part of fiscal 2003.
R&D costs for the first quarter of fiscal 2004 increased $1.5 million, or
18.7%, as compared to the same period of fiscal 2003. R&D costs increased due to
the shift of certain personnel in other areas of the Company to R&D activities
in the latter part of fiscal 2003.
Selling and marketing costs for the first quarter of fiscal 2004 were
comparable to the same period of fiscal 2003, increasing only 0.4%.
General and administrative costs for the first quarter of fiscal 2004
increased $1.1 million, or 8.6%, as compared to the same period of fiscal 2003.
The increase in general and administrative costs is primarily due to increased
insurance costs for director and officer liability insurance, and increased
professional fees for legal, tax and other services.
Other Income and Expense. Interest expense for the first quarter of fiscal
2004 decreased $0.4 million, or 44.5%, as compared to the same period of fiscal
2003. The decrease in interest expense is attributable to the reduction in debt
from financing agreements (balance at December 31, 2003 of $19.7 million as
compared to $38.7 million at December 31, 2002). The Company recorded interest
expense of $0.5 million and $0.9 million during the three months ended December
31, 2003 and 2002, respectively, related to this debt.
Other income for the first quarter of fiscal 2004 was $2.2 million as
compared to other expense for the same period of fiscal 2003 of $1.1 million.
This variance is primarily due to foreign currency gains and losses, with the
Company realizing $2.4 million in gains during the first quarter of fiscal 2004
as compared to $0.9 million in losses during the first quarter of fiscal 2003.
Income Taxes. In fiscal 2003, the Company undertook an extensive review of
its overall tax position with the intent of reducing its effective tax rate.
Certain tax-saving strategies were implemented during the latter part of fiscal
2003, which have resulted in a lower effective tax rate for the first quarter of
fiscal 2004 as compared to the same period of fiscal 2003. The effective tax
rate for the first quarter of fiscal 2004 was approximately 43.3% as compared to
47.3% for the same period of fiscal 2003. The improvement in the effective tax
rates resulted primarily from recognition of R&D credits, extraterritorial
income exclusion benefits and expected utilization of foreign tax credits. The
Company continues to review additional options that could reduce its current
effective tax rate even further. However, there can be no assurance that the
Company will be able to further reduce its effective tax rate, and assuming the
Company is successful in reducing the rate, there can be no assurance of the
timing and amount of any such reduction.
Each quarter, the Company evaluates its historical operating results as
well as its projections for the future to determine the realizability of the
deferred tax assets. As of December 31, 2003, the Company had deferred tax
assets of $18.6 million (net of a $51.9 million valuation allowance). The
Company analyzes the recoverability of its net
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deferred tax assets at each
reporting period. Because unforeseen factors may affect future taxable income,
increases or decreases to the valuation reserve may be required in future
periods.
Liquidity and Capital Resources
As of December 31, 2003, the Company's principal sources of liquidity
consisted of $126.8 million in cash, cash equivalents and marketable securities.
The Company may decide to use cash in the future to acquire new products and
services or enhance existing products and services through acquisitions of other
companies, product lines, technologies and personnel, or through investments in
other companies.
The Company's net cash flows provided by operating activities for the first
quarter of fiscal 2004 amounted to $11.1 million as compared to $4.6 million
provided by operating activities during the same period of fiscal 2003. The
increase in operating cash flows resulted primarily from increased net income.
The largest changes in operating assets and liabilities related to billed and
accrued receivables, deferred revenue and income taxes.
The Company's net cash flows used in investing activities totaled $0.3
million for the first quarter of fiscal 2004 as compared to $0.5 million used in
investing activities during the same period of fiscal 2003. Investing activities
during each of these periods primarily related to purchases of property and
equipment. During the first quarter of fiscal 2004, the Company purchased
property and equipment of $0.4 million as compared to $0.6 million for the same
period of fiscal 2003.
The Company's net cash flows used in financing activities totaled $0.7
million for the first quarter of fiscal 2004 as compared to $4.6 million used in
financing activities during the same period of fiscal 2003. During the first
quarter of fiscal 2004 and 2003, payments made to third-party financial
institutions to repay factoring debts were $5.2 million and $4.6 million,
respectively. During the first quarter of fiscal 2004, however, the Company
received $4.5 million from the exercise of stock options as compared to almost
no proceeds in the first quarter of fiscal 2003.
The Company's net cash flows resulting from exchange rate fluctuations for
the first quarter of fiscal 2004 amounted to $1.6 million as compared to $0.7
million during the same period of fiscal 2003.
The Company believes that its existing sources of liquidity, including cash
on hand, marketable securities and cash provided by operating activities, will
satisfy the Company's projected liquidity requirements for the foreseeable
future.
Factors That May Affect the Company's Future Results or the Market Price of the
Company's Common Stock
The Company operates in a rapidly changing technological and economic
environment that presents numerous risks. Many of these risks are beyond the
Company's control and are driven by factors that often cannot be predicted. The
following discussion highlights some of these risks.
o The Company's calculation of backlog is based on customer contracts
that exist on the date of the calculation. A number of factors may
change after the date of calculation, which could result in actual
revenues being less than the amounts contained in backlog. The
Company's customers may attempt to renegotiate or terminate their
contracts for a number of reasons, including mergers, changes in their
financial condition, or general changes in economic conditions in their
industries or geographic locations, or the Company may experience
delays in the development or delivery of products or services specified
in customer contracts. Accordingly, there can be no assurance that
contracts included in recurring or non-recurring backlog will actually
generate the specified revenues or that the actual revenues will be
generated within a twelve-month period.
o The SEC Enforcement Division has issued a formal order of private
investigation in connection with the Company's restatement of its prior
consolidated financial statements. Although the Company has fully
cooperated with the SEC in this matter and intends to continue to fully
cooperate, the SEC may determine that the Company has violated federal
securities laws. The Company cannot predict when this investigation
will be completed or what the outcome will be. If the SEC makes a
determination that the Company violated federal securities laws, the
Company may face sanctions including, but not limited to, significant
monetary penalties and injunctive relief. The findings and outcome of
the SEC investigation may also affect the class
20
action and derivative lawsuits that are pending. There is risk that
the investigation could result in substantial costs and divert
management attention and resources, which could adversely affect the
Company's business, financial condition and results of operations.
o The Company is currently in the process of evaluating the claims made
in various lawsuits filed against the Company and certain directors and
officers relating to its restatement of prior consolidated financial
results. The Company intends to defend these lawsuits vigorously, but
cannot predict their outcomes and is not currently able to evaluate the
likelihood of its success or the range of potential loss, if any.
However, if the Company were to lose any of these lawsuits or if they
were not settled on favorable terms, the judgment or settlement could
have a material adverse effect on its financial condition, results of
operations and cash flows.
The Company has insurance that provides an aggregate coverage of $20.0
million for the period during which the claims were filed, but cannot
evaluate at this time whether such coverage will be available or
adequate to cover losses, if any, arising out of these lawsuits. If
these policies do not adequately cover expenses and liabilities
relating to these lawsuits, the Company's financial condition, results
of operations and cash flows could be materially harmed. The Company's
certificate of incorporation provides that it will indemnify and
advance expenses to its directors and officers to the maximum extent
permitted by Delaware law. The indemnification covers any expenses and
liabilities reasonably incurred by a person, by reason of the fact that
such person is or was or has agreed to be a director or officer, in
connection with the investigation, defense and settlement of any
threatened, pending or completed action, suit, proceeding or claim.
Additional related suits against the Company may be commenced in the
future. The Company will fully analyze such suits and intends to
vigorously defend against them. There is a risk that the
above-described litigation, as well as any additional suits, could
result in substantial costs and divert management attention and
resources, which could adversely affect the Company's business,
financial condition and results of operations.
o New accounting standards, revised interpretations or guidance regarding
existing standards, or changes in the Company's business practices
could result in future changes to the Company's revenue recognition or
other accounting policies. These changes could have a material adverse
effect on the Company's business, financial condition and results of
operations.
o The Company is subject to income taxes, as well as non-income based
taxes, in the United States and in various foreign jurisdictions.
Significant judgment is required in determining the Company's worldwide
provision for income taxes and other tax liabilities.
The Company's positions in its amended income tax returns filed for
its 1999 through 2001 tax years are the subject of an ongoing tax
examination by the Internal Revenue Service ("IRS"). This examination
may result in the IRS issuing proposed assessments. The Company
believes that its tax positions comply with applicable tax law and it
intends to defend its positions through the IRS appeals process.
However, if the IRS positions on certain issues are upheld after all
the Company's administrative and legal options are exhausted, a
material impact on the Company's financial condition and results of
operations could result.
The Company's foreign subsidiaries could face challenges from various
foreign tax authorities and it is not certain that the local
authorities will accept the Company's tax positions. The Company
believes its tax positions comply with applicable tax law and it
intends to defend its positions. Although the Company believes it has
adequately provided for any probable outcome related to these matters
and does not anticipate any material earnings impact from their
ultimate settlement or resolution, differing positions on certain
issues could be upheld by foreign tax authorities, which could
adversely affect the Company's financial condition and results of
operations.
o No assurance can be given that operating results will not vary.
Fluctuations in quarterly operating results may result in volatility in
the Company's stock price. The Company's stock price may also be
volatile, in part, due to external factors such as announcements by
third parties or competitors, inherent volatility in the technology
sector and changing market conditions in the software industry. The
Company's stock price may also become volatile, in part, due to the SEC
investigation related to the Company's restatement of its prior
consolidated financial statements.
21
o The Company has historically derived a majority of its total revenues
from international operations and anticipates continuing to do so, and
is thereby subject to risks of conducting international operations
including: difficulties in staffing and management, reliance on
independent distributors, longer payment cycles, volatilities of
foreign currency exchange rates, compliance with foreign regulatory
requirements, variability of foreign economic conditions, and changing
restrictions imposed by U.S. export laws.
o Historically, a majority of the Company's total revenues resulted from
licensing its BASE24 product line and providing related services and
maintenance. Any reduction in demand for, or increase in competition
with respect to, the BASE24 product line could have a material adverse
effect on the Company's financial condition and results of operations.
o The Company has historically derived a substantial portion of its
revenues from licensing of software products that operate on HP NonStop
servers. Prior to its merger with HP, Compaq Computer Corporation
announced a plan to consolidate its high-end performance enterprise
servers on the Intel Corp. Itanium microprocessor by 2004. Any
reduction in demand for the HP NonStop servers or in HP's ability to
deliver products on a timely basis could have a material adverse effect
on the Company's financial condition and results of operations. The
Company has not determined whether consolidation of the high-end
servers, if it occurs as announced, will materially affect the
Company's business, financial condition or results of operations.
o The Company's BASE24-es product is a significant new product for the
Company. If the Company is unable to generate adequate sales of
BASE24-es, if market acceptance of BASE24-es is delayed, or if the
Company is unable to successfully deploy BASE24-es in production
environments, the Company's business, financial condition and results
of operations could be materially adversely affected.
o The Company's business is concentrated in the banking industry, making
it susceptible to a downturn in that industry. Further, banks are
continuing to consolidate, decreasing the overall number of potential
buyers of the Company's products and services.
o The Company may acquire new products and services or enhance existing
products and services through acquisitions of other companies, product
lines, technologies and personnel, or through investments in other
companies. Any acquisition or investment may be subject to a number of
risks, including diversion of management time and resources, disruption
of the Company's ongoing business, difficulties in integrating
acquisitions, dilution to existing stockholders if the Company's
common stock is issued in consideration for an acquisition or
investment, the incurring or assuming of indebtedness or other
liabilities in connection with an acquisition, and lack of familiarity
with new markets, product lines and competition. The failure to manage
acquisitions or investments, or successfully integrate acquisitions,
could have a material adverse effect on the Company's business,
financial condition and results of operations.
o To protect its proprietary rights, the Company relies on a combination
of contractual provisions, including customer licenses that restrict
use of the Company's products, confidentiality agreements and
procedures, and trade secret and copyright laws. Despite such efforts,
the Company may not be able to adequately protect its proprietary
rights, and the Company's competitors may independently develop similar
technology, duplicate products or design around any rights the Company
believes to be proprietary. This may be particularly true in countries
other than the United States because some foreign laws do not protect
proprietary rights to the same extent as certain laws of the United
States. Any failure or inability of the Company to protect its
proprietary rights could materially adversely affect the Company.
o There has been a substantial amount of litigation in the software
industry regarding intellectual property rights. The Company
anticipates that software product developers and providers of
electronic commerce solutions could increasingly be subject to
infringement claims, and third parties may claim that the Company's
present and future products infringe their intellectual property
rights. Any claims, with or without merit, could be time-consuming,
result in costly litigation, cause product delivery delays or require
the Company to enter into royalty or licensing agreements. Royalty or
licensing agreements, if required, may not be available on terms
acceptable to the Company or at all, which could adversely affect the
Company's business. A successful claim by a third party of intellectual
property infringement by the Company could compel the Company to enter
into costly royalty or license agreements, or require the Company to
pay significant damages or even require the Company to stop selling
certain products.
22
o The Company's software products are complex. They may contain
undetected errors or failures when first introduced or as new versions
are released. This may result in loss of, or delay in, market
acceptance of the Company's products and a corresponding loss of sales
or revenues. Customers depend upon the Company's products for
mission-critical applications. Software product errors or failures
could subject the Company to product liability, as well as performance
and warranty claims, which could materially adversely affect the
Company's business, financial condition and results of operations.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes to the Company's market risk for the
three months ended December 31, 2003. The Company conducts business in all parts
of the world and is thereby exposed to market risks related to fluctuations in
foreign currency exchange rates. As a general rule, the Company's revenue
contracts are denominated in U.S. dollars. Thus, any decline in the value of
local foreign currencies against the U.S. dollar results in the Company's
products and services being more expensive to a potential foreign customer, and
in those instances where the Company's goods and services have already been
sold, may result in the receivables being more difficult to collect. The Company
at times enters into revenue contracts that are denominated in the country's
local currency, principally the United Kingdom, Australia and Canada. This
practice serves as a natural hedge to finance the local currency expenses
incurred in those locations. The Company has not entered into any foreign
currency hedging transactions. The Company does not purchase or hold any
derivative financial instruments for the purpose of speculation or arbitrage.
Item 4. CONTROLS AND PROCEDURES
As noted in the Company's Form 10-K for the fiscal year ended September 30,
2003, management and KPMG have advised the Company's Audit Committee that during
the course of the fiscal 2003 audit of the Company's financial statements, they
noted deficiencies in internal controls related to timely reconciliation of
intercompany accounts and revenue recognition procedures pertaining to
documentation of software delivery, as well as evaluation and documentation of
customer creditworthiness. Deficiencies were also noted related to revenue
recognition on a percentage-of-completion basis at one of the Company's
subsidiaries. Although there have been improvements implemented during the first
quarter of fiscal 2004 related to the Company's internal controls over financial
reporting, these deficiencies remained as of December 31, 2003. However, the
Company has initiated corrective actions to address the deficiencies noted.
KPMG has advised the Audit Committee that these internal control
deficiencies constitute reportable conditions and, collectively, a material
weakness as defined in Statement of Auditing Standards No. 60. Certain of these
internal control weaknesses may also indicate deficiencies in the Company's
disclosure controls. The Company has performed substantial additional procedures
designed to ensure that these internal control deficiencies do not lead to
material misstatements in its consolidated financial statements and to enable
the completion of KPMG's quarterly review of its consolidated financial
statements. Based upon an evaluation as of December 31, 2003 of the Company's
disclosure controls and procedures, including these additional procedures, the
Chief Executive Officer and Chief Financial Officer have concluded that the
Company's disclosure controls and procedures were effective as of such date to
provide reasonable assurance that information required to be disclosed by the
Company in reports that it files or submits under the Securities Exchange Act of
1934 is recorded, processed, summarized and reported, completely and accurately,
within the time periods specified in Securities and Exchange Commission rules
and forms.
In connection with the requirements of Section 404 of the Sarbanes-Oxley
Act, the Company has commenced documentation, evaluation and testing of its
internal controls over financial reporting and has retained independent
consultants to assist in this process. The Company will continue to evaluate the
effectiveness of its disclosure controls and internal controls and procedures on
an ongoing basis, and taking corrective action as appropriate.
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PART II - OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
31.1 Certification of Chief Executive Officer pursuant to
SEC Rule 13a-14, as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to
SEC Rule 13a-14, as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K:
On October 28, 2003, the Company filed a current report on Form 8-K
announcing that on October 28, 2003, the Company issued a press release
announcing its financial results for the quarterly period ending September 30,
2003. A copy of the press release was attached thereto.
On October 31, 2003, the Company filed a current report on Form 8-K
announcing that on October 28, 2003, the Company held a teleconference and web
cast discussing its financial performance for the quarterly period ending
September 30, 2003. A transcript of the teleconference/web cast was attached
thereto.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TRANSACTION SYSTEMS ARCHITECTS, INC.
(Registrant)
Date: February 17, 2004 By: /s/ DAVID R. BANKHEAD
-------------------------------------
David R. Bankhead
Senior Vice President,
Chief Financial Officer and Treasurer
(principal financial officer)
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